Calculating Monthly Average Overhead And Breakeven Point

Calculating Monthly Average Overhead And Breakeven Point

Chart courtesy of Lanzarote Business Club

In this blog we will look at how to calculate your monthly average overhead and breakeven point as measured in gross profit dollars.  There are 2 steps required to calculate your monthly average overhead.  Why is that?  That is because there are 4 overhead expenses that should not be averaged.  These include office/officer/overhead staff payroll, payroll taxes on overhead staff, 401(k)/IRA for overhead staff and health/medical insurance.  Step A therefore is to calculate monthly overhead expenses for these 4 items.

The first element in Step A is to identify all your overhead or nonbillable staff and list their weekly compensation.  Multiply this number by 4.33, as there are 13 weeks  in a quarter.  The resultant number is your monthly overhead payroll expense.

The second element in Step A is to calculate payroll taxes on overhead staff.  There are 3 types of payroll taxes including FICA, FUTA, and SUI.  FICA taxes (Social Security and Medicare) are currently 7.65%.  FUTA taxes (federal unemployment tax) are currently 6%.  SUI taxes (state unemployment insurance) are different for each state so you will need to research this for your area.  Once you have determined that rate, multiply your total overhead staff compensation by the total percentage of payroll taxes to calculate your monthly overhead payroll tax expense.

The third element in Step A is to multiply your total overhead staff compensation by your matching 401(k) or IRA contribution, if applicable.  The final element in Step A is to determine your health/medical expense.  This can be done by researching last months health insurance bill.  Add together the numbers obtained in each of the 4 elements of Step A.  This number will be added to the number determined in Step B below.

Step B involves looking at the overhead chart of accounts, referencing the chart we showed in the last blog.  First, highlight the 4 areas we showed in Step A above.  Then, add the yearly totals of all overhead expenses with the exception of those highlighted and divide by 12.  Add this result to the number determined in Step A to obtain your total average monthly overhead.

This average monthly overhead expense represents the firm’s monthly breakeven point as measured in gross profit dollars.  It is important to periodically review these expenses to see if things have changed in order to have the correct average monthly overhead.  In the next blog, we will show how to use average monthly overhead to calculate your overhead per man day burden.

Courtesy of HVAC Business Dr.


Understanding Overhead in Your Business

Recent blogs have provided a wealth of information for home services contractors with regard to properly pricing service labor and understanding the income statement.  If you missed these, I highly encourage you to revisit them, as follows.

 

February: Correctly Pricing Service Labor & Calculating Demand Service Rate.

 

March: Understanding the Income Statement; Departmentalizing Your Income Statement & Analyzing Your Income Statement.

 

In the next few blogs we will start to take a look at the importance of understanding your overhead expenses, understanding and calculating your breakeven point and making more informed financial decisions as a result.

 

Let’s start off with a definition of overhead.  Overhead costs are those that relate to the ongoing expense of operating a business and which cannot be directly attributable or traced to any specific job.  Examples of these expenses include facility rent, office personnel and utilities.  Often times you will hear a contractor say that his overhead is 30% of his business.  When looking at a yearly aggregate for example that may be true.  When looking at it from a month to month basis however that may very well not be true.  For example, if your sales are $2,000,000 a year, 30% overhead would equate to $600,000.  Your sales however are not equal every month so one month you may have $200,000 in sales, and in another only $85,000.  If your overhead runs about $50,000 a month, that would mean it was 25% in the month you sold $2,000,000 and 59% in the month you sold $85,000.  The point here is that your monthly overhead is a dollar amount, never a percentage.  After all, your fixed monthly expenses cannot be paid with by a percentage.

 

In order to accurately determine your firm’s average monthly overhead, you must first make sure your overhead is properly classified.  You can use the chart below to do this.  First, using this chart, highlight all direct costs or cost of goods sold that you currently have classified as overhead expenses.  Next, reclassify and move the general ledger accounts that should be listed in your cost of goods sold section but are listed as overhead in your P&L.  Incoming blogs, we will go through how to compute your average monthly overhead and breakeven point.

