CMX 2004 - Plumbing & HVAC

Shop Management
Develop a financial
structure that works
Our business guru crunches the numbers
By Ron Coleman
Many contractors
have difficulty
understanding
what
their financial
structure should
look like. That
may not be too
surprising,
given that it is different for each segment
of the industry. Even within segments
there are major differences
depending on size and work mix.
The following commentary is based
on a survey of 25 members of the Heating,
Refrigeration and Air Conditioning
Contractors (HRAC) Association of
Canada. The average company had sales
of $1.27 million, with no company over
$2 million. There is a combination of
service and contracting work. We have
not established what that mix is. The
contractors are based across Canada,
with most of them in Ontario.
This particular group of contractors
shows pre-tax profits at 5.7 percent,
which is almost 50 percent higher than
the average North American contractor
in this market segment.
The issues that we will explore are:
• What is the typical overhead structure
of these companies?
• What is the level of break-even
sales required to operate them?
• How to reduce the level of breakeven
sales and …
• What is the capital structure of
these companies?
The following table shows the average
overhead structure:
Income Statement
Average of 25 companies
$1000s
Total Sales 1270 100.0%
Job Costs
Materials 565 44.5%
direct labour 216 17.0%
Subs & other direct 16 1.3%
TOTAL DIRECT 797 62.8%
Gross Profit 473 37.2%
Overhead
Salaries* 196 15.4%
Advertising & promotion 23 1.8%
Vehicles 44 3.5%
Depreciation 22 1.7%
Insurance 15 1.2%
Occupancy 28 2.2%
Office and admin 59 4.6%
Repairs, shop supplies etc 13 1.0%
400 31.5%
Net Profit 73 5.7%
Note: Salaries include owner/manager at
$75,000 per annum
make a real impact on them. Most of
them are virtually fixed.
If you can’t do much to lower your
overhead there are only three things you
can do to make more profit – increase
volume, increase selling price or improve
productivity.
However, a volume increase means
more cost, while the other two options
are 100% profit. Going for volume often
means lower selling prices, expensive
marketing, poorer productivity and
higher overhead. So, it makes sense to
focus on selling price and productivity.
Increasing efficiency or increasing
your selling price has the biggest impact.
Your gross profit percent will
increase.
Your break-even sales number is calculated
by dividing your overhead by
your gross profit percent. Lowering
your overhead or increasing your gross
profit reduces the amount of sales you
need to break even.
You will see from the table that by
increasing your gross margin from
37.2% of sales to 44% of sales that your
additional profit is $164,905, or the
amount you need to break-even is
$164,905 less. You should be easily able
to generate this increase in percentage
by a combination of increased pricing
and improved productivity.
A typical balance sheet looks like this:
Balance Sheet
Average of 25 companies
Current assets $1000s
Cash 70
Receivables 121
Inventory 113
Other 12
316
Capital (Fixed) assets
Vehicles & Equipment, at cost 284
Depreciation -173
Net capital assets 111
Total assets 427
Current liabilities
Accounts payable 112
Bank debt 34
Other current 30
176
Term debt 40
If you lease your vehicles
Break-even table
rather than buying
them, your cash outgoings
Overhead $400,000 $400,000 $400,000
will be higher and
Gross profit 37.2% 40.0% 44.0% your investment lower.
It is very difficult to reduce your Break-even sales $1,073,996 $1,000,000 $909,091 On average these companies
are turning over
overhead. Overhead represents a relatively
small percent of sales and, as you
their working capital at a
Additional profit $164,905
can see, it is difficult to cut back. The
rate of almost ten times a year.
only area of significance that you could Capital structure
Working capital is the net of the current
reduce would be to reduce overhead So, if you want to set up a company like
assets and current liabilities
salaries. When you look at your own this, you need to put some money ($316,000-$176,000 = $140,000).
numbers, you will realize how difficult together.
Annual sales are $1,270,000. Divide
this really is.
You need to buy or lease vehicles, working capital into sales and in this
In our sample we are showing overhead
equipment and tools. You need to instance you get 9.2 turns a year. On this
of $400,000 with almost half of finance the activities such as the inven-
basis you need to provide approximate-
that in salaries. The rest is spread over tory and the receivables and you must ly 10% of your expected sales in working
so many categories that it is difficult to meet the payroll.
capital for your business. That is the
money to operate the business, excluding
Why is this man smiling? the money for fixed assets. This is
money that you have to provide.
Our average owner has invested
Reason
$211,000 in his company, or approximately
$1 in investment for every $1 in
#7
debt. These companies are very well
financed. This $211,000 is (broadly
Member Advantage
speaking) providing $140,000 in working
capital and $51,000 for fixed (capi-
Programs
HRAC membership means this man's
tal) assets.
company enjoys access to a variety of
If you start up a new business,
groupdiscount programs. Savings on
remember that it is going to take up to
vehicle leasing, business supplies, fuel for
three years before you can turn a profit
his company's trucks and Visa Merchant
fees will more than pay for his company's
and take a full salary. Many business
membership. These are only a few of the
owners run out of money before they
saving programs offered by HRAC.
have given the company a real chance to
So, why is this man smiling?
survive.
For many start-up businesses the
growth has to be financed by profits. So,
Because his company is a
unless you start off making money you
member of HRAC.
will never be able to finance your
You should be to!
growth.
Ronald Coleman is an accountant,
business management consultant, author
and educator specializing in the construction
1-800-267-2231 www.hrai.ca/hrac.html
industry. He can be reached at
rcoleman@coleman.bc.ca.
Circle Number 175 for More Information
Circle Number 176 for More Information
70 Plumbing & HVAC Product News – March/April 2004 www.plumbingandhvac.ca
Total debt
Owner's investment 211
Total liabilities and investment 427