By Dick Glass, CET
Evolution of your accounting
Thousands of servicers have discovered to their dismay that technical electronics ability alone is not enough to produce a successful repair business. In fact, many sharp technicians have . failed in business.
To a well-trained tech who enjoys finding and repairing the causes of electronic defects, it seems reason able that his reward of an abundant income will follow automatically, as he becomes faster through experience, and his competence becomes well known to his potential customers.
At first, the plan appears to work. His shop becomes very busy, perhaps having more work than he can finish. But his 60 or 70 hours of work per week seem to bring in only enough for mere existence.
He wonders what is wrong.
Perhaps he should hire an account ant to keep his books in order.
That would give him more hours to do extra repairs. And, after all, he much prefers electronics over keeping books.
The bookkeeping firm he contacted was helpful, by explaining why he must keep accurate and adequate records of income and disbursements. Their accountant set up a system for him to record each day's business transactions, fill out payroll information, keep track of inventory and equipment, and ac count for his own draw of money.
Although these steps required some time to do, he knew they were necessary. Also, his mind was relieved of all worry about trouble from the IRS. Now, he could concentrate on technical repairs, and finally earn the amount of money he needed.
However, as the months went by, his profits still lagged behind. What could possibly be wrong? If this typical case history de scribes your situation accurately, then read on. There's hope for you.
Always remember this statement: Accurate bookkeeping for tax purposes is not enough to give you proper financial-management information. Most small electronic ser vice shops have adequate tax information -the IRS sees to that. But, few have good management data of the kind that can prove where you are making money and where you are suffering losses.
Here are a few possible results of this bad situation:
• Some shop managers receive their annual business tax reports which show either a meager profit or a loss. Instead of becoming alarmed, they assume (incorrectly) that the accountants have somehow hidden part of the real profits, and shrewdly saved them tax money.
• Others receive monthly or quarterly Profit-And-Loss (P&L) statements which have varying costs and net-profit figures. These, varying figures make little sense. Perhaps a shop owner looks at the bottom line, but takes no action because the percentages appear unreliable (even though he assumes that the accounting system has made them technically correct).
----- DICK'S TV SERVICE, INC. PROFIT AND LOSS STATEMENT FOR QUARTER ENDING
9-30-78
*Fractions have been omitted, so expenses do not add to 31 %.
Figure 1
This is a typical Profit-And-Loss statement, as produced by a CPA or an accountant.
• Parts sales, parts costs, merchandise sales and merchandise costs are all combined, thus preventing any identification of the relative profitability of these various segments. There is no opportunity to reduce or eliminate a low-profit category of business, or to take advantage of another that's highly profitable.
• The owner's salary might or might not be included in the costs.
If it isn't, the profit picture looks fine. If it is, the business probably is showing a net loss.
Analysis of true costs
To solve this real problem, you must be able to read and to understand your financial reports.
For example, you must know these facts:
• the percentage of your parts cost relative to the selling prices;
• your cost of labor, including your own time when you do repair work.
• the value of other items, which are not included on your financial records.
These include the value of rent for your own building where the shop is located; depreciation, which is not figured except at tax time; and the value of work performed by any unpaid employees, such as your wife.
Rework your P&L
You should take your P&L and pencil in some revisions based both on facts and on your knowledge and intuition. This can produce a monthly "true costs" analysis which gives you a more realistic picture of your business, and one you can understand easily.
Add all of the real costs -as you know them to be-and discount any unusual income or expense items which occasionally distort the P&L. Then, you will have the facts needed to establish proper prices, or to head off problems before they become more severe.
Information from CPA
Figure 1 is a close representation of a typical quarterly P&L given by a CPA firm to a service shop. From this P&L statement, try to calculate the parts costs, the labor costs, and whether or not the owner made a profit.
Quiz of the P&L
Fill in your answers to the following quiz, marking "T" for true and "F" for false in each space:
(1) Percentage of parts cost is 37%.
(2) Owner drew $300 per month as his salary.
(3) A part-time technician and a clerk (wife) together drew about $340 per month in salary.
(4) This firm had no "product" sales, such as TVs, radios, etc.
(5) If business retains the same level, the firm could expect to increase its NET WORTH (retained earnings) by more than $12,000 during the remainder of the year.
(6) The 32% NET PRO FIT shown here is an unusually high return for a service business.
(7) The taxes shown under "operating expenses" are primarily sales taxes.
(8) Compared to other types of businesses, the 63% gross profit is excellent.
(9) Labor costs were approximately 20%; an excellent percentage.
(10) Although the parts gross profit should be improved, the overall operation appears to be profitable and very efficient.