 

The following chart should serve as a guide for properly classifying your overhead expenses.

 

Employee Expenses

Officer Salaries

Office Salaries

Sales Salaries

Payroll Taxes

Uniforms

Employee Benefits/401(k)

Insurance Expenses

General Liability Insurance

Life Insurance

Health Insurance

Dental Insurance

Property Expenses

Property Taxes

Rent

Cleaning/Sanitation

Refuse Removal

Utilities

Communication Expenses

Cell Phones

Answering Service

Office Expenses

Postage

Software Updates & Support

Office Equipment Repair

Office Supplies

Marketing Expenses

Trade Shows

Travel/Meals

Advertising

Printing

Web Expenses/Yellow Pages

Professional Expenses

Professional Fees

Dues & Expenses

Payroll Services

Retirement Plan Fees

Financial Services

Bank Service Fees

Collection Service Fees

Credit Card Fees

Interest Expense

Other Expenses

Truck Leases

Bad Debt/Returned Checks

Depreciation

Amortization

Leasehold Improvements

Courtesy of HVAC Business Dr.


Plug-And-Play And the Tech Shortage

Plug-And-Play And the Tech Shortage

Picture courtesy of ACHR news

For years we have been hearing about the skilled labor shortage in the HVAC industry and construction industry at large.  Have you ever stopped to think about what that might mean for your business?  The May 23 issue of ACH & R news talked about the ramifications of this in an article entitled, Is HVAC Becoming a Plug-And-Play Profession?  The article started off by telling the story of one of the writers neighbors whose water heater had recently died.  They simply went to Home Depot, bought a new one and replaced it themselves.  Another neighbor purchased a ductless mini split off Craigslist and had a friend help him install it for a new room which he had finished off above his garage.  Both apparently cited how easy it was to install their equipment and how little skill was needed.

 

One contractor in the article said this was the perfect storm of skilled labor shortages, huge demand for our products and manufacturers who have always been looking to make their products easier to install and service.  This is not just a recent phenomenon.  Refrigeration piping used to consist of all braised joints requiring skilled technicians to install it.  Technology and a workforce shortage caused manufacturers to introduce quick connect fittings so other mechanical trades could install this equipment.  This trend is not exclusive to the residential side of the business either.

 

According to Kirk Thorne, Executive Vice President of sales, marketing and aftermarket at Daikin Applied, “Unfortunately there is no sign that the tide is turning on the skilled labor market in any quadrant of the industry.  To that end, Daikin’s product portfolio is designed around their customers needs for ease of installation.  We are responding with product solutions that reduce the tasks and requirements for installation and commissioning as well as limiting the requirement for on-site commissioning .  For example, Daikin’s modular central plants are pre-engineered and preassembled, arriving at the site on a trailer, ready for simple installation ” he said.  The article mentions similar comments by executives at Nortel Global, Victaulic and Ruskin.

 

What does this mean for your business?  It means that simply being an installer and servicer of mechanical equipment may not be a sufficient skill set for the future.  It means you need to take a strategic look at your business and plan for its future, not just letting its future happen.  Perhaps you need to expand your skill set to become a full mechanical systems provider for your customers.  One such well-known company in the industry for example handles everything from furnaces to boilers to air-conditioners, heat pumps, air cleaning and filtration devices, humidifier/dehumidifiers, gas fireplaces and inserts, water heaters and standby generators.  They also offer service plans, duct cleaning, electrical service, plumbing services and handyman services.  Other companies have become the energy experts for their customers by offering home energy audits covering everything from efficiency evaluations to air and duct sealing, attic ventilation, renewable energy products and indoor air quality solutions.  How do you begin this transformation of your business?  First, identify the areas that you have a passion for and that represent profitable areas for expansion.  Second, look at your trade area and make a list of all the competitive businesses, the services they offer and   the strengths and weaknesses of each.  From those two things, you can begin to fashion a business plan for your company.

