Par for the Course

Par for the Course

Frank Blau
Contributing Writer

There are a few things you should know about the company whose Profit & Loss sheet I am about to analyze:

  1. This is strictly a service & repair company – no new construction work.
  2. This is a “C” corporation and at the end of the year the company was six years young.
  3. They employed three persons in the office, one of whom was part time.
  4. There were six full-time service technicians and installers.
  5. The owner worked 500-600 hours in the field – in addition to another 3500 hours or so being the “boss.”
  6. Field technicians were paid for 9,634 payroll hours at a rate of $13/hour, including mandatory fringes. (Base wage rate was actually in the area of $8.40 an hour.)
  7. The company used a flat rate program with a retail labor rate of $65 factored in. (Obviously not enough.)
  8. There was no profit sharing or medical plan for the owner and his faithful associates. (This sucks.)
  9. The owner joined Nexstar and is now in the process of transforming his former “slug” company into a model of success.
  10. The owner is a wonderful student and gentleman – a Blau “cult” member whom I have a lot of love and respect for. He’s going to make it big time.
  11. After the owner gets it all together, he wants to learn how to play golf so he can pick my pockets!

So, it’s time to teach him a little golf-speak. Among the hundreds of P & L statements and balance sheets that I have received from PHC contractors through the years, this one is pretty much “par” for the course. He even shot a few birdies, although there are many more bogeys and multi-bogey scores in this effort.

This first birdie scored by this contractor deals with the layout of his actual P & L statement. It’s easy to read and has a lot of detailed information under overhead. (It had even more detail in its original form. I’ve condensed it to save space.)

The second birdie deals with the president/owner listed as an overhead entry under the heading of “salaries.” Most owners don’t list themselves as an overhead player. In fact, they’re no place to be found on the course. They simply depend on a positive bottom line (often there is none) to make a draw for themselves, their slave wives and business partners.

Lousy Shots: Now let’s talk about the bogeys, double – and triple – bogeys.

First, while most of his direct and indirect costs are properly allocated, he goofed in placing his payroll taxes as an overhead item. Payroll taxes of field workers need to go as a sub-item of direct labor costs. Office payroll taxes should remain under overhead. This is mere quibbling, however, compared with some of the more serious flubs represented by this P & L.

Sales of $609,923 represent a sizable amount of business. The phone was certainly ringing for this contractor.

There was a fair amount of material cost for this mainly HVAC firm ($226,385). Yet there was nowhere near enough compensation for his technical people who contribute so much to society. His direct labor cost of $80,856, divided by six service techs, comes out to an average $13,476. Add to that average $4,636 paid to each field worker for nonproductive labor, which is captured under the salary portion of overhead ($27,818 divided by 6). So his average service tech earned a little over $18,000 last year.

Granted, this company is from a state with a relatively low cost of living. Yet, even factoring in an extra 20-25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} still would be pathetic technician compensation. Remember, this does not include anything for retirement or medical coverage for those people who work so hard in the trenches. How the hell can anyone live on that and raise a family? Score this a double bogey.

To simplify our lesson I am going to leave his direct labor costs as is, even though you and I know they are far too low. What I wish to focus on instead this month is the overhead portion of this contractor’s P & L.

Under salaries, we can see that this owner paid himself $38,950 last year. Considering his state’s low living costs, that is about in line with industry averages that show PHC contractors averaging around $45,000 in annual compensation. This is not to say that my friend shot par, however. It means that the entire industry is firing bogeys when it comes to owner compensation! Considering that my friend put about 4,000 working hours into his business last year, his compensation amounted to around $9.75 an hour. That’s another double bogey on my scorecard.

Even worse were the two and a half office employees who split $19,095 in compensation – again, with no benefits. You bet they included some family members. Who else would work for such slave wages? Triple bogey!

Further down the overhead column we see a line item for “Donations.” It tells us that this company donated a grand total of $450 to worthy causes last year. I must inform my friend that when he takes up golf there will be days when he may lose that much in wagers and picking up the 19th Hole bar tab! I know my friend has a charitable heart. Once he gets his business where it ought to be, he will be able to afford more donations.

His $6,062 in education costs is more reasonable. Most of that was wrapped up in Nexstar membership – another birdie!

Finally, we see that this company turned a profit of $17,747 last year. That’s a little under 3{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} return on sales, again in keeping with industry averages. Bogey!

Fill In The Blanks: The two remaining examples on this P & L are labeled “Should have been” and “Could have been.” I have concocted them for teaching purposes.

In example 2, “should have been,” I have kept all costs the same but brought the gross profit percentage in line with a service business ideal of 65{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. That is, a service firm ought to strive to keep direct costs within 35{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales – as opposed to 50.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} in the actual results.

Below, under the overhead and profit numbers, I targeted 45{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} as the ideal overhead percentage for a PHC service firm, not too far off the actual mark of 46.4{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. For net profit, I set a target of 20{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales.

Assuming all direct costs remain the same (again, just for teaching purposes – in the real world they were far too low), we see that this firm would have had to generate $882,874 in sales to achieve these benchmark percentages.

In example 3, “should have been,” I followed the same basic principles but varied a couple of figures to reflect less than optimal performance. That is, I assumed that direct costs would account for 40{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales rather than 35{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, and net profit of 15{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} rather than 20{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}.

Most of the numbers plugged in are the same. I have left some lines blank, however. I invite you to fill in your own numbers for President and Office Salaries, Payroll and Sales Taxes on those salaries, plus Donations and Education spending. Make sure that when combined with the given numbers, they add up to the total overhead expenses of $397,293 and $347,631, respectively.

P&L

Should Have

Could Have

Par for the Course