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Knowing both your direct and overhead costs is key to improved profitability.
Many years ago, I was a claims adjuster in Santa Clara, Calif. It was during that time that I learned the value of knowing and understanding your cost and profit structure from a lesson taught by a collision industry veteran who really knew his numbers.
As usual, I arrived at the shop, was handed a copy of the shop’s estimate, inspected the damaged vehicle (a brown 240Z), made a few “adjustments,” ran a tape on the adjusted estimate and sat down to issue a draft. The owner placed his hand on mine and said, “Don’t do that yet. Let’s enter that into the computer.”
He came back a moment later and said, “It’s not good enough. There isn’t enough money in the job for me. Let’s look at the car again and see what else we can find. Or you can take it somewhere else.”
He pointed out P-page items that had been improperly deleted and some other operations that had been missed such as burn damage, underside refinish and blending. I added those to the estimate and he “entered it into the computer” again. He finally accepted the job.
Until that day, I had never seen a computer in a body shop. The owner simply loaded the estimate totals into a program that projected profits for the repair. If the projected gross profit percentage was not 44 percent, he refused the job. He understood his costs and used that information to generate additional revenue
Warning! I do not recommend the above as a negotiation technique in today’s collision environment. I only recounted the experience to illustrate the importance of understanding costs.
In collision repair, just as in any business, the key driver is profit. If there is no profit, there is no business! Collision repair facility owners and managers must generate profit. And the formula for profit in a collision repair shop is the same as in any business:
Sales – Direct Cost = Gross Profit
Gross Profit – Overhead Cost = Net Profit
A clear understanding of costs is critical to getting to a healthy net profit number. The above math forms the basis of a collision center’s profit and loss (P&L) or operating statement.
Cost also factors into the generation of Key Performance Indicators (KPIs). Knowing and understanding your gross profit percentage (GP%) is vital to successfully running any business.
GP% may be calculated for the business as a whole, or by profit center such as body labor, paint labor, parts, paint, etc. Sales and direct cost (the price of labor, parts, paint, etc.) are used in the calculation of GP%:
GP% = (Sale – Cost) / Sale x 100
Example: A shop sells $1,000 in parts. The cost of the parts is $700. GP% = ($1,000 – $700)/$1,000 x 100 = 30 percent. The shop has a 30 percent GP% for these parts.
Overhead is the ongoing cost of running a business that cannot be attributed to a sale. In collision repair, overhead is rent, insurance, lease payments, utilities and other expenses that cannot be directly assigned to an RO. Overhead is shown on the P&L as the summation of these expenses. Dealership collision centers may have different methods of calculating overhead, so dealership managers should work with their controllers to find their overhead costs.
There are many overhead items in every business. Remember, each line of overhead on your P&L is someone else’s sale. Many feel you can’t do much about overhead, but you can. Virtually all overhead expenses are negotiable. There should always be a focus on the reduction of overhead cost. Why? Let’s look at breakeven sales.
Breakeven sales is the point at which the accumulated gross profit dollars = total overhead expense for a month. At breakeven, there is no profit, there is no loss. At that sales point, the company “breaks even” for the month. The business only generates a net profit on those sales that happen after breakeven is achieved.
Breakeven may be calculated by dividing overhead by GP%.
Example: A shop has overhead of $50,000 per month and a GP% of 38 percent.
Breakeven sales = $50,000/38% = $131,578.95.
The shop must sell $131,578.95 to break even.
If the shop is selling $150,000 per month, it’s generating net profit on the last $18,421 of sales each month!
Let’s say that management has decided to look at each line of overhead on the P&L and negotiate better deals on rent, insurance, uniforms, etc. They’re able to reduce total overhead by $3,000, from $50,000 to $47,000. What happens to breakeven?
$47,000/38% = $123,684.21.
That $3,000 reduction in Overhead results in a reduction of Breakeven of $7,984.74. With sales holding at $150,000, the shop is now generating net profit on $26,315.79 of post-breakeven sales.
Breakeven also may be applied to the decision to purchase a new piece of technology or hire an additional person. The concept is called “investment breakeven” and answers the question, “If I pay this much for this tool, how much do I have to sell to pay for it?” Simply divide the “investment” by your overall GP% to determine this.
Example: The shop owner wants to buy a tire machine, and the cost is $4,000 and GP% is 38 percent. How much additional sales must be generated to pay for the tire machine? Divide the $4,000 investment by the 38 percent GP = $10,526.31. The shop must generate $10,526.31 in additional sales. Improved efficiency or the opportunity to maintain work “in-house” may be additional advantages. But one way or another, you need to generate that $10,526 in sales or improve efficiency to cover the cost of the investment.
The Cost of a Stall
When asked, “What is the cost of a stall?” most respond by dividing the monthly rent by the number of stalls. That’s not quite correct. Think about it. Those work stalls are where all revenue is generated for the business. Everything runs off billed labor hours. Those billed labor hours are generated in the work stalls.