Quiz answers
Check the answers you gave against these. If you have half (or more) correct, you are very good at analyzing P&L statements.
(1) FALSE
Parts costs should be shown as a percentage of PARTS SALES, not TOTAL SALES, as given in Figure 1. If the accountant has not included some merchandise sales and costs in the figures, the parts cost percentage is 59%. If he has included other items, no one can know what the true parts cost is.
(2) TRUE
The owner drew only $300 per month, totaling $900 for the quarter, and it was shown as dividends.
(3) TRUE
Salary for the technician is included under OPERATING EXPENSES, and not under COST OF SALES. The total was $1018, and the clerk was unpaid.
(4) TRUE
According to the P&L, the firm had no product sales.
Actually, about 10% of sales was of products, but parts and merchandise sales were lumped together to make the accounting easier.
(5) FALSE
The P&L misleads you into believing the statement. But, when figured by true-cost analysis, the $4443 quarterly net profit is found to be a NET LOSS for the year.
(6) FALSE
The 32% NET PROFIT is wrong, Probably the 32% will tend to soothe the owner into believing he is doing fine, when the business actually is nearing bankruptcy.
(7) TRUE
Sales of more than $8000 in PARTS (and merchandise) would require more than $300 (at 4%) in sales taxes. The remaining taxes might be withholding, unemployment or some other taxes; it's not clear.
(8) TRUE
If it were a true figure, the 63% GROSS PROFIT would be very outstanding. Unfortunately, in service businesses, the COST OF SALES must include the costs of getting the repair work done. This is not included in Figure 1, resulting in a false and misleadingly high GROSS PROFIT, which fooled the owner, while being satisfactory to the IRS.
(9) FALSE
In the Figure 1 P&L, the labor costs don't include the major producer of labor income in this business, the technician/owner.
There is no practical way of reducing labor costs to 20%. For proper analysis of costs and prices, the true cost of labor should include an equivalent salary for the owner/technician. At the $300 monthly rate of draw, the salary would have been $3600 per year. But, he would have had to pay a technician about $6 per hour to do the same work. So the salary equivalent should have been more than $12,000 per year.
(10) FALSE
It appears from the P&L that the business is sound and solvent. Actually, it suffered a net loss for the year, even after paying the owner a very low salary and paying nothing to the clerk. Both parts and labor prices must be raised drastically, to cover all costs and to produce a reasonable in come for the owner.
Figure 2 The P&L, after additions and changes, becomes a "true-cost" analysis
which shows the real condition of the business. DICK'S TV SERVICE, INC. TRUE-COST
ANALYSIS FOR QUARTER ENDING 9-30-78
Change the P&L for "true-cost" analysis
To demonstrate the recommended analysis, we'll begin with the Figure 1 P&L, then amend the figures so they display the real costs. The "true-cost" analysis is shown in Figure 2, and it includes some letters that are tied to the following conclusions:
(A) The $6 per hour is what the owner/technician should have been paid, but wasn't. Some might believe the $900 draw (as dividends) should be subtracted from the (A) figure, but we will consider the $900 as a return-on-investment, and not part of the owner's wages.
(B) We have listed the clerk's salary at only $3 per hour. While some clerks can be obtained for the minimum wage, dedicated ones (such as family members) should receive more.
(C) Probably the technician only works part time. However, if the tech is understood to be underpaid, you should (in a true-cost analysis) include an additional "insufficiency" expense to value the employee's contribution properly.
(D) If it is to properly express this business cost, the advertising expense should include costs of "Yellow Pages" ads, which account for the major portion of most phone bills. Many accountants merely lump them together. Both are legitimate deductions, so the IRS doesn't care.
It's not easy to be precise about assigning parts and merchandise costs to the proper month, since invoices from distributors tradition ally are paid 30 days or more later.
Therefore, the owner should use adjusted amounts, based on his knowledge of parts sales and purchases, and movements of the merchandise.
(E) To correct the inadequate profits problem used in this example, the owner needs to begin the remedy by recognizing that his labor costs are disastrously high compared to the income from labor. He must raise the prices and attempt to produce income of at least twice as much as his "true cost" total labor costs.
Comments
Try making a "true-costs" analysis of YOUR business. It will give a true picture of your business health and allow you to make decisions that are based on fact-not fiction.
This is the last article of the Service Management Seminar series. If you have suggestions about other business areas that should be covered, write to the editor.
Or, write to Dick Glass (Dick Glass and Associates, 7046 Doris Drive, Indianapolis, Indiana 46224, USA), if you have individual questions.
(adapted from: Electronic Servicing magazine, Dec. 1978)
Also see: Servicing Information... What kind is best? What kind do you want?