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Use Your P&L As a Tool, Part I

Need to know what to do to increase profits? How many ROs to sell? Your profit and loss statement can tell you all that.

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Hank Nunn is a 35-year collision industry veteran. He is now retired.

P&LCollision repairers are, by nature, tool people. We understand wrenches, welders, scales, hammers, dollies, grinders and the rest of the tools used in the auto body business. But few understand the use of a Profit and Loss (P&L) statement as a tool.

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This tool, like most tools, goes by several names. Some call it the P&L, while others call it a Statement of Income and Expense. In a dealership, it’s called the operating statement.

No matter what you call it, the P&L should be viewed as a wonderful tool! It can tell you what you have to do to increase profits, exactly how many ROs your sales team needs to sell, how many body and paint hours will need to be produced and how much you can pay for those hours to achieve your profit goals. The P&L can also tell each technician how efficient he needs to be in order for your company to achieve your overall goal.

In this article, we’ll look at formatting and calibrating the P&L so that it may be used as a tool. In ensuing articles, we’ll uncover some of the magic hiding in the P&L.

History

Like many in the collision repair industry, I began using the P&L reluctantly. I opened my first shop in 1980 as a partnership. For me and my partner to pay ourselves, we “drew against the net,” simply writing ourselves a check. After a couple of months, we hired an accountant to keep our books as we needed to keep track of income and expenses, primarily for tax purposes. Being “smart” business people, we hired the cheapest accountant we could find.

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The accountant took information from our checkbook and sales ledger and created an initial P&L and balance sheet. That system worked just fine…until we needed to borrow money to buy a frame rack on credit. The banker pointed out that our balance sheet had no receivables. So we went to the accountant and asked him why our statements didn’t have receivables.

The accountant asked us how much people owed us.

“Insurance companies owe us $10,000!” I responded.

He entered $10,000 as receivables into our financials, we took that to the bank, the bank gave us a loan and we bought the rack.

To me, the P&L in those early years was something I looked at once a month when the accountant told me how much I had to pay for taxes. I would look at the statement and, if the last number was black and didn’t have brackets, it was good. Then, I would grumble about paying all those taxes. I hated my accountant. He only brought bad news.

Later in my business life, I discovered just how wonderful the P&L is when used as a tool.

Warnings

Warning No. 1: Most of us are not able to make changes to our P&L, and most of us will need help, primarily from an accountant or controller, to fully realize the power of the P&L. Don’t be afraid to ask for help! If your accountant isn’t comfortable working with you and your P&L, find a better one.

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Warning No. 2: Dealership shops! If you’re in a dealership, your accounting is done through the dealership using dealership software. The collision center is generally given an operating statement instead of a P&L. We’ll be using an independent P&L format for our illustrations. You can do all of this in a dealership!

You’ll need to work with the controller to find the right numbers within the operating statement. Hint: Work with the controller, but leave them alone during the first seven days of each month.

Take a look at the sample P&L. There is simple math involved in the generation of the P&L. The P&L begins with a breakdown of sales into the separate sales categories (profit centers) for a collision center. Next, direct costs (or expenses or COGS) are broken down. Sales – Direct Costs = Gross Profit. Following gross profit, overhead is itemized and subtracted from gross profit to arrive at net profit.

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We’ll look at each section below. Remember, the P&L is a look at the past performance. When you look at your P&L, you’re looking at what your business did last month, last quarter or last year. To really use the P&L, you’ll need to use it to look into the future, set goals and develop a budget. Unfortunately, most P&Ls are not properly formatted and cannot be properly used as a tool. So the P&L needs to be properly formatted and calibrated.

Calibrate Your P&L

Remember centerline frame gauges? Before you hung them, you slapped them together to make sure they were properly centered. Don’t you zero the mixing scale before mixing color? Most tools need to be properly calibrated to work properly.

To use your P&L as a tool, it needs to be calibrated. It needs to be properly formatted with sales and expenses in the proper categories.

There are two accepted methods to calibrate or generate financial statements: cash and accrual.

My initial P&L, back in 1980, was a cash-based P&L. In cash-based accounting, sales are recognized when the money comes in and expenses are realized when the money goes out. Our accountant took our checkbook and sales ledger to create our statements. Cash-based accounting does not recognize receivables or payables, and it does not recognize incurred liabilities such as taxes payable.

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In accrual accounting, sales are recognized when the product is delivered and expenses are recognized when the invoice is received. It recognizes receivables and payables as well as reserves for taxes and other liabilities that don’t show up in cash accounting.

Remember how my accountant simply added a $10,000 receivables asset to my balance sheet? In doing so, we moved out of cash accounting by inserting an accrual accounting item, which is not accepted in cash accounting. So, my books were no longer cash-based, but they were not fully accrual-based either. To calibrate your P&L use accrual-based accounting, making sure all assets and liabilities are contained in your financial statements.

Calibration: Loaded or Unloaded?

Collision centers sell labor. Hopefully, you sell a lot of labor as it is the primary profit center in most shops.

It’s a unique item on the cost side as there are many related expenses incurred when labor is paid. When a technician is paid, social security, worker’s comp, medical insurance and many other expenses are also incurred. Where you place those expenses on your P&L is important in the structure of your P&L.