 

According to Monty Betts, product manager for Viega, “While most do not believe that HVAC systems will become plug-and-play devices anytime soon, contractors will have to respond accordingly.  I still do not fully appreciate or understand the depth and breath of changes being considered by manufacturers, but as shown here they are becoming very innovative at designing systems and components to address the lack of skilled labor in the HVAC industry.”


You’ll Kick Yourself If You Miss out on This!

cr-cbstNormally, you look to this column for sage advice on matters relating to home service businesses.  This week however were going to take a bit of an end run on such topics.

 

Callahan Roach Business Solutions is an ardent supporter of the Joseph Groh Foundation, as you may have noticed from our website.  Who are they and what do they do you ask?  They are a 501©(3) Texas public charity which provides (among other things) financial assistance to those who are living with a life altering disability AND who have some kind of connection to the construction trades industry.  That makes them the only organization that we are aware of dedicated exclusively to providing financial assistance to those individuals in need who have made their living in the HVAC, electrical, plumbing, roofing etc. business.

 

The foundation was started by one such individual – Joseph Groh.  After spending 35 years in the HVAC industry, Joe had a freak bicycle accident on Father’s Day 2008 – and that accident left Joe a quadriplegic.  In other words, Joe is completely paralyzed below the shoulders.  In 2009 however he started up the foundation to help others in need, and Callahan Roach Business Solutions was an immediate supporter.  Since that time, the foundation has helped dozens of individuals in states all over the country purchase such items as handicapped accessible vans, rehabilitation equipment, complete home and bath remodels and more.  For more information on this unique organization please visit Josephgrohfoundation.org.

 

All of this brings us to a unique opportunity for you – when you will kick yourself for if you miss out on it.  The foundation has 2 tickets to the Dallas Cowboys-Houston Texans football game on Thursday, September 1 at 8 PM, but these aren’t just any tickets.  These tickets are in club level section C108!  If you were going to get any closer to the action you would have to suit up!

 

These seats normally cost $350 each or $700 for the pair, but the foundation will award them to the first caller who contacts them with a bid of $250 or more – for the pair!  If interested, please call Joe Groh at 214-998-9749.  Shoulder pads not included!


The Internet of Things

By now you have undoubtedly heard the term, The Internet of Things, often expressed as IoT. You may have wondered to yourself what exactly that is and more importantly, what does it mean to those of us in the HVAC industry?

The Internet of Things can be described as a network of physical objects – devices, appliances, vehicles, buildings etc. that are all embedded with electronics, software sensors and network connectivity that enables these objects to collect, exchange, analyze and act on this data. Stop and think for just a minute about the breathtaking implications of that definition. A ubiquitous network of data-gathering sensors communicating through the cloud in constant, real time and instantaneous connection. But what does it really mean?

Picture courtesy of iotworm.com

Picture courtesy of iotworm.com

Steve Case, cofounder of AOL in 1985, can be seen making the rounds of talk shows discussing his new book entitled The Third Wave. With the title, Case pays homage to futurist Alvin Toffler, who published a book by the same name in 1980 and was written as a sequel to Future Shock, which was published 10 years earlier. According to Case, we are entering a new paradigm called the 3rd wave of the Internet. The first wave saw AOL and other companies lay the foundation for consumers to connect to the Internet. The 2nd wave saw companies like Google and Facebook create search and social networking capabilities while a variety of apps leveraged the smart phone revolution. The 3rd wave describes a period in which entrepreneurs will vastly transform major sectors like health, education, transportation, energy, construction and food in ways that fundamentally change the way we live our daily lives. These changes, Case explains, will require a different skill set for employees and will require companies to rethink their relationships with customers, competitors – even the government. How will these changes manifest themselves?

