MEASURING FINANCIALS: INTERNAL OPERATING STATEMENT ELEMENTS AND ANALYSIS
by Bob Greenwood
Too many shops do not monitor their business on a regular basis with a full analytical Financial Statement. The facts speak for themselves that “If you can’t measure it, you can’t manage it.”
Operating a modern shop today by just looking at the bank balance and sales compared to same month last year is a recipe for potential financial disaster.
Our studies have shown that a shop which produces $500,000 to $650,000 in sales per year but does not understand how to “measure” itself, is missing anywhere from $35,000 to $90,000 in net income (net profit) per year out of the current business coming through the door. That amount is truly real money to anyone’s business.
A shop under financial duress should produce a proper management operating statement for at least 24 consecutive months. This allows management to see the trends and understand how the profit is made in the shop.
Every shop should produce a monthly operating statement to ensure full measurement and discussion of the operation takes place. Measuring your business only once per year is too late to embrace opportunities. They have already passed.
The basic elements of an Analytical Financial Statement are: (A) Total revenue in predetermined categories for the month and year-to-date; (B) Gross Profit return measurement for each revenue category for the month and year-to-date; (C) Expense categories for the month and year-to-date; (D) Net profit for the month and year-to-date; and (E) full Balance Sheet compared to the previous month.
(A) Revenue Categories: The basic revenue categories that are measured today include fluids, tires, aftermarket parts, dealer parts (domestic and foreign name plate separately), maintenance labor, diagnostic labor and re-flash labor. Some shops will break labor down even further such as including fluid labor, tire install labor and vehicle inspection labor. Before one gets too complicated and confused, it is recommended to start with the 8 initial categories mentioned.
By understanding where the revenue of the shop comes from, it becomes easier to measure performance against industry data and surveys. It also allows you to determine what type of customer/client base you are serving. For example, in the measurement of its parts sales, if the shop is averaging in sales mix 95 percent aftermarket parts and 5 percent dealer parts, traditionally it means the shop is repairing and working on older vehicles. Conversely, if the shop is averaging 70 percent aftermarket parts and 30 percent dealer parts, then clearly, the shop is working on more new vehicles. Each scenario has repercussions as to the staff and equipment the shop requires to meet the demands of its client satisfaction. As the sales mix changes over the course of two to three years, either way, one can judge quite accurately the future demands of the shop in terms of staff competency levels, staff training requirements and equipment acquisitions required.
(B) Gross Profit Measurement: Gross profit return is critical to net profit performance. But once again, one must understand where the profit is made. The following guidelines work well to ensure one is on the way to a healthy bottom line. The gross profit return for oil should average a minimum of 45 percent, however 50 percent is achievable through good management. Tires will average from 10 percent to 26 percent for a traditional independent service shop; aftermarket parts can be managed to an average of 45 percent; dealer parts domestic usually range from 18 percent to 22 percent, while foreign name plate can even drop to a low of 8 percent but can be managed in the range of 14 percent to 20 percent; maintenance/mechanical labor should average 90 percent and higher when technician wages are eliminated from the cost of labor and only sublet costs inserted into the labor cost, while diagnostic, re-flash and the other labor categories would show a 100 percent GP percentage return. Put all the other costs such as freight, supplies, etc. that accountants insert into the cost of labor (that is a cost accounting format) down into their own expense categories.
Ensure that your gross profit percentage for fluids, tires and parts is calculated using the correct accounting formula for cost of goods sold, which means you must insert the correct inventory numbers. Cost of goods sold is calculated by taking the opening inventory plus purchases and subtracting the closing inventory. Dollar sales less dollar cost of goods sold equals dollar gross profit. Dollar gross profit divided by dollar sales equal the gross profit percentage achieved. When a shop only uses the purchase made, they are wrong in their calculations because without a correct inventory number, the shop cannot account for inventory shrinkage that may have taken place. Don’t be misled or mislead yourself, use the correct accounting formulas.
The shop should target to produce $1.25 in total labor revenue (maintenance, diagnostic and re-flash combined) to $1 in total parts sales (aftermarket and dealer parts combined). The shop also wants to target a minimum of 15 percent, but preferably 20 percent of its total labor revenue as diagnostic labor, which is charged out at a higher tier rate.
When these guidelines are achieved and measured in this fashion, the shop will average 70 percent to 75 percent total gross profit return from total sales of the bays.
(C) Expense Categories: It is important to take the time to customize the operating expenses of the shop to your needs and requirements. What expenses should be measured and are important to you? One of the unique ways of setting up the entire wage expense is to break it out into technician wages, service advisor wages, administration wages, management wages, and shop burden (shop’s portion of payroll taxes, Workers compensation, group insurance etc.). One of the criteria of measurement is to produce a minimum of $1.20 in total labor revenue to $1 spent on the entire wage package of the shop including management wages (at a professional wage level) and includes shop burden.
The balance of the shop expenses should be monitored and managed answering the real question of whether the expenses are controllable, non-controllable or common-sense expenses in relation to what the shop is trying to achieve in client service and satisfaction. I believe you will find, with a detailed analysis that many of the operating expenses fall into the surprising category of common sense in relation to what the shop is trying to achieve in client value and satisfaction.
(D) Net Profit: Net profit seems to be an elusive figure to many shops. The shop should measure true net profit after the management wage, drawings and dividends have been factored in. The objective should be to net a minimum of 10 percent of the shops total gross sales. The net profit is before corporate taxes, but definitely after professional management wages, drawings and dividends. When this is achieved, the capital is usually in decent supply to keep the shop well equipped not only with top equipment, but also with top quality staff.
(E) Balance Sheet: A full balance sheet compared to the previous accounting period allows the management to see where the profit dollars went throughout the shop. Some profit may be tied up in accounts receivable, inventory or equipment. Maybe some net profit got “spent” by reducing debt load or accounts payable. Wherever it went, it is important to see how management is handling the profits made in the shop. Only a full comparative balance sheet allows you to accomplish this.
The more accurate and complete information I have on my business, the more accurate and conviction action I have with my management decisions.
Take the time to measure your business completely and accurately. You will be shocked at where there are net profit dollars to be found on your current business and with your current client base.
Establish a more structured approach to managing your business. The biggest obstacle you face to making real change in your management system will be your tradition of doing things.