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Accounting principles state that payments to productive employees and all related expenses should be considered as a “direct expense” or “cost of goods sold.” If you itemize all labor-related expenses as direct costs, then you’re using a loaded P&L as all labor expenses are loaded into direct expenses. If you carry all of those labor-related expenses as overhead items, your P&L is unloaded.

Check your P&L to make sure it’s either loaded or unloaded. One or the other is fine, but there are many out there that have some items listed as direct expenses and others listed as overhead.

Most KPI benchmarks available to the industry utilize an unloaded format. If you’re in a dealership, you’re working from an unloaded format. We’ll discuss KPIs next month.

In the examples to follow, we’ll use an unloaded P&L to illustrate the use of it as a tool.

Calibration: Format Your P&L

Take a look at Illustration No. 1, the basic P&L. For the purpose of this article, the P&L is condensed so that it can fit into the pages of BodyShop Business. Compare your P&L to the sample. One feature has been added to the sample P&L: gross profit percentages for each sales category, or “profit center.” We’ll look at that more later in this article.

CS_illu-1ALook at the sales section of the P&L highlighted in Illustration 1A on pg. 40. Sales are broken down into the different categories generally sold in a collision repair center, but keep in mind you can certainly have more sales categories. In our example, there are OEM and “other” parts. You can add more parts sales categories such as used parts, aftermarket parts and misc. parts. OEM parts may be broken down into foreign and domestic or even by make.

Labor sales are shown as body, paint and other labor. More sales categories may be added such as detail labor, structural labor and mechanical labor.

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Materials sales are shown as paint materials, body materials and misc. materials. In your shop, you can certainly break it down further; it’s up to you.

In our sample, “Sublet and Misc.” sales represent towing, storage, hazmat and sublet sales, all of which could be broken down into individual sales categories.

Next, look at the direct cost categories, as highlighted in Illustration 1B (this page). Remember, direct cost can go by different words such as Cost of Goods Sold (COGS) or simply “expenses.” These are the cost of items that go directly into the product or, in a collision center, the items directly associated with the repair.

CS_illu-1BNotice that there is a cost category for each of the sales categories. This is mandatory! If you don’t have a corresponding cost category for each sales category, you cannot calculate gross profit percentages for each sales category. If you decide to break your parts sales down into foreign and domestic parts, you must break your cost categories into the same categories.

In our example P&L, materials sales and expenses are broken into paint materials and misc. materials. One of the most common problems in collision center P&L format is the posting of materials sales and material expenses.

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Example: An estimator sells seam sealer as a $20 part. The seam sealer is purchased from the local jobber for $15 and included in the jobber bill. The shop pays the jobber bill and posts the entire bill to paint materials. In this example, the seam sealer is sold as a part, but the cost is shown as a paint material. Parts profit is overstated by $20, and paint materials cost is overstated by $15. Multiply that by the hundreds or even thousands of similar items going through a collision center each year and you can see why paint materials profitability is such a problem. Much of the problem is based on similar incorrect posting of sales and expenses for parts and materials.

Getting back to the example P&L, Total Sales – Direct Expenses = Gross Profit. Gross profit may be stated as a dollar amount and as a percent of total sales. This gross profit percentage is a key driver for many collision center KPIs. Gross profit percentage may be calculated for total sales or for any of the profit centers. In each case, the math is the same:

GP% = (Sale – Cost) / Sale x 100

In the sample P&L, the gross profit is calculated for each profit center.

CS_illu-1COverhead is the next item on the P&L and is shown in Illustration 1C (this page). Overhead expenses are those expenses that are not directly involved in the creation of the product, a repaired vehicle. Overhead items include rent, lease payments, utilities, laundry, benefits and taxes as well as all of the other small items involved in running a collision repair center. The amount left over, after overhead expenses are paid by gross profit dollars, is net profit.

One of the common problems with the statement of overhead comes from the manner in which the owner pays himself. Remember how my partner and I were paid back in 1980? We wrote a check to ourselves every Friday. “Drawing Against The Net” is a common way for owners to pay themselves as it’s simple. In my 1980 shop, there was no labor cost as all of the work was produced by the owners. Our net profit percentage as shown on the P&L was huge! But we drew most of that out as owner’s draws.

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In a working collision center, the owner’s compensation – when the owner is involved in the operation of the business – should be an overhead payroll item along with the associated taxes and benefits.

Homework

Yep, homework. Compare the format of your P&L to the sample P&L accompanying this article. Is your P&L properly formatted? Are there appropriate sales categories with matching direct cost categories? Are your financial statements fully generated using the accrual method of accounting? Are paint material sales and expenses properly posted? Is your P&L loaded or unloaded? How is owner’s compensation handled? Do you have a management system? Are sales categories coming from the estimating platform being automatically posted to the correct sales category in the management system? Is that date flowing properly into your accounting package?

To be able to use your P&L as a tool, it must be properly formatted and calibrated. To do so with yours may take some time and effort and frequent collaboration with your accountant as well as your management system provider.

Next month, we’ll use the sample P&L as a tool to set goals and production targets, budget and make more money!

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To continue on to Part II, click here.

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