Basic financial knowledge allows shop owners to measure, improve performance

FOR MOST OF my life, I haven't been a big fan of math. I did what I needed to do to get through math classes in high school and beyond, but I didn't embrace its benefits. As I grew older, however, something changed. I began to understand the benefits of a thorough understanding of mathematic principles and applications of those principles in daily life. I began to understand most of what I did every day involved math. The light bulb finally went on.

Now I look at math as a challenge and source for answers to questions about everything. By understanding basic finance principles, I was able to increase my business and create more accurate projections of my potential for success. Basic financial knowledge allows you to measure performance so you can improve it.

Gross profit

Most of us have heard buzz words and acronyms such as EBITDA, net, EBIT, markup, discount and margin – all of which are important. But the first basic principle you need to understand is gross profit, which equates to the selling price per job minus the cost per job. In other words, it's the selling price of a repair, or a completed RO total, minus the direct costs involved in doing the repair. Pretty simple.

These costs should be broken down by category or job costed. For example, a shop completed a repair for a customer on his new minivan, and the total repair bill was $1,000. This repair number was derived through the estimating system. The sale breaks down like this:

• Labor – $650
• Parts – $250
• Material – $50
• Tax – $27
• Sublet – $23

The total repair cost $1,000. To accurately job cost this repair, you need to know the cost associated with each department. How much did the labor cost you? The parts? The material? This might be difficult to do by hand, but it's not impossible. I don't recommend calculating these percentages by hand. Every shop should use a management system. If you don't have one, get one as soon as possible. There are robust products on the market that will provide all of these numbers for a minimal cost. In our fast-paced world of business, it's almost impossible not to use some type of management system to run an operation.

In each department, you should make a certain gross profit percentage. The total of these departmental percentages, when averaged, will be the overall gross profit. As a rule of thumb, try to maintain a gross profit average of 45 percent or more on every job. Obviously, the higher the gross profit percentage, the higher the net profit. In the example repair, the profit percentages are:

• Labor – 60 percent (attained by paying techs on a 60/40 split).
• Parts – 30 percent (attained by negotiating good discounts with vendors).
• Paint and material – 35 percent (attained through help by your paint jobber).
• Sublet – 15 percent.

The resulting gross profit on this job would be almost 50 percent. This is a respectable and attainable number. Remember each job has to be job costed and reviewed daily to keep the profit percentage as high as possible. If you carefully monitor each job individually, your profits are guaranteed to increase. The fact you're watching them will force you to improve your performance. Gross profit is where it all starts from a money-making standpoint. You must maintain a healthy gross profit average.

Many factors can affect gross profit. If you buy parts and don't charge them to the job, what will happen to your parts gross profit? What if your labor charges are too low, or if you don't charge for an operation you perform and pay a technician to do? Your gross profit will decline for obvious reasons. This sounds simple, yet I see shops not charging for all the parts they use on a job, or not charging the proper labor on a repair every day.

The gross profit you make on a repair will directly affect your ability to run your shop profitably, or even keep it open. It's one of the areas you can control. Look at your parts margins. If they're not high enough, negotiate better discounts from your vendors. Monitor your paint and material usage. If you're not getting at least a 35 percent profit on paint and material, you're throwing money away. I've seen shops that make 50 percent on material. It's possible by belt tightening and monitoring.

Overhead

These overhead costs have to be paid with monies you retain in gross profit from the repairs you perform. I'm not sure why, but some owners and managers don't understand the simplicity of this. Consider this. Your gross profit represents your paycheck as an employee. Your paycheck allows you to buy certain things, such as groceries, cars, etc. You can't buy more than your paycheck will allow without getting into trouble. At home, you know how much you have to make every month to be able to pay your bills and have a little fun.

The same holds true in your business. How much does it cost you to run your shop per month regarding overhead? How much do you have to generate in sales at your average gross profit number to pay those overhead costs before you start making money? In other words, what's your shop's break-even number?

Overhead costs are more difficult to control than the direct costs involved in a job. Watching overtime, turning down heaters at night, and shopping for the best available services for the best cost are examples of how to save money on overhead. You can't save your way to profitability, but it helps.

Break even

It's imperative you know your shop's break-even number. By understanding this aspect of your financials, you'll be able to begin to plan for proper work volume and mix. Work mix pertains to the type of work you bring into the shop by understanding what types of jobs allow you to make the highest gross profit percentages. For example, shops generally make a greater profit percentage on labor sales than they do parts sales. Jobs with more labor than parts will result in a higher gross profit. A higher gross profit percentage means more available cash to pay overhead costs. Shops that monitor work mix and volume will make more money than those that don't.

To calculate a break-even number, add monthly expenses. Take several months of numbers and average them to come up with a representative monthly overhead number. Let's say the overhead number is $15,000. Simplistically, you have to generate at least that much in gross profit to pay overhead costs. What do your total sales have to be at 47 percent gross profit on average to generate the $15,000 you need to pay the bills? About $32,000, which is your break-even number.

Any sales you generate more than $32,000 in any month will allow you to generate a profit. Every dollar generated adds costs, so not every dollar over the break-even number represents pure profit, only a percentage does. You can make more money on less sales by monitoring gross profit.

Using a management system or accounting package generates reports needed to calculate these numbers, which allows you to begin the measuring process, which, in turn, leads to improvement. Most of the commercially available management software will provide the raw data needed to generate reports. Ask other shop owners in your area what systems they use and why. These answers will help you decide when it comes time to purchase one.

Understanding and mastering these basics will allow you to move toward more complex financial data sets. I suggest you get preformatted spreadsheets that contain the formulas needed to calculate overhead, break-even, gross profit and net profit numbers.

You also can look at cash flow and how receivables and terms from your vendors affect your ability to operate smoothly. I use the spreadsheet tool often, and as you begin to understand it, I am sure you will as well. Plug in the numbers in the highlighted columns, and it will do the rest for you. If you would like to receive this spreadsheet, send me an e-mail at [email protected].

There's no need to be intimidated by these concepts. In fact, you'll probably embrace math like I have once you better understand and realize its benefits.