Financial Basics for Contractors, Part 2
Editor’s Note: Part 1 of this two-part series, which appeared in the March issue, covered “Five Crucial Measures for a Sound Company.”
I hope last month’s column convinced you to learn more about business finance. Once you have, you may start to rethink some of the financial-management methods that you’ve used in the past.
I have compiled some of the highlights of what I’ve learned over the years as a teacher and commercial contractor. It’s important to understand that this information is based on my business experience, my business model (commercial; no residential), and my outlooks and opinions. What is presented here are guidelines. Learning more about your own business will help you understand how these concepts might apply.
Job Costing and Other Formulas
Job costing has many facets. In last month’s column, we spoke about the cost of delivering a talented technician to the customer on an hourly basis by adding in your personal return on investment and the impact of market dynamics.
Additionally, most of us have slow seasons no matter how hard we try to take seasonality out of our business. Pricing a bid that will give us work during our slow season requires additional factors such as the value of subsidizing payroll to provide our employees a 40-hour workweek.
Here’s an example for a commercial contractor that shows how to quote a job:
- material costs.........$500
- equipment costs .....$2,500
- direct labor costs. $0 ($50 per hour for 40 hours)
- sub-contract costs ..$500
- sales tax ................$180
- warranty ................$500
- other .................$250
- total ..................$4,430
- material, sub-contract, warranty mark up 35%
- total costs without labor ....$5,980.50
- add labor at prevailing hourly rate ($100 per hour) ...$4,000
- total quote.............$9,980.50
Another major challenge is collecting accounts receivables. Here is a simple formula that will give you an idea if your collections are helping or hindering your business.
Accounts receivable collection days: Accounts Receivable divided by Annual Sales, multiplied by 365 days
In general, the chart below will indicate whether you are operating an efficient commercial business:
- Excellent .........Less than 30 days to collect
- Good.......... Less than 60 days to collect
- Fair ............. Less than 90 days to collect
- Poor. ..............Over 90 days
Sometimes you may run into the 60- to 90-day period at times due to customer billing cycles. If you know (and you should) that a customer will take 90 days to pay a bill due to administrative issues and not due to marginal business practices, we factor in the cost of not having that money for at least 60 days. What would it cost us to borrow this money from a bank? We take this value and add it to the job.
Working capital: Total Current Assets minus Total Current Liabilities
Simply put, you need cash to pay your bills. It can come from the sale of stock, loans, and lines of credit. Your working capital should be at least 10% or more of your annual sales. Depending upon billing cycles and collecting accounts receivables and the type of business you operate (such as new construction or service and repair), this percentage will vary. In my business we target 25% of annual sales for funding our business.
Return on sales: Net Income divided by Gross Sales (assume annual numbers)
This figure will give you an idea whether your business is generating adequate income for the exposure (gross sales). Remember, you need to look at your equity exposure to the risk of business to decide if the net income you generate is adequate. Here are some guidelines:
- Excellent........ Greater than 10%
- Good........... Between 6% to 10%
- Fair................ Between 3% to 5%
- Poor ...................Less than 3%
Return on total assets: Net Income divided by Total Assets (assume annual number)
This formula reflects the return (income to yourself in addition to a salary) you should expect on your investment. Many business owners neglect to take their return on investment out of their business annually. Here are some guidelines:
- Excellent ........Greater than 20%
- Good...... Between 11% and 20%
- Fair.......... Between 5% and 10%
- Poor ...................Less than 5%
Debt-to-equity ratios: Total Liabilities divided by Total Equity
This is a quick way to find out how liquid your company is. Here are some guidelines:
- Excellent ...........Less than 0.50
- Good ........Between .50 to 1.25
- Fair......... Between 1.26 to 2.00
- Poor .............Greater than 2.00
One easy way to improve your financial responsibility as a business owner is to follow this checklist:
- No one person or department should handle all aspects of a transaction from beginning to end.
- Perform a periodic physical inventory and augment with cycle counts.
- The receiving, disbursing, and reconciliation of cash should be split up among different people and departments.
- Secure unused checks and check signing stamps/plates.
- Segregate check writing and bank reconciliation.
- Bank statements/canceled checks should be mailed to the owner’s home.
- Only sign checks with proper support documentation.
- Minimize use of manual checks and account for all check numbers.
Skip Snyder was president of Snyder Company Inc., Upper Darby, Pa.; was the 2004 chairman of ACCA; and was chairman of NATE from 2000 to 2003.
Financial Management 101
Financial Management 101 is a hands-on workshop designed to teach contractors how to understand financial terminology and utilize information from financial statements to enhance the accountability and profitability of their business. Learn more at www.acca.org.
What ACCA Did For Me
By Skip Snyder
I was a business major at Temple University in Philadelphia. I enjoyed the business curriculum, the case studies, and the strategies to win market share and grow profit. All very interesting stuff to me, but even with my bachelor’s degree, I wasn’t prepared to run the family business. I still needed the guidance of those older and wiser. Learning from case studies is not the same as experiencing it. I found myself working harder and earning less, always trying to catch up with payables, always trying to collect receivables, afraid to purchase new trucks due to the debt burden I’d be facing. Yet, I saw some of my older and wiser competition living well — a Jersey shore house, newer trucks, uniformed technicians, and jobs in the better part of town.
Since I was their competition, I couldn’t learn their secrets, their methods, or their strategies. It was frustrating, and I was burning up a lifetime of energy and not achieving my goals. In fact, as I look back today, the goals I had chosen were very modest. I grossly underestimated the income potential of my hvacr company. My wife Laurel was supportive but knew that I wasn’t accomplishing my goals. She saw me wallowing in a static environment. In fact, I was starting to lose my desire to work. Something had to change.
I was a member of ACCA. I tried desperately to join an ACCA MIX Group but couldn’t find an opening. They are invitation only. Finally, I received a call from another ACCA member from New York who was forming a MIX Group. And I was his first call. Together, we formed our own MIX Group. My ACCA MIX Group gave me what I was missing. I learned about pricing jobs, setting hourly billing rates, handling material, and equipment mark ups. My ACCA MIX Group provided the knowledge and experience I was lacking; the members helped set my company direction, achieve greater profits, and develop leadership within the company so I didn’t need to be in my office every day. These are things that were not learned in one day but over a lifetime, and they shared their experiences with me.
ACCA MIX Group is exclusive to ACCA. This is a peer-review group that usually meets twice a year with follow up between meetings. The same group of hvacr contractors from across the country share financials, marketing, best practices and, in many cases, evolve into your unofficial board of directors. For further information contact:
Hilary P. Atkins
General Counsel and Vice President, Finance & Administration Air Conditioning Contractors of America
2800 Shirlington Road, Suite 300
Arlington, Va. 22206