The 2002 and 2003 profit and loss statements attached reflects an actual case for a Midwestern plumbing and drain cleaning firm. In 2002, the business was a partnership jointly owned by a plumber and a realtor. The realtor bought out his partner and, after attending one of my seminars, revamped the business in a way that resulted in revenues almost tripling. The 2003 financial statement was also much improved, though, as I will explain, it still falls short of the ideal.
The most glaring problem with the 9-month statement for 2002 is in the Cost of Sales category near the top. All it shows is a single line item for Plumbing – $19,115, amounting to 8.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales. I don’t remember what this was supposed to measure, probably materials. In any case, it is an inadequate breakdown. (I was told that this statement was prepared by a CPA, which goes to show how little many accountants know about our industry.
As you see with the revised 2003 format, the Cost of Sales category was expanded to include several items that previously were tallied, mistakenly, under Operating Expenses. We see wages broken out for both plumbers and drain cleaners, as well as subcontracting costs, commissions, parts & materials, permits and payroll taxes. All of these are direct costs, or what we call overhead.
The Bottom Line: Now let’s skip the bottom line. After three quarters of 2002, this company showed an abysmal 8.65{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} loss in operating income, boosted a bit by some unspecified income from other sources. The owner shored up operations to show what seems to be a healthy 15{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} operating profit in the same period a year later. However, to some extent this is an illusion.
Go to the top line item under Operating Expenses. We see that officer salaries – in this case, just the owner – amounted to $22,800 after three quarters of 1993. This projects a little over $30,000 for the year. I know I sound like a broken record, but I’ll keep saying it in the hope that it will seep through some of the very thick skulls that inhabit our industry –
My friends, this is a pitiful amount to pay yourself for all the risk, hard work and aggravation that goes with operating a business. It is too little, in my opinion, even to pay the plumbers who work for you. This is the fundamental problem of our industry. We will never attain the level of professionalism we all pay lip service to unless we begin charging enough to adequately compensate owners and employees alike.
End of sermon. The problem here is that the low owner’s salary distorts the bottom line. That $90,684 of operating profit, 15{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales, appears better than it really is. If the owner’s income were up where it should be – at least $60,000 after nine months of the year for a company this size. This would slice operating profits to around $30,000 and 5{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales. That would still represent significant improvement from the previous year, though not nearly enough for a PHC service business.
In this case, $60,000 in owner’s salary would represent close to 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of the company’s revenues to date. Some circumstances might dictate a little more or less, but the 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} benchmark is a pretty good rule of thumb to shoot for in regard to owner compensation.
One of the first things I look at when a client shows me a P & L is the combined percentage of sales taken up by owner and other administrative salaries. It it’s up in the 18-20{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} range, I know this is a company that’s doing right by the owner and key personnel. Unfortunately, I see far too many statements where the combined salaries of all office staff amount to only 7-8{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales. It’s a sign of underpaid, under-performing staff and spousal slave labor!
The excuse I always hear is, “I’m putting it all back in the business.” That’s not an honorable thing to do it its at the expense of your spouse and other loved ones. The proper way to put money back in the business is through retained earnings, meaning what’s left of your net profit after you pay taxes.
Another glaring omission is the lack of any provision for a retirement plan. One of the great tragedies of our industry is the number of business owners who must work well beyond the time they want to or ought to, simply because the only retirement income they can count on is social security. This is not enough to live on comfortably, and the present generation can’t even be sure that social security will be around by the time they reach retirement age. Some people count on selling their business to support retirement, but without the owner’s expertise, many PHC firms are not that marketable. Many end up being liquidated instead of sold.
Please, my friends, put something aside for the future. Otherwise your “golden years” will be filled with misery instead.
Allocations: Here are some other random observations about this company’s allocation of expenses.
• Advertising. One of the reasons this company managed to triple its business was because they pumped up advertising from $25,087 to $47,008 during the same year-to-year period. Yet I would recommend even more. In my estimation, somewhere between 6-10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales is the proper level of advertising for a PHC service firm. As the company grows in size, economies of scale come into play and the lower end of that scale becomes sufficient. However, for a business, I would recommend spending closer to 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales on advertising. You need it to grow.
• Credit card fees. Note that in 2002 this company had accumulated merely $199.86 in credit card fees.. This indicated to me that they were not promoting credit sales enough. Credit cards are one of the best sales tools a service firm can have.
• Education. The line item for “Schooling – Employees” comes to merely $100. That is far too low for any business. Continuing education for your employees is one of the best investments a business can make. You will get paid back many times in the long run.
• Give-backs. There is no line item here for this category, but there should be. I recommend that a company allocate 1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales to what might be called “give-backs.” This would cover un-billable call backs, rebates after billing complaints, referral discounts and so on. Don’t think of give-backs as a give-away, but as a sound business investment.
Next issue we’ll deal with some other important issues that can be found imbedded in a PHC business’s P & L statement.
2002
2003