To calculate the monthly cost of a stall, divide total overhead cost by the number of stalls. Let’s use the example shop above. It has eight stalls. Monthly stall cost = $50,000 (overhead)/8 Stalls = $6,250. If the shop is open 20 days per month, the stall cost per day would be the monthly cost ($6,250) divided by 20 days, or $312.50. If the shop is open eight hours, that’s $39.06 per hour.
Think about it: that stall sitting empty or with a vehicle waiting for parts is costing $39.06 per hour! A stall is a place to generate billed hours. If it’s not being used to generate billed hours, is still has a cost! In this case, it’s $39.06 per hour.
Calculate your shop’s stall cost by month, day and hour. The cost can decrease by using the stall more hours per day or more days per month. If this shop worked four hours on Saturday and was open 10 hours per weekday, the stall cost per hour would be reduced to $28.40!
An empty stall has more than overhead expense assigned to it. The lost sales expense of an unused stall is staggering.
Assume a door rate of $50 per hour, a 150 percent labor efficiency ratio and 50 percent of gross sales are labor. What sales could be generated in an eight-hour day? 8 hours x $50 per hour x 150% efficiency = labor sales x 2 to account for parts, paint and miscellaneous = $1,200 in sales per day per stall. If the GP% is 38, the lost gross profit opportunity for an unused stall is $456!
Add the $456 in lost GP opportunity to the overhead daily cost of $312.50, and the total cost of a stall in our example is $768.50 per day or $96.06 per hour in an eight-hour day. Keep those stalls full and working! A vehicle sitting idle in the shop waiting for parts or a re-inspection is costing our sample shop $96 per hour!
Direct costs are those costs that may be directly assigned to the individual job or RO. Other words may be used such as variable expense or cost of goods sold, which are the cost of generating the product. In a collision repair shop, it’s the cost of labor, parts, paint, materials, and sublet items and operations.
Above, we looked at the formula for GP%: sale – cost) / sale x 100. If we want to increase GP dollars or percentage, we have two choices: increase sales or reduce costs.
When looking at parts, the discount we receive will be our GP%, as long as we’re being paid for the part. Giving away little stuff like clips, sound pads, sealers adhesives, etc., directly hit profitability. Step 1: Sell the stuff and quit giving it away! Step 2: Know your cost of these items!
Example: I have audited many estimates that show a “door skin adhesive” as a miscellaneous part sale of $12. Look at your invoices and find your cost of “door skin adhesive.” I bet it’s in the $40 range, and we sell it for $12?
True Cost of Labor
Labor is the biggest profit center in any collision repair facility. If you don’t sell body labor, you don’t sell parts. If you don’t sell paint labor, you don’t sell paint or materials. Labor is the biggest sales category and the biggest cost category!
Understanding the “true cost of labor” is vital knowledge for any owner or manager. The hourly wage, commission or flat rate we pay does not represent the true cost of labor. In addition to that hourly wage or flat rate, the employer’s share of social security and other federal, state and local wage-based taxes must be paid. Worker’s comp is paid based on wages. Add in other benefits such as health care, vacation, sick pay, holiday, uniforms and company 401K contributions. Total all of these items up, and you’ll discover your true cost of labor is far above the base pay. Generally, the true cost of labor will be 30 percent to 40 percent higher than the base pay rate.
For our example, let’s use 35 percent. That $20-per-hour flat-rate employee costs $20 for each billed hour produced. They also cost an additional 35 percent of the $20 per billed hour to pay for taxes and benefits. So, the true cost of this technician’s labor is $20 + ($20 x 35%) = $27 per hour.
Many shop owners feel that paying a flat rate or commission that equals 40 percent of the door rate will result in a 60 percent GP%. In our example, with a $50 door rate, that would seem to be true because the $20 flat rate is 40 percent of the $50 door rate, which yields percent 60% GP.
But let’s use the true cost of labor instead as the base rate:
($50 sale – $27 True Cost) / $50 sale x 100 = 46% GP
Instead of enjoying a 60 percent GP on labor, this shop has an actual labor GP% of 46 percent.
This is a common situation! Most don’t see it because the numbers are poorly formatted in the company P&L, with many of those costs being shown as overhead items. P&Ls may be “loaded” or “unloaded,” with the difference being how labor-associated expenses are assigned. Work with your accountant or controller to discover your true cost of labor.
Warning! I am not saying cut your flat rate or hourly rate to technicians. If your labor GP% is not 60 percent using the true cost of labor (it should be), then look for ways to produce the product for less cost. Some examples of actions that will increase labor GP% are: mixing hourly and flat-rate technicians, pay based on required skill level or increasing door rate at one level and increasing flat rate at a lesser level. Those are just a few! There are many others.
Don’t forget the true cost of labor when making decisions about hiring. Remember the “investment breakeven” discussion earlier. If the “investment” is an additional employee, factor in your true cost of labor number into the investment breakeven calculation.