My major in college was Marketing, which, to my chagrin, required an accounting course to graduate. In those days, the homework assignments required pencils, paper, and adding machines – not even calculators. Watching my two roommates work late into the night trying to balance their Accounting 101 assignments, I dreaded the thought.
During one of my “how-can-I-get-out-of-this” moments, I stumbled across a course description for Managerial Accounting. It said that it dealt with interpreting financial statements instead of creating them. That was my saving grace. Let the bookkeepers create the financial statements, and I’ll just learn how to use them. While it wasn’t quite that simple, I did avoid the dreaded accounting homework.
Managerial Accounting proved valuable for making sound financial decisions for my transmission businesses. However, it took years to discover the secrets for uniquely applying those principles in our industry. Some of the generally accepted accounting principles taught in college are limited (even flawed) for practical use auto repair shops.
To better understand the differences, let’s look at some accounting terms that I’ll use in this article and apply them to auto repair shops.
- The P&L (Profit & Loss Statement) is the most often used financial tool for measuring performance over a month, quarter, or year. It shows the cumulative results of sales minus costs and expenses. The simplest version is Sales – Total Expenditures = Profit or Loss.
- The Detailed P&L includes a breakdown of the Sales by category and classifies the Costs and Expenses as Variable or Fixed, each with its more detailed breakdown. This added detail helps interpret results and make management decisions. It’s also an excellent tool for financial modeling.
Sales – Variable Costs = Gross Profit – Fixed Overhead Expenses = Profit or Loss- Sales are broken down into categories like retail, wholesale, or other meaningful categories for auto repair shops: Labor, Parts, Major, Minor and more.
- Variable Costs are also called Cost of Goods or Cost of Sales and refer to expenditures that only occur if something is sold and produced. For example, sales commissions are only paid if a sale is made, and parts and materials are only used to do the job. There are two forms of variable costs.
- Predictable variable costs are predetermined percentages of every sale. They include credit card fees, commissions, royalties, warranty allowance, etc.
- Truly variable costs in an auto repair shop differ from one job to the next and include parts, fluids, sublets, flat-rate labor, etc. They do not vary predictably but uniquely as direct job costs.
- Fixed Overhead Expenses occur even if nothing is sold or produced. They’re necessary just to open the business. Examples include loan payments, rent, utilities, insurance, office staff, and hourly technicians. While some of these costs do vary from month to month, like utilities, for instance, they do not vary relative to sales. They’re part of the total overhead required to be open for business.
In this article, we’ll look at some pitfalls with traditional accounting principles for auto shops and how you might benefit more from the P&Ls you’re getting from your accountant.
Are you settling for the leftovers? Think of your shop as a funnel with holes. (See the picture.) Money is dumped into the top of the funnel every time you sell a job. The holes in the funnel comprise costs and expenses involved in operating your business. Of course, there are more holes (categories) than depicted in the picture, and the categories and sizes of the holes vary from job to job and from one shop to the next.
Shops try to sell as much as possible while limiting the holes – number and size. Then they “hope” there’s something left over at the end of the subject period – usually a month, quarter, or year.
The funnel is a metaphor for a P&L statement, telling the same story and essentially defining profit as what’s left over.
This results in the flawed belief that more sales fixes everything. If profit is lacking, let’s sell more. If you set goals on sales targets rather than profit targets, you’re settling for the leftovers.
Settling for the leftovers doesn’t mean you aren’t making plenty of money. It just means you’re leaving the amount to chance and making money by accident.
Instead, I recommend reverse engineering your model P&L. Start with your desired profit and work backward. Determine what needs to occur to achieve your predetermined profit goal.
A simple example would be building your P&L upside down. Make your profit goal a line item in your Fixed Overhead Expenses and stop settling for the leftovers. You deserve a profit just as much as the bank deserves its payments or the landlord expects the rent. The simplified version of the new model might look like this.
Fixed Overhead Expense with Profit + Variable Costs = Sales
SINALOA (Safety in Numbers and Law of Averages) doesn’t fit our industry. Managerial accounting utilizes averages to identify trends and anomalies for decision-making. In theory, you can look at certain key elements of your financials and find deviations, identifying potential problem areas. The most common example would be comparing sales and parts costs.
For our industry, the variety of job types, parts costs, time requirements, and selling prices, make using averages unworkable. Take just 3 jobs for example.
- Transmission overhaul for $4,750 with $1,000 of parts cost.
- Clutch replacement for $1,200 with $300 of parts cost.
- Transmission flush for $200 with $80 of parts cost.
- The average job price is $2,050, which isn’t close to any of the jobs.