Take our nation’s aging infrastructure. How do we possibly prioritize spending given such massive needs? We could for example, embed sensors into “smart cement” to monitor stresses, cracks and warpages. Sensors in smart cement – the same ones used to detect stress – can also detect ice on the bridge and communicate that information to a wireless Internet in your car. Once your car knows there is a hazard ahead, it will instruct the driver to slow down, and if the driver doesn’t, then the car will slow down for him. In the case of HVAC, sensors in the building, ductwork, thermostat etc. will work in harmony to deliver a ratio of comfort to efficiency not possible today. There is not a single job in the industry that won’t be transformed by such technology, and there are predictions that this future is as close as 10 years away – well within the career span of many people working today.

The entrepreneurs in the HVAC industry are those companies and employees who stay on top of current developments, while preparing for how to monetize on those advances. The opportunities are endless, and much more vast than most of us realize!

Sources: Simon and Schuster; Wired.com


Analyzing Your Income Statement

In the last blog we talked about the benefits of departmentalizing your income statement and the commensurate requirement to set up a purchase order system as well as using weekly coded timesheets for labor.  These last 2 items allow you to properly assign both material and labor costs to the appropriate job and department inside of the income statement.  Let’s say you have now done this – congratulations!  You have taken a most important step on the journey toward developing financial information – not for the accountants or the IRS – but for your use in making management decisions about your company!  Now that you have this information, what is it telling you?

 

To answer this question we must look at some of the ratios.  For example, if we divide our HVAC installation material and equipment cost by our installation sales, we will see what percentage of our installation sales being consumed by material.  For new construction that percentage should run about 35 to 40% and for retrofit about 40 to 45%.  If the percentage is too low, that might be telling us that we are selling too much low end equipment and potentially not enough accessories.  Conversely, if our material costs exceed the upper end of these percentages we could be underestimating our equipment and material costs on each job or might indicate we have a waste or shrinkage problem.

 

What about labor?  If our labor costs exceed 15% of our installation sales, that could indicate that we are underestimating the amount of time it will take to complete a job, or it may indicate that we don’t have a good handle on our true cost of labor, including fringe benefits.  It could also mean that our field staff lacks sufficient supervision to complete work in a timely manner.  Before we leave this topic however we need to address one other key statistic.  Do you know what your warranty labor costs are as a percentage of sales?  This percentage should run 1 to 1.5%. Some additional percentage guidelines are listed below.  Hopefully this begins to give you a feel for how properly reported accounting information can be used to make management decisions that are critical for your company.

  • Cost of service materials to service sales ~ 15 to 20%
  • Cost of service labor to service sales using flat rate pricing ~ <25%
  • Cost of service labor to service sales using T & M pricing ~ <35%
  • Cost of service agreement labor to service agreement sales ~ 35 to 45%

 

Chart Courtesy of Warranty Week.com

Chart Courtesy of Warranty Week.com

Courtesy Of the HVAC Business Dr.


Departmentalizing Your Income Statement

If you have only been getting consolidated income statements like those described in the previous blog, it can be difficult to answer questions such as, should I increase my demand service rates or, am I making enough money doing residential new construction work?  It can be difficult to answer these questions if you can’t isolate the profits associated with doing each different type of business.  In addition, some segments of your business require a greater investment in things like inventory, while others such as your service business, may not be accounting for paid man-hours that are not billable.  These decisions become much more clear when you have a departmentalized income statement.

 

The first step in this process is to identify what the different areas of your business are such as residential new construction, residential replacement, service department etc.  When you are doing this, give some thought to the future.  For example, you may not be doing any commercial replacement business now, but you have been thinking about it.  If that is the case, then set up this profit center now so that it better fits into the flow of your accounting as you move into the future.  Once you have done this, the next step is to set up a purchase order system that will allow you to separate your parts, material and equipment purchases by profit center.  This may mean that you need to place separate orders when ordering equipment destined for installation from service parts when you order from the same vendor.

