# Back to Basics: Financials

*Part 5 of a 6-part series. See Part 1 (Marketing), Part 2 (Selling), Part 3 (Damage Analysis) and Part 4 (Track KPIs).*

In the Back to Basics series that began in the November 2010 issue of *BodyShop Business*, we’ve looked at marketing (everything you do to bring a customer to your door), sales (getting the customer to sign the RO), damage analysis and production concepts. Now, it’s time to understand your financials better.

**We’re In Business
**

Most of us are really good at repairing collision-damaged vehicles. But boil it down, and the fact is that we are in business. How well we do in business is measured by the company financial statements.

Think of it this way: Everything we do in our business is reflected in our financial statements. Sure, we fix cars and trucks. But the end result of everything we do is how big or small the number is at the bottom of our financial statement. We could be the best repair shop for miles in any direction, but if the number at the bottom of a financial statement is red or has brackets around it for any extended period of time, we’ll be closed by our creditors.

As body shop owners and managers, we need to spend as much time reviewing and understanding our financials as we do understanding unibody construction and repair, refinish systems and negotiations with insurance adjusters. Remember, bad financials can put us out of business.

In this article, we’ll look primarily at the profit and loss statement and some Key Performance Indicators (KPIs). We’ll also spend a few moments with the balance sheet as well as consider some suggestions for using a management system.

Remember that this is a “Back to Basics” article. I strongly suggest you pursue a much deeper understanding of your financials than what can be presented in this article.

**Basic Definitions
**

The best way to understand your financials is with some basic definitions.

**Cash accounting vs. accrual accounting**: There are two accepted methods of accounting, cash and accrual.

Cash accounting recognizes sales when the check is deposited and expenses when the payments are made. Accrual accounting recognizes sales when the vehicle is delivered to the owner and expenses when the invoice is received.

For collision repair, accrual is the only way to go. Collision repair facilities have accounts receivable and payable, work-in-process, reserves for taxes due and many other items that are recognized in accrual accounting but not in cash accounting. Review your financials with your accountant to make sure your financial statements are “fully accrual based.”

In my consulting work, I’ve seen many financials that were something in between cash and accrual. That just doesn’t work.

**Profit and loss statement or P&L **(aka income and expense, operating statement, income statement, etc.): The P&L is the basic financial statement for tracking how the business is doing from a sales and expense standpoint. The P&L accounts for revenue and expense by department, or profit center, and overhead over a period of time, usually a month and year.

The basic structure of the P&L is simple: Total Sales — Cost of Goods Sold = Gross Profit — Overhead = Net Profit

It’s important to have a properly formatted P&L. Check out the sample P&L for a shop doing about $2 million per year. Notice how sales are broken into separate categories, or profit centers. Note that cost of goods sold (direct cost) is broken into the exact same categories. The rule is that for every sales category, you must have a corresponding cost category.

Note how overhead expenses are listed individually. In this sample, all payroll-related benefits and taxes are carried as overhead (“below the line”). That makes this an unloaded P&L, the most common format in the collision repair industry.

**Balance sheet**: The balance sheet is a statement of what the company owns and owes, as of a moment of time. The balance sheet lists assets, liabilities and net worth for the company. Total assets must equal (balance) with total liabilities plus net worth. Bankers use formulas generated from the numbers on a balance sheet to determine if a company is strong enough to obtain a loan.

**Key Performance Indicator** (KPI): KPIs are numbers, formulas or ratios generated from the P&L or other business data which can be used to compare one shop’s performance to another shop’s or a group of shops’.

**Gross profit dollars**: The amount of money left over after subtracting the direct cost of the product (the cost of labor, parts, paint, sublet and anything else that went directly into the repair) from the sale. Gross profit may be calculated by profit center or overall. It may also be calculated by the individual job.

**Gross profit percentage**: This is a key driver behind many KPIs used to measure performance and is a statement of gross profit dollars converted to a percentage. Like gross profit dollars, gross profit percentage can be calculated by profit center, job, day, week, month or year. The math is always the same:

(Sale – Cost) / Sale x 100 = GP%

**Look at the sample P&L by clicking here to download it.** For illustration purposes, gross profit percentages are listed by profit center in the righthand column. You generally won’t find that information in a P&L – you need to calculate the number yourself. But it’s easy!