- The average parts cost is $460, which also doesn’t relate.
Even if you run the numbers on several jobs within one job type, transmission overhauls, for instance, you’d find similar results. The parts swings are dramatic even within the same transmission types. Cumulative across-the-board averages simply don’t make sense for auto repair shops.
Here are some things that do make sense to track and compare as a total or within similar job categories.
- Labor time on a job-to-job basis and analyze results to look for potential problems.
- Track times for individual performance as well as cumulative team averages.
- Compare labor hours billed year to year, month to month, or week to week.
- Marketing performance to track sales acquisition costs. For example, divide total ad expenditures by the number of leads to get the per-lead cost. Watch for anomalies from month to month.
- List your various lead sources – coupons, radio, referral, sign, website, etc.
- Track the number of leads generated by each lead source
- Track the number of appointments
- Track the number of jobs
- Track sales for each lead source
- Stop spending money on advertising that’s not working
- Fixed Overhead Expenses should be compared each month. Watch for sudden changes.
- Compare the total parts purchased to the total parts sold/used in the jobs completed.
- Significant differences between parts purchased and parts sold should be investigated.
- Possible theft – parts leaving for side jobs or ????
- Possible quality issues – comebacks
- Possible diagnostic issues – never left the shop comebacks
- Possible systemic issues – incomplete parts lists given to service advisor
- Possible sales issues – service advisor failing to charge for everything
- Significant differences between parts purchased and parts sold should be investigated.
Gross Profit is overrated. Gross Profit is the difference between sales and the variable costs to produce the job.
Sales – Variable Costs = Gross Profit.
Most shop owners tend to focus on parts cost. However, the cost of a job also includes any amount you spend to sell and produce the job: fluids, sales commissions, flat rate labor, credit card fees, and sublet services like reprogramming, towing, etc.
Gross Profit Percentage is Gross Profit Dollars divided by Sales Dollars.
- $400 Gross Profit / $500 Sale Price = 80% Gross Profit Percentage.
One of the most common questions shop owners ask me is some iteration of, “What percentage should my Gross Profit be?” or, “What percentage should my parts cost be?”
It blows their minds when I say, “Gross Profit doesn’t matter provided it’s over 1%.”
Now, that’s an exaggeration to make my point. If you’re selling jobs for more than the cost of the jobs, you can produce a net profit regardless of the Gross Profit Percentage.
Of course, the lower your Gross Profit the more jobs you’ll have to do, but sales dollars will eventually overcome the low Gross Profit to turn a net profit. You need to look no further than Quick Lubes and Tire Stores to see that doing enough jobs overcomes their low gross profit.
For example, if you only made $100 gross profit on every job, and your overhead expenses totaled $10,000, you’d need to sell 100 jobs to cover your overhead and variable costs. From that “breakeven point” on, gross profit = net profit.
For years, auto repair management trainers have preached that 20% Parts Cost with 20% Production Labor and 40% Overhead Expenses yields a 20% Profit. Those percentages are not practical nor achievable in most cases.
Look at three sample jobs to see the flaws in this model.
- A transmission overhaul that takes $850 of parts with fluids and 17 labor hours would sell for $4250.
- A transmission reseal service with $75 of parts with fluids and 7 labor hours would only sell for $375.
- A reman transmission that costs $2500 with fluids and 7 labor hours would have to sell for $12,500.
All three jobs have a 20% parts cost, but only the overhaul is reasonably close. Not to mention, labor hours are ignored. Jobs with little or no parts, like electrical repairs, are even more out of whack.
Percentages are fine for look-back comparisons, but not for pricing jobs. Out of 100 jobs, a transmission shop might sell jobs from $200 to $10,000 with parts costs from near zero to thousands. With that kind of volatility, how can they fairly and profitably price jobs?
The only thing consistent with all jobs is that time will be consumed. While labor times vary from job to job, an hour is still an hour. We’re already charging for labor independent of parts cost and adding parts at a cost-plus markup.
What if we calculate the job price based on labor plus our desired job profit plus parts at cost? It wouldn’t matter if $50, $500, or $2,500 of parts were involved. All that matters is that we sell the parts at our cost plus a small percentage to cover predictable variable costs.
To do this, we need to predict, with reasonable accuracy, our company’s capacity to sell and produce a certain number of labor hours per month. Then, we can build a financial model for pricing jobs fairly and profitably regardless of parts costs.
Use this model to determine the right price and the traditional estimate format to sell the job.
Visit CoachThomMarketing.com for a full explanation of how you can do this, and sign up to get free unlimited access to our library of articles and videos. Watch the 13-minute video called What Is PIF?