 

Similarly, you need to separate individual employees labor into the appropriate activity by using weekly coded timesheets.  By setting up new general ledger accounts, you can track the various labor accounts.  As you make these changes in your business, don’t be afraid to do some research and use the professional assistance at your disposal for advice.  For example, your accountant/CPA should be more than someone who just does your taxes.  They should be able to serve as a financial consultant to your company to advise you in such matters.  If they are unwilling or don’t have the expertise, you should find a new accountant or CPA.  In addition, if you use QuickBooks you can find an accountant who is an expert with this system to advise you.  If you use some other form of industry software, contact that vendor to help you devise the best possible system for your business.  After all, you encourage DIY homeowner/service technicians to refrain from diagnosing and attempting to fix their air-conditioning problems by calling experts such as yourself.  Why should your business be any different?

 

The next blog in this series will look at using information gained from departmentalized income statements to make better management decisions.

 

Service Tech: David Hours Worked Total Compensation
Res.  Replacement service 25 $500
Residential installation 6 $120
Svce Agreements 4 $80
Callbacks 2 $40
Res.  Installation warranty 3 $60
Total 40 $800

Sample Timesheet For Service Technician Broken Out By Type Of Work Performed

 

Courtesy HVAC business Dr.

 

 


Understanding the Income Statement

The income statement is, in practical terms, one half of the set of documents that make up your financial statements.  This blog will discuss the elements of your income statement along with the case for cash versus accrual accounting methods.

The income statement tells you whether or not your firm is profitable or not and consists of 3 major sections; the revenue section, the cost of goods section and the overhead expense section. The revenue section is just that, it is a description of the revenues generated for the business that are invoiced or collected as a result of performing the work that your firm does.  This revenue can be broken down by profit center or can be shown as all revenue for the firm.

The cost of goods section is where you show all costs that can be directly attributable to the work performed.  For example, costs shown here would be those for material used, labor performed, subcontractors used, permits taken, items rented etc. – in other words, costs that would not be incurred except for the specific job for which they were.  Again, these could be shown for the firm as a whole or broken down by profit center.

Overhead expenses represent general operating costs that cannot be attributed to a specific job, but are costs shared by all jobs.  Examples include rent, utilities, phones, office supplies, office staff etc.  Note, these expenses must be paid even if there is no revenue!

Understanding the Income Statement

Example courtesy of slidepayer.com

There are 2 types of accounting systems used to record these activities, the cash method and the accrual method.  Both measure profitability for a specific period of time, but vary in one important aspect.  The cash method records a sale when the money was received, and an expense when the bill is actually paid.  Therefore, if you ran a COD service call in August and replaced a homeowners compressor, the revenue would be recorded in August but the expense for the compressor you purchased from a vendor may not be shown until it was paid for, perhaps September or October.  In contrast, the accrual method accounts for activity during the time period in which it happens.  So for example, with the accrual method both the revenue and expense for the service call described above would be accounted for during the month of August, regardless of when the invoice for the compressor was paid.  Why would you choose one over the other?  In general terms, the cash method is simpler to execute and easier to understand while the accrual method offers a truer picture of profitability.  In addition, if your business maintains inventory, is a corporation or has gross revenue in excess of $5,000,000 per year, you are required to use the accrual method according to the IRS.

The next blog in this series will look at departmentalizing the revenue and cost of goods section of your income statement.


Is the HVAC Industry Still Doing This?

A Contractor Actually Installed This Furnace Exhaust!

A Contractor Actually Installed This Furnace Exhaust!

It was not uncommon in the last century to see a news sting on TV of an HVAC contractor caught in the act of ripping off a customer.  It was a real irritant to everyone who made an honest living in the HVAC industry because it gave us all a black eye.  Manufacturers, distributors and contractor associations such as ACCA made a concerted effort to get rid of this behavior in their midst.  I can’t remember the last time I saw one of these news stories showcased on the local news.  It appeared that perhaps at last, we had as an industry, put this behavior behind us.  Apparently that is not the case.

