Setting Up Internal Systems
One of the biggest debates in the remodeling industry centers on how companies should account for their initial showroom display fixtures. By display fixtures I mean any faucet, bathtub, cabinet, countertop or other material that can be taken off display and sold to a customer.
Planning and building out a new showroom will include many items that can be considered either inventory or display assets. How you account for each of these items may help or hurt your business as you start your new remodeling operation.
A little background is important here. The two philosophies regarding the bookkeeping of display materials go something like this: The first approach treats all salable materials as inventory, or work in process materials. The second approach treats display materials as assets to be depreciated over a specific number of years. Both are correct, but both have advantages and disadvantages.
The typical bathroom display will include many items that can be taken out and delivered to a customer right off the floor. These items may include a whirlpool tub, lavatory faucets, toilets, accessories, light fixtures, medicine cabinets, vanity cabinets and counter tops. Treat these as inventory items.
On the other hand, treat the other parts of the display such as floor tile, drywall, electrical outlets, recess can fixtures and wallpaper as display assets.
Keeping track of all of your initial showroom display expenses is important, and the more detail the better as it makes decisions as to where to plug in the costs easier in your first year.
Inventory ApproachOne big advantage of treating salable material as inventory is that it is the easiest way to account for everything upfront, and at the time that the materials are sold down the road.
Most of the faucets, for example, you put on display today will get tired looking eventually and will need to be sold. As a result, it may make sense to show these materials on your books as inventory. The costing and accounting of materials is simpler if you have done a good job upfront identifying the cost of everything you have on display.
This method also simplifies the depreciation schedule that your accountant must calculate each year. The less items being depreciated, the less the cost to figure the schedules.
Our business uses a simple spreadsheet to account for all the display areas individually with each item number, color, finish, etc., clearly written. We have the current list price and original net cost per item shown. We keep the current list price updated yearly so that we can determine the "current value" of the display area when customers ask, "How much for that vanity, top and faucet?"
If you figure that the materials "appreciate" each year as the manufacturers raise their prices, a display area that has a "list price value" of $5,000 when new may have a current list price of $6,000 five years later.
Keeping current list prices for all items also helps when it comes time to run a special "display sale" on these items. By showing list price along with the display sale price, the larger list will give potential buyers more of an incentive to get the bargain of a lifetime when they decide to buy your old display.
Also, remember that in most cases the original cost for your display has an extra discount above what you would normally pay. Selling those fixtures down the road for a decent profit should be possible.
Another advantage of treating the material as inventory is that it gives your balance sheet a larger "current asset" number. This may be important for some companies who are smaller or just starting out, and may be in need of additional working capital.
Most banks will lend money or extend lines of credit to young businesses by looking at the inventory on the balance sheet as good collateral. It is easier to leverage the display inventory on a dollar-for-dollar basis if it is shown as a current asset vs. a display asset.
DownsidesEven though material list prices appreciate, in reality some of the fixtures and materials also depreciate from the standpoint of salability. For example, antique brass faucets and accessories may be hot sellers today, but five years from now, the hot seller may be satin nickel finish. Where does that leave your antique brass stock?
Depending on how far out on the limb you go with the fixtures and fittings in your original displays, some of those display items may have to be given away at less than your cost in order to make way for the new displays. Because you are not accounting for that "depreciation of value" on a monthly basis, you may have to sell some displays at a loss.
Another disadvantage is with cabinets and counter tops. Depending on how well you keep your showroom up, display areas will start to show some signs of wear and tear after a few years. Even the best sales staff will have to deal with the consumer who is just "looking for a deal on the display" and not willing to buy the items as is. The additional cost to dress up the materials at the time of sale will be additional costs against profit. Without the ability to reduce your costs from the original purchase price, your profit margins on display sales will be less than desired.
Asset ApproachNow that we have discussed the inventory approach, we should also talk about the advantages and disadvantage of using the asset approach. The biggest advantage with this method is that you can depreciate display items each year and deduct the depreciation expenses on a monthly basis. If your business strategy is to reduce taxable income by maximizing legitimate expenses, this monthly noncash expense will reduce your taxable profit.
Because it's a noncash expense, it may be easier to build up retained cash, and use that money for future growth or expansion with another branch operation. When it comes time to sell the display, you will have to use the "current depreciated cost" to figure the profit on the sale vs. the original cost. But, again, this may be helpful when selling old cabinet displays to still show a profit.
The asset approach will also help you keep better track of the remaining "current inventory," which is an account established to hold materials used for jobs in the near future. After the job is sold, you will be bringing in materials that may be held in a warehouse or onsite until the job begins. Each vendor will have different shipping lead times, and you will have to account for each vendor invoice separately.
Depending on how many jobs you have sold but not yet started, this account may hold materials from a number of projects at one time.
By keeping close watch on the current inventory account each month, you may discover that some of the materials purchased for a project are not "picked up" at the end of the job.
These items may be small, miscellaneous items. But over time, if you cannot keep track of all materials, that current inventory number may become a problem when your inventory at the end of the year is smaller than your physical count.
Some computer software does a better job than others do when it comes to tracking materials and job-costing, but if you can set up an additional check method, the yearend surprises will not happen.
As for disadvantages, the biggest problem is that the required bookkeeping duties may be too much for a small, startup business.
Figuring out the current value of many items each year, plus the adjustments to the monthly depreciation expense can get to be confusing. After five to 10 years, going back and figuring out what was sold and what was added is difficult. I suggest you get advice on this area of your bookkeeping before making any decisions.
Whether you use the inventory method or asset method, thinking about these bookkeeping items in the planning stage can make a big difference in your success as a company. In some cases, a combination of both methods may be used, but if you decide to use both, make sure the records are clear and accurate so the accounting of the sale can be made easily.
In my next column, I'll start to look at some of the ways that the bathroom remodeling processes can be developed to make each individual job profitable.