Columns

Stone Soup?

Focus on the “big rock” numbers - labor and materials - and watch for patterns in accounting.

My hero Oprah was on the Dave Letterman show recently. Touted as “The Super Bowl of Love,” it was Oprah's first appearance on the show since May 1986. Dave claims that his people had been contacting Oprah's people every week for every one of those 16 years.

Finally, Oprah said, “Yes,” and made her way to the Ed Sullivan Theater. I imagine that Oprah - smart chick that she is - took into account the opportunity to promote the opening night of her Broadway production of the musical “The Color Purple.” Oprah arrived and Dave conducted a thoughtful and interesting interview.

At one point, Dave was trying to uncover Oprah's reason for coming on the show. Was it his unrelenting pursuit? Did she just succumb to the pressure?

Oprah, in perfect icon fashion, instructed, “No, I wanted to come on the show. I am at the point in my life that I just don't do anything I don't want to do.”

Nice.

Me, too. I've made a decision that I won't do anything I don't want to do. If I am going to do something, I consciously choose to do it. In some cases, the shift is a subtle one from “have to” to “choose to.” I am finding that this is a good boundary to set - a liberating discipline.

One of the things I don't want to do anymore: argue about selling prices. No need to argue about that. We are not going to flog the dead horse of “T&M vs. Flat Rate.” We are not going to argue about whether or not you can make money in new construction. No arguments for us!

Now, if you ask me, I will be happy to help you get to and operate from a KFP - known financial position. You want to put together a budget and establish a reasonable selling price based on your goals and data? I am here to serve.

One of the things I know for sure: Convince a man against his will, he's of the same opinion still. I also know that there are lots of ways to make and lose money. The only way to know if you are making or losing money is to keep score. I will help you do that. It is my pleasure and my professional purpose to help you do that.

So, instead of arguing, let's discuss the data. In order to do that, we need sound, simple data arranged in such a way that we can understand it. And to do that, we can use the Divisions and Job Costing features in your accounting program.

Let's explore using divisions. Here are the basics:

In your accounting program, create divisions that reflect your company. Customize your chart of accounts (your “Bean Team” can help you do this). Create sales divisions and corresponding direct costs per division. For example:

Sales - Residential Service
Sales - Remodeling
Direct Cost Labor - Residential Service
Direct Cost Materials - Residential Service
Direct Cost Labor - Remodeling
Direct Cost Materials - Remodeling

Aim for a chart of accounts that strikes the right balance between too much and too little detail. In order to comply with Uncle Sam, you don't need much more than Sales - Expenses = Profit (or Loss). In order to make good financial decisions, you may choose to pour the financial information into a few more buckets.

Just don't overdo it. Don't bother creating divisions for operating expenses (overhead) unless you are going to use the data to make better, faster, more profitable decisions. If you have multiple divisions, you could go through the painstaking process of determining how much of each box of paperclips should be assigned to each department. Or, you could make an executive decision and assign a percentage of total overhead to be born by each division. I prefer the second method.

Focus on the “big rock” numbers - labor and materials. If you are not making enough money, look to labor and materials. There are only two ways to make more money: increase the top line, or decrease expenses. Raise your selling prices, or figure out how to be more efficient with your time and expenses. Business is easy. Those are your only options.

Yes, overhead is a significant dollar amount. Look at your overhead accounts and note that the indirect costs of labor are a big rock item in overhead. Making money is a result of charging more than it costs. Price according to what you want to spend on those big rock items. How much do you want to pay yourself and your hardworking team? It is up to you.

By tracking the big rocks of labor and materials per division, you can determine which divisions are winning or losing. Are you getting closer to your goals? The goals come from the budget. Simple! You can identify which big rock number is out of line and there is always something you can do to improve the score.

Once the chart of accounts is squared away, make sure that the data entry team is on board. Follow the path of information flow. Are the sales invoices being coded to the right sales accounts? How does the data get from the timecards and the supply house invoices into the right accounts? Think of putting the big rocks into the proper “buckets.” You don't have to be an accounting ace to get this concept. We are looking for the patterns - compare like items. Your team will get this idea and help you make sure the data collection and entry goes into the right places.

Next Step, Job Costing

The same patterns are reflected in job costing. In most accounting systems, there is a job costing function. Job costing helps you match the big rocks of labor and materials to a specific sale.

You can use purchase orders to help you put the information in the right bucket. Don't overdo the purchase order systems. Sheesh, I see a lot of wasted time on PO systems. If you use your accounting system to generate the PO, then you must reconcile each PO once the packing slip shows up with the order.

Why not use a manual system - a simple paper and pencil form that lists the material requested. This makes reconciliation a lot easier. A manual system can work great to help you accomplish the main objectives of using purchase orders:

All material purchases are approved.
The material is coded to the proper direct cost account.
The material is coded to the proper job.

Job costing works like this: Let's say you put a bid (a mini budget) together for a bathroom remodel for Mrs. Fernwicky. In that bid, you have a guesstimate of the labor and materials costs. Enter that information as a job in the job costing module. Give it a job number. Make sure your plumbers are held accountable for indicating which jobs they complete on their timecards. Then, when you enter payroll data into your accounting system, there is a field that allows you to “flag” the information with the job number. The accounting system will send a copy of the payroll info to the job file. When you enter materials, “flag” the appropriate entries with the job number. This will send a copy of the materials information to the job file. Then you can run a job cost report for the Fernwicky remodel project and see how you did compared to the bid (the budget). Don't fuss with applying overhead to job costing. It is a baloney number at best. Sales - Direct Costs = Gross Profit. The job will be won or lost at the gross profit level.

I have seen firsthand lots of big, profitable companies with low tech and highly effective purchasing and warehouse systems. Keep it lean and mean. Stock the trucks right. Replace what is used every day. Carry as little stock (inventory) as possible.

If you are technologically obsessed, you could use bar coding and tight warehouse management to keep purchases up-to-date in the computer. Maybe the best option is to have your main supplier help you organize your bare minimum warehouse stock - and even offer to store it on consignment at your shop. There are several ways to manage your materials. Keep score and you will know if you have a problem.

It's all about the patterns. Watch the patterns and look for exceptions. When something is out of line, dig deeper. Make sure that the accounting is accurate (that the big rocks went into the right buckets). Then, get out in the field and see what's happening with labor and materials. If you can, make operational improvements that will reduce your labor and material expenses. However, if you need to raise your prices, raise your prices. Don't try to make “stone soup” by squeezing labor costs. Pay your people well and price accordingly. Charge enough to make lots of money - even if you make a few mistakes.

You don't have to be Agatha Christie. Finding and solving the challenges is easy when you are paying attention and have the big rock data. No need to argue.