Fixing the Big Five financial numbers
Do you rely on your monthly and annual financial statements to tell you how your business is doing?
Do you rely on your monthly and annual financial statements to tell you how your business is doing? If you are relying solely on your financial statements (assuming you are producing one monthly), you are not managing the operations of your business day to day.
Don’t get me wrong, your monthly financials play a very important role in the success of your company. However, they are a lagging indicator. Said differently, you can’t change your past simply by reading your results, but you can change your future by understanding what your financial statement is telling you. Every month’s financial statement and balance sheet is a story. What’s your story? Better yet, what are you doing about it?
Let’s walk through a financial statement and see what it can tell you. As you read through the following, notice what stands out to you.
Let’s talk about the Big Five numbers in the context of a contractor I’ve been coaching for the past 12 years. When we met, his financials looked similar to the profit and loss statement in Table 1 (see pdf below), but after one year, they looked more like the financial statement in Table 2 (see pdf below). Let’s walk through the story.
As you can see, this contractor was only eking out about a 2% profit.
In 1990 when I met Frank Blau, the founder of Nexstar Network, he told me the typical contract at that time was only making about 2%. He was right.
However, being typical was not going to help increase profits for this contractor. So we reviewed his financial statement in Table 1 and it screamed at me. It was clear what needed to be done.
1. Materials.The first thing that hit me was his material cost as it related to his sales. For a plumbing service company, the material cost benchmark is 10% of the sales. He found his cost to be 15.6%. After asking a few more questions about how he accounted for material, we discovered that when the company added a service vehicle to the fleet, the material purchased for the vehicle was hitting the financial statement and not the balance sheet.
Said differently, the material was being expensed, rather than being added to the current asset account under inventory on his balance sheet. This changed the picture by 1.2 percentage points; however, he was still left with 4.4% over the target.
What we discovered next was the company didn’t have a purchase order system in place, and technicians were free to go the supply house and pick up anything they needed without verification. He fixed that broken process immediately and in the following year drove his material cost to 10% of sales. He lost a technician during this process, which was a good thing. We uncovered later that this particular technician was doing side jobs and loading up on materials for those side jobs from the supply house. The owner said goodbye to that crook.
2. Labor.The benchmark for plumbing service labor is 24% of sales when fully burdened (this includes taxes, workers’ compensation, medical benefits, retirement, etc.). We found labor to be more than 6 points too high, so we tracked the hours worked by all the technicians and found, on average, each of the 10 technicians were generating close to 400 hours in overtime pay at 1.5 times the regular pay of $28 per hour.
The technicians were getting $42 per hour for 400 hours each. Multiply that by 10 technicians, and you have $140,000 in overtime pay, equivalent to at least two additional full-time technicians with fully burdened pay. This just smelled bad from the beginning. The 10 technicians were averaging only $200,000 per year in gross sales.
After interviewing the technical staff, we came to the conclusion the owner had the wrong guys. We started a recruiting program that is in effect today and within six months, he lost all 10 of the existing technicians and replaced them with six. During the course of the following year, the Nexstar Service System training was implemented with the new staff. As you can see in the second table on page 72, the average rose to $333,000 per technician. Lower technician cost, same total sales. This was a huge win.
3. Overhead salary.The benchmark for overhead salaries is 15% of sales, again fully burdened. After a day of watching the internal staff members go about their day-to-day activities, I saw the company had no idea about structure. In addition, 100% of the internal processes were broken. After about a week of training, the company had all the staff doing the right processes.
The broken processes were rooted in the start of the business six years prior. Staff members were given tasks and continued to own the tasks as their roles changed — so their activities did not change. This caused total inefficiency inside the office. This mess was cleaned by having a meeting with the owner, going over the staffing model for a business his size and showing him how this same staffing model will scale as his business grows.
He jumped in with both feet and restructured the entire company, but found he had too many people and needed to make a few layoffs. Hard to do, but it was a reality.
4. Advertising.The owner was adamant he had to spend more money on advertising to get more calls to make more money. This was the biggest hurdle to get him over. I convinced him he had plenty of calls; his call count wasn’t the problem. The problem was his technician’s ability to close and maximize the calls the company was currently running. This is where the Nexstar Service System came into play.
We enrolled all his technicians into the training program the following month. The company went from a 60% conversion rate to a 90% conversion rate. The average ticket went from $225 to $845. The company ended up generating the same sales with six technicians as it did with 10 technicians and kept the marketing cost flat. This proves again that more sales won’t bring you profit — performing well will.
5. Vehicle cost. Notice that vehicle cost rose to 5% of the sales; the benchmark is 4%. The company was purchasing vehicles, so we needed to include the depreciation of those vehicles to the vehicle expense. We determined after diving in that the 0.6% cost of depreciation associated with the vehicles made the vehicle cost 5.6%, or 1.6% greater than the benchmark.
The technicians had fuel cards, but no one was tracking the fuel. We also found the fleet was old and worn out, and the repair cost outweighed the cost of bringing on a new vehicle. We turned over the entire fleet with new trucks, set the company up with a tracking fuel purchase program, and watched the vehicle cost slide down like a rock on a mountain top.
This company did a total transformation over the course of a year. This would have never happened had I not had the opportunity to read the story of this owner’s financial statement. Simply by fixing the Big Five, this company went from 2% to nearly 20% in net profit.
So what’s your story? What is your plan for moving your company’s trajectory up? Send me your financial statement. We’ll get on the phone and I’ll read you a story.
This article was originally titled “Fixing the Big Five” in the January 2016 print edition of Plumbing & Mechanical.