 

The most recent issue of the ACH & R news featured a guest article by Butch Welsch, a St. Louis area contractor, where he says he is seeing an increasing and discouraging trend of contractors using unethical tactics.  He cites two of them that are pretty hard to even imagine.

 

The first was of a lady who called and said that a contractors service technician had condemned her furnace because it had holes in the heat exchanger.  He had red tagged the furnace and told the lady if she ran it it could kill her.  When Butch’s technician went out he found a 17-year-old furnace with a heat exchanger that lacked even a speck of rust.  Although the technician attempted to ensure the lady the furnace was in really good condition, she had been scared to the point where she wanted the furnace replaced.  Following the replacement, the old furnace was returned to Butch’s shop where they had the heat exchanger removed and thoroughly checked out.  There was absolutely nothing wrong with it.  This is

a-typical of the kind of stories you used to see on the local news channel and it is despicable, but if you think that’s bad, read on.

 

The second story begins when one of Butch’s salespeople showed up at an appointment to give a couple a price on a new furnace.  When they arrived there was a truck from another company in the driveway, so not wanting to be rude the salesperson waited in his car.  After 30 minutes, the salesperson decided he had waited long enough and knocked on the door.  As he attempted to apologize for interrupting, the lady of the house apologized profusely saying “I can’t get rid of him.”  The couple went with Butch’s sales engineer to the basement to inspect the furnace, but the other salesperson refused to leave – sitting on the couple’s living room sofa the whole time.  When Butch’s sales engineer had finished looking at everything, the lady finally got tough with the other salesmen and asked him to leave.  This kind of behavior is not only totally unprofessional, it is downright embarrassing to the industry!

 

If you know of a contractor in Texas who is exhibiting behaviors such as those described above, report them to the Texas Department of Licensing and Regulation, regardless of whether they are licensed or unlicensed.  The link to their website is below. We should all pledge to drive this kind of behavior out of our industry once and for all!  https://www.tdlr.texas.gov/Complaints/

Courtesy of Contracting Business Magazine


If You Were Fired – Would You Be Missed?

If You Were Fired - Would You Be Missed?

Courtesy of blogging4jobs.com

A couple of years ago there was a great article in the ACHR News that asked the question, what makes an employee indispensable? One employee that I used to know said the secret was to be like a blade of grass – keep your head down so it doesn’t get chopped off. That strategy however would suggest that you blend in, fly under the radar, not stand out, fit in, in essence – be an average employee!

 

The article then referred to a post by Joe Crisara of ContractorSelling.com who posed the question that is the title of this blog. Joe suggests that rather than being invisible, you should strive to be indispensable. He further pointed out that being indispensable is a three-legged stool which includes the traits of being the go to expert, having customers who are your fans and bringing home the bacon. Joe went on to explain in his post that being good with customers is not enough if you have callbacks, and that being technically sound is not enough if you are not good with customers.

 

Being a good employee means that you have to put yourself in the mindset of your employer or supervisor. Do you know what their goals are and how they are being measured? If you don’t know, you should ask. Furthermore, look at those employees in the organization who are succeeding and who are getting the promotions. Observe their behaviors and see what it is that makes them successful. Often times, you will likely see that they are the people who tackle the tough jobs, not the easy ones. You will also likely find them to be among the first to lend a hand to a coworker who is having difficulty with something, and a common denominator of these individuals is that they have a positive attitude about both their job and the company. Finally, the successful individuals in any organization are not ones who look at their job as an 8-5 proposition. They are the ones who work to better themselves by becoming a knowledge expert, studying after hours in an effort to hone their expertise. When you’re amongst the 80/20 crowd, be the latter, not the former!