It’s Your Business
- Author: Terry Greenhut
- Subject Matter: Shop management
- Issue: Gross and net
Tools for the Excellent Manager
13th in a series
No matter what the product or service might be, and no matter how large or small the company, the goal is always the same: to make a good profit. Profit dollars drive everything. They allow for employees to make a good living, for new equipment to be purchased, for expansion to take place and for the owner to make a good return on investment.
In our business we only sell two things; parts and labor. We don’t manufacture the parts. We buy them at a certain price and then mark them up by a percentage we feel we need to make a profit on them. We could say the same for labor. We buy our employee’s time for so much per hour, considering everything that an employee costs, and resell that time to the customer. How much we buy those two commodities for, and how much we are able to sell them for, as simplistically as we can look at it, determines how much we will have to take care of all of our commitments.
There are two types of profit to be considered, gross and net. Gross profit is the amount the business takes in after you subtract your complete cost of labor and parts from the selling price of the job. Net profit is what’s left after you subtract every other possible expense.
To determine how much you need to charge for anything you sell, you first have to know exactly what everything costs, so a chart of accounts needs to be developed and updated continuously so you know what all of your expenses add up to.
Your chart of accounts needs to include items like rent, insurance, electricity, taxes, uniform rental, company vehicles, advertising, legal fees, health insurance, monthly payments on equipment and on any other debt being carried and anything else for which you get billed.
Of course, you will want to work out the exact numbers for all of your expenses, and they will change often, but for the sake of demonstration let’s say that you do nothing but rebuild transmissions and do 80 of them per month. If your rent is $4,000 you’d have $50 worth of rent expense in each transmission. You can run that equation for each of your recurring monthly bills, add your cost of parts and labor based on the number of hours any particular transmission should take to rebuild and install, figure in your warranty cost and don’t lie to yourself about your comeback percentage, and you will know your cost. Decide on the percentage of profit you want to make, add that in and you’ve got your selling price. Sounds like baking a cake, doesn’t it? Add this and that in, stir frequently, stick it in the oven for a while, and you’ve got it.
Don’t forget the owner’s salary when figuring your costs. I’ve seen too many balance sheets in which there is no compensation allowed for a working owner. The assumption there is that the owner only makes money if there is a profit. I can understand that if he or she is simply an investor in the business, but if they perform any kind of labor, be it physical or mental, they should be on the payroll because if they weren’t performing the tasks someone would have to be hired who would. How much should a working owner be paid? That’s a question I’ve fielded many times over the years. My best answer is whatever the owner thinks he or she would be paid if they did the same job, working the same amount of time, for someone else. If that number, for example, came out to $50,000 a year, then that’s the salary they should put themselves in for.
After all costs are accounted for, including the owner’s salary, there should be a net profit. If there isn’t, if the business just breaks even or consistently loses money, the problems usually lie in one or more of these areas: pricing is too low, not enough volume, salaries are too high often including the owner’s, comeback rate is out of control, not shopping for good prices on quality parts, fluids or other shop consumables that would include services such as that of accounting firms and insurance companies.
Many of a shop’s expenses go unchecked for lengthy periods of time. Parts prices go up by small percentages at a time and go unnoticed, but every time a repair order is written more money is being lost. Many owners don’t realize that they have “demand” electric service, which means that if the system senses a huge demand being placed on it all at once, it spikes the cost of a kilowatt hour for the entire day, so first thing in the morning, instead of running around turning on every light and machine in the place, they should be turned on a few at a time to avoid the spike. Many electric companies also charge a higher rate for peak seasons or peak hours of the day. It’s good to find out exactly what those seasons or hours are and see if you can adjust usage. For example, parts or clothes washers, or other machinery that can run unattended, could be run overnight. Night rates are always lower because demand and usage drop way down.
Often shop owners don’t think about all the ramifications of hiring additional people. They just do it when they feel that production needs a boost. If they aren’t hiring to meet an increase in sales they will likely lose money. Although owners often feel they don’t have enough techs on the payroll that might not be the case. The techs they have may not be producing to their capacity. Shops that pay their people an hourly wage or weekly salary don’t always track productivity of individual workers. They just lump all the production together and, if the work gets out and not a lot of it comes back, they feel they are doing all right. If the work isn’t getting out and especially if the shop is turning away work because it can’t keep up, owners need to investigate the reasons why and fix the problems before hiring additional staff.
I’ve seen incidences where the shop had so many people on the payroll they were tripping over each other. On one consulting assignment in which the owner felt he needed more techs, it turned out by letting two of them go his efficiency increased dramatically while his payroll dropped significantly.
If the cost of labor is 25% of the selling price of the work, then to justify another salary of $30,000 a year including all employee costs, the shop would need to sell an additional $120,000 worth of work to warrant the extra employee’s salary. Unless the shop is in a position to do that because of increased sales and having a large enough facility, it doesn’t make a lot of sense to bring on additional help.
Shops that do not pay based on flat rate hours booked often don’t realize that their productivity runs, in general, at only about 50%. What that means is that an hourly employee putting in and being paid for 40 hours of time is only producing 20 hours of billable work. So when the owner scratches his head wondering why the shop doesn’t make money it’s easy to understand. The labor rate that shops decide to charge is always based on 100% productivity. If the techs, for whatever reason, only produce 50% of what’s expected, then the labor rate is off by half. In other words if the shop’s labor rate is $100 an hour, it would need to be $200 to make up for the inefficiency.
I’m not saying that the fault for low production lies only with the techs. There is only so much each one of them can control. It can be for any number of reasons. Lack of facility, chaotic working environment, outdated or missing equipment and tools, lack of training, poor quality or wrong parts being ordered, parts not delivered in a timely manner, underestimating the time when selling the job, poor job scheduling, absentee ownership so decisions aren’t made quickly enough, labor rate and/or parts markup too low, and it may even be that the shop is too cold in the winter or too hot in the summer.
Suppliers don’t always notify customers of price increases, sometimes drastically cutting into the shop’s profit margin. While I’ve never been a big advocate of price-shopping parts on every job, I do believe that it must be done from time to time so prices don’t sneak up on you. Expensive costs such as insurance should be shopped every time a policy is set to expire. Insurance companies and/or their brokers or agents will get as comfortable as you let them. Without competition there’s a very good chance your premiums will increase. (I’ve never seen them go down without the threat of changing companies or alternatively cutting back on coverages.)
Many shop owners who have been successful in our trade will tell you that they made a good living from the shop over the years, but that the big money they made was from buying and later selling the real estate. When you rent, you work for the landlord and when the time is up you walk away with nothing to show for all those rent checks you wrote. Additionally, whenever your lease is up your rent can be raised to who knows how much (sometimes enough to put you out of business) and you will no doubt be billed for any increase in taxes the same as if you owned the property.
When you buy the property you are in control and every mortgage payment you make will give you more equity. Even if the property value remains constant over the years you will still get a whole lot more money out of it when retirement time comes than if you had paid rent. It’s like a forced savings plan if nothing else, but most properties increase in value forming a nice retirement fund. Often owners find that their mortgage payment isn’t much more than rent would have been, and they get to benefit from writing off certain building expenses that they couldn’t as renters. All in all, buying the property the shop operates in is usually the best way to go even if the thought of it in the beginning scares you to death.
That’s just the basics of shop finances. Of course you can get into much more sophisticated numbers if you start figuring interest on loans and payroll or profit taxes, but it might be better to leave the figuring of such items to the professionals. What’s important is that you know how to read and understand them so you can determine when and how to make necessary changes to your business model.