To calculate Sample Autobody’s body labor gross profit percentage for the month of December, subtract body labor COGS from body labor sales, divide that by body labor sales and multiply by 100:

($51, 700 – $18,950) / $51,700 x 100 = 63.35%

Departmental gross profit percentages are important KPIs.

**Breakeven point** (BEP): This represents that magic point in time when accumulated gross profit percentages equal overhead for the month.

Look again at the sample P&L. Overhead is all of those expenses that you would have to pay even if you didn’t repair a car. To calculate BEP, divide overhead by the current gross profit percentage, usually for a month. Sample Autobody’s BEP for December is:

Overhead of $58,894.41 / GP% of 39.73% = $148,236.63

That means that Sample Autobody must sell $148,236.63 per month to cover overhead.

**BEP in days**: Calculating BEP in days is useful for many. The math is simple:

BEP / average daily sale = BEP in days

For Sample Autobody, let’s assume that there are 20 working days in a month. The shop is selling $164,265 per month, so the average daily sale is $8,213.25 ($164,265 / 20). Therefore, the BEP in days is:

$148,236.63 (BEP dollars) / $8,213.25 (average daily sale) = 18.05 days

In other words, it takes Sample Autobody 18.05 days to break even. That means Sample Autobody only generates net profit on the 19th and 20th day of the month! What happens in November and February? Those nasty, short months may only have 16 or 17 working days. For Sample Autobody, there is simply not enough time to break even and it will lose money in those months.

Know your breakeven point! Get there as quickly as possible, then keep pushing to maximize profit. Understand that net profit is only generated once breakeven sales have been achieved. If it takes 18 days to break even, find a way to reach breakeven in 17 days, then 16 days!

**BEP reduction**: The BEP formula has only two variables, gross profit percentage and overhead in dollars.

There are two ways to reduce BEP. Remember, we want to get to the BEP number as quickly as possible, so we can increase gross profit percentage or reduce overhead dollars.

Example 1: If we can increase gross profit percentage from 39.73 percent to 41 percent, breakeven point is reduced to $143,644.91 ($58,894 overhead / 41%) and our BEP in days is reduced to 17.49 (BEP of $143,644 / $8,213 average daily sale).

Example 2: If we can reduce overhead by $3,000 from $58,894 to $55,894, BEP is reduced to $140,755 (new overhead of $55,894 / gross profit percentage of 39.73%). BEP is now 17.14 days.

Hint: To reduce your breakeven point, look at every line of overhead on your P&L. Each line has a human attached. Negotiate every line. Find a series of small reductions in overhead expenses to achieve a significant reduction in BEP.

**Profit sales**: Face it, we’re not in business to break even. We want to make money! Understanding financials can tell us what we have to do to make a target profit. Ask, “How much do I need to sell to make ‘X’ amount of dollars in net profit?” That question is answered with the concept of profit sales.

To determine the amount of sales required to achieve a target net profit, simply add the target net profit to overhead and divide by your current gross profit percentage.

Sample Autobody has a monthly net profit of $6,366.14. How much must Sample Autobody sell to achieve a net profit of $12,000? We’ll assume that there will be no change in gross profit percentage or sales mix:

Current overhead of $58,894.41 + target net of $12,000) / current gross profit percentage of 39.73% = $178,439.47

Sample Autobody can net $12,000 instead of $6,366 by increasing sales from $164,265 to $178,439. It doesn’t seem real, but it is. That’s because once we “break even,” all of our gross profit dollars fall to the bottom line. Many call that “post-breakeven sales,” and those are really good! In this case, we nearly double our net with an 8.5 percent increase in sales.

**By the Numbers
**

Keep in mind that we’ve only scratched the surface of understanding our financials. But by understanding the proper layout of our P&L statement and understanding BEP and profit sales, we can begin to drive our business “by the numbers.”

