Frank Blau
Contributing Writer

Last eBuzz, I pointed out some problems with the format of an actual profit-loss statement from a Midwestern service contractor. You may wish to re-read “Numbers Tell a Story” article to refresh your memory. This edition I’m going to take it a step further by reconstructing the format and plugging in some new numbers that make more sense. The line items highlighted in bold face on the chart are the ones we concern ourselves with.

First, look what I have done with the revenue side. The numbers are higher because I factored in modest 9.62{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} increase in selling prices for this firm. This was an arbitrary percentage that I came up with to achieve a reduction in direct cost of sales from 44.5{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, which was too high, in  my opinion, to a more reasonable 37{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. I believe that this firm could raise its selling prices and revenues by much more than 9.62{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. However, for the purpose of this article, I wish to make the point that even a modest increase in price can reap great benefits.

Some people would argue that by raising prices, this firm might lose some sales rather than gain. My response is, with flat rate pricing, not necessarily. Furthermore, in line 32 I boosted advertising by about $10,000. For the sake of this example, let’s assume the greater level of advertising would help attract more business to compensate for the marginal loss of customers that might result from a small price increase.

Inventory Is An Asset: Next I wish to draw attention to line 13, where my reconstruction reduced the “Parts & Materials” line item by some $30,000 from the original. When I first saw the original figure, I thought it was too high for a service business in relation to the labor costs. Upon investigating this contractor’s business, I found out that he kept a fair amount of inventory that was not accounted for separately. This resulted in a misleading entry on the P & L statement.

What happens to the $30,000 in inventory that I subtracted? It gets recorded as an asset on a separate balance sheet statement, along with cash, property, equipment, etc. The category “Direct Cost of Sales,” which includes this line item, means just that. It exists to keep track of the parts and materials, labor and other costs that result directly from the work performed. Here you keep track of the material cost as it gets used, not as it gets purchased.

Next take a look in tandem at lines number 15, 25, 26, 27. This is basically a matter of bookkeeping. The actual statement tended to lump too much of the personnel taxes under overhead rather than segregate the field labor and salaried (non-productive) employee totals.

The $2,614 reported under direct costs in the actual P & L shows some attempt to do this, but does not jibe with the wages paid. Frankly, I don’t know how this contractor’s accountant derived that amount. My reconstructed version gives a more realistic picture of cost allocation.

More Income: Next, I used my hypothetical reconstruction to boost the owner’s salary (line 19) to $75,000 for the nine-month period, which projects to $100,000 a year. As I’ve noted many times in my articles and seminars, this is the level of compensation that contractors in our industry ought to shoot for, rather than being content with the industry average of some $45,000 or less. In the next line, I also factored in salary increases for other management personnel.

Where does this money come from? First, remember that we gained almost $68,000 in revenue by instituting a price increase, plus another $30,000 by removing inventory cost from the P & L. The rest comes out of the so-called “bottom line.”

As noted last month, this firm reported what seems a to be a fairly impressive 15.04{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} pre-tax net profit, though this is an illusion. My reconstruction shows a more realistic allocation of expenses and the profit left over.

Now I wish to draw everyone’s attention to line 45.  In the original version published last month, the minuscule $100 allotment was for schooling employees only. I injected the word “Boss” to remind everyone that all of us could stand some education – and a much bigger dose of it than this contractor had planned. $1,000 a quarter is not all that unreasonable.

Planning For The Future – Look what I’ve done with line item number 50. I plugged in retirement plans for the boss and employees. The way I came up with $63,529 was to take the wages and salaries reflected in lines 9, 10, 12, 19, & 20, then multiply by .225, representing 22.5{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of income devoted to profit-sharing and/or money purchase pension plans. The government allows a maximum contribution of up to 25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of income.

The details are far too complicated to go into here. Pension planning is a subject unto itself and something none of us would want to tackle without extensive consultation with our accountants and financial planners. Suffice to say that very few PHC firms have employee pension plans, and this is a serious industry shortcoming. My hypothetical P & L statement shows how one could be affordable by even a modest size service business.

Likewise, in the next line I conjured up a company medical plan. Health insurance is another benefit missing from most companies in our industry. “Can’t afford it,” is the popular excuse. Just put it in overhead and build your pricing structure in a way that covers it, and of course you could afford it.

One last line item goes to what I’ve whimsically labeled  “ripped-off or screwed clients.” This reflects what I wrote about in the article “Handling Customers Who Think They’ve Been Had”, where I recommended allocating about 1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of sales for givebacks to people with complaints.

Bottom Line: The next to last line shows an overhead burden of 60.36{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, which is somewhat high for a PHC service firm. However, what we are looking at here is not only a reconstructed P &L, but a blueprint for reducing that overhead percentage over time. This gets accomplished through increased sales and reduced costs as higher paid employees, backed by the security of pension and medical plans, become inspired to work harder and smarter. The extra advertising and schooling also will pay off in the long run.

The bottom line shows that, despite all the added expense for salary increases, retirement plans, medical plans, give-backs, etc., this company could still show a profit.

Not much of one. The 2.64{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} pre-tax net profit shown here is just a little about the abysmal industry average. I always recommend that companies shoot for 20{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, which would put them in line with high performing firms in many other industries.

But don’t forget that my reconstruction was based on a modest 9.62{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} price increase. It’s possible to go far higher than that, and much of it would fall to the bottom line.

It works, my friends, it really does. There are scores of firms in the industry who have taken my recommendations to heart and are now enjoying the kind of prosperity for themselves, their families and their employees that they so richly deserve. Take a look at that reconstructed P & L. That could be you.

A Reconstructed P & L