In the example above, we found that we could increase our net profit to $12,000 per month by increasing our monthly sales from $164,265 to $178,439. That $178,439 is a sales goal. The first step in achieving a goal is to write it down and share it!

Create a scorecard, breaking the sales goal into daily sales. In this case, $8,921.95 per day for 20 days will achieve the goal. You could even state that goal in ROs per day if the average RO is known.

Let’s say our average RO (total sales / number of ROs) is $2,400. That $178,439 sales goal could be stated as 74.4 ROs for the month, or 3.72 ROs per day. If we have two estimators, that’s less than two ROs per day each to achieve the new sales goal. By the way, achieving that new sales goal will provide $12,000 in net profit!

**Producing the Work
**

Once we sell the $178,439 in repair, we have to produce the work. From the P&L and our new sales goal, we can determine production goals as well. Our sales goal of 3.72 ROs per day is also a production goal, which may be posted, measured and monitored on a daily basis. But let’s dig deeper.

From our P&L, we can see that labor accounts for 48.03 percent of our total sales. If we increase our sales to $178,429, it follows that labor sales will be 48.03 percent of the $178,439, or $85,699.45 instead of the current $78,900. Divide the $85,699 labor sales target by your average door rate (let’s use $45) to determine the total number of sold hours required ($85,699 / $45 = 1904.4) to hit our goal. From that number, we can determine the overall daily hours target (1904.4/ 20 days = 95.23 hours / day).

By understanding our financials, we set a sales goal which is driven by how much net profit we want to see on the bottom line of our P&L. From that number, we can drive the numbers down to how many hours must be produced per day. In our case, it’s 95.23 hours. That number can be further divided so that each technician knows how many hours he or she must produce each day to help achieve the company’s overall goal.

**Real World
**

As I mentioned before, we’re only scratching the surface, but the transition outlined above represents a major move for many repairers. To make it happen in the real world takes some work.

First, make sure your P&L is properly formatted. Just like a mixing scale must be calibrated, the P&L must be properly formatted to be a useable tool. Sit down with your accountant with this article and begin to understand how the P&L is built, then format yours so that it may be properly used. Use Sample Autobody’s P&L as a guideline.

Once you have a good P&L, work with your accountant to build a spreadsheet model of your P&L. Then you can play “what if” games to fully understand how the numbers flow and how to impact the numbers.

Work with your accountant to build good “pro-forma” P&Ls, or forecast P&Ls that take today’s information and carry it into the future.

Want to go deeper? Build “cash basis pro-forma P&Ls” to use as future cash flow statements. Believe me, you’ll know your numbers!

**The Balance Sheet
**

An entire article, a day in fact, could be spent on the balance sheet alone. These statements, a snapshot of the business as of a date in time, are generally used by bankers to determine if a business warrants a loan. Should you ever decide to sell your business, the balance sheet is very important.

IRS auditors look at balance sheets, too. I once learned an expensive lesson when I was penalized due to an understatement of inventory on my balance sheet.

Most balance sheet errors are due to improper format. The balance sheet must be “fully accrued” and include all assets and liabilities. Frequently, work-in-process and inventory aren’t included in a collision business balance sheet, but these are large assets that should be included in the formulas used by bankers and IRS agents to evaluate the business.

**Management Systems
**

If you’ve been reading the “Back to Basics” series, you’ve learned about the importance of management systems. These wonderful tools provide a wide array of measurement capabilities ranging from marketing and sales to accounting functions.

The baseline benefit of using a management system is the ability to job cost every job. Job costing, in effect, is creating a P&L for every job, every day. The implementation of a good management system catches cost and profitability issues while the vehicle is in the shop and you can do something about it. Job costing is the basic function of a management system and the key to understanding your financials.

The ability to understand financials and drive the business “by the numbers” is how truly successful collision repair facilities get ahead and stay ahead in our rapidly changing industry.

__Download the sample P&L statement__

*Hank Nunn worked in the collision repair industry in a variety of roles for more than 35 years. He is now retired. If you would like more information on the subject you just read about, email BodyShop Business Editor Jason Stahl at [email protected].*