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Perplexed by Profits

Today’s collision repair business is more complex than ever, yet most shop owners still don’t understand an elementary principle of business: profit. If you really want to make money, quit acting like you’re running a non-profit organization.

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Think back. Do you remember why you went into business for yourself? Maybe you didn’t like your old boss. Or maybe you didn’t like how it seemed he made all the money while you got just the crumbs. Or maybe you knew you could do it better.

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Fast forward to today: It sure isn’t as easy as it seemed, is it? The market has been changing rapidly — and it appears it will continue to do so — while pressure to do more for less is coming from all angles, not just from insurers.

Without a doubt, today’s collision business is a complex model of interactions and transactions. What’s unfortunate is that many shop owners still don’t understand one of the most elementary principles of business: profit. They seem to think it’s something that shouldn’t be discussed — as if it’s some sort of four-letter word that should never be uttered (it’s actually a six-letter word).

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This way of thinking isn’t productive or business minded. Profit is one of the primary indicators of a successful transition from start-up business to stable, healthy business enterprise. Without profit, why be in business? You aren’t running a public school system or a non-profit organization! You’re running a business — so start acting like it.

Some of you may be thinking, "Hey, where’s he get off telling me how to run my business? I’ve been doing just fine all these years without his advice."

That may be true. But, again, times are changing. I’m not saying this applies to you, but time and time again, I’ve seen shop owners and managers become successful in spite of themselves. They’re hard working and possess a great internal sense of profit without having sufficient information available to make well-informed decisions and judgments. Today and in the future, however, that "sixth sense" won’t be enough; it’ll take discipline and knowledge to survive — no more managing "by the seat of our pants."

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This knowledge starts with understanding that to run a successful collision repair business anywhere in the United States today requires some consistent processes and procedures. Along those same lines, collision businesses — whether in Maine, Florida, Indiana, Texas, California or Nebraska — incur some consistent costs. Equipment, supplies, computers, software and parts all have very similar pricing no matter where you are. Building, lease and wage costs may vary, but generally they’re proportional to income. For this reason, you can look at financial information from other collision businesses and compare it to yours. This process is called benchmarking and is extremely valuable to consistently analyze your business for improvement areas.

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But before this can be useful — before you can compare your business to other businesses — you need to be sure you’re comparing apples to apples. To do that, we’ll first cover some areas that are vital to analyzing profits, then we’ll begin the actual process of analyzing profits.

Profit and Loss Statements:
The profit and loss statement (P&L), if used properly, can be very beneficial when analyzing your business’ health. Keep in mind, however, that it’s only a history of what occurred in a specific time frame, so the closer to the period completed you receive and review this information, the sooner you can address problems and find solutions.

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Many times, I’ve worked with clients who either never look at their P&L statement until after the close of the year or receive it months past the close of the monthly or quarterly period. This defeats the whole purpose of the tool. It’s like sending flowers to a funeral home a month after the funeral took place.

It’s critical you receive information within days of the close of the month to be able to analyze your operation’s health. How can this be achieved? With today’s computerized management and accounting packages — if proper procedures are implemented for file closings.

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Work in Process
It’s also important to identify work in process (WIP) and adjust your P&L statement accordingly. WIP adjusts income and costs into the same reporting period. Why is this important? If it weren’t done, it’s very likely that costs associated with jobs would be included as costs for a month without income associated. Parts, labor and sublet costs are normally incurred during the month, but if the vehicle is delivered after the close of the month, the income could be placed in the following month. This will produce roller-coaster P&L statements that mean very little. WIP reports and adjustments will allow for better analysis.

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The Balance Sheet
Along with the P&L statement, a balance sheet includes additional information that’s extremely important. P&L statements look at a current income perspective, while the balance sheet brings a larger accumulated view.

The balance sheet includes accounts receivable, accounts payable — including long- and short-term debts — and other liabilities and assets. This all funnels down to the net worth of the business and stock worth if incorporated.

If you’re interested in a more specific analysis, some companies offer a service in which they look at ratios of each asset to earnings, the entire earnings to investment and other asset-related items to determine your true return on investment (ROI). To do this, the initial profit received on parts, labor or sublets must accumulate, and then expenses are deducted to achieve an acceptable return on investment (ROI). If your ROI isn’t acceptable, then you’d probably be better off working for someone else and investing your money in the stock market or even a bank (if your ROI is really low). Keep in mind, your investment return is your risk for being in business, and if you fail to look at profitability properly, you may be in jeopardy of losing your investment or not getting a return that could be received from other investments.

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This type of analysis goes much more in depth than the normal balance sheet, but since it’s so specialized, it can also be a very beneficial tool for your business.

Gross Profit Dollars and Gross Profit Percentage
It’s important that terminology be consistent and understandable so let’s define gross profit dollars: Gross profit dollars (GP$) are calculated by taking the retail price of a service/part and subtracting the actual cost of the service/part.

Retail or Income – Cost = Gross Profit Dollars.

Example: Part lists at $100 – it costs $70, which = $30 Gross Profit Dollars.

Sounds simple, right? Unfortunately, this is probably the most disagreed (heated at times) area in collision industry accounting. Does actual cost of the service include employee benefits? Does it include indirect costs such as the employer’s portion of FICA and other related tax liabilities?

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Why is this such an issue? Back in the 1970s, paying technicians 50 percent commission was common. But business consultants and seminar leaders in the ’80s convinced us that we weren’t going to be able to continue this and invest in the equipment upgrades necessary for our survival. Why? Because when paying 50 percent commission, shop owners may only receive 37 percent after subtracting benefits, insurance, etc. Hence, loaded labor calculations began and continue to exist in many management systems even today.

In my opinion (and many others), gross profit doesn’t consider overhead costs, such as employer tax liabilities or employee benefits — in other words, not loaded labor. But whether you agree or disagree with loaded or unloaded labor calculations for gross profit isn’t as important as this: How do you make sure you’re comparing apples to apples when some shop owners include benefits (which vary from shop to shop), some include employer tax liabilities and others include all or none? You can’t! Don’t get me wrong, you need to know your true costs at all times, but gross profit dollars shouldn’t reflect these additional costs if you’re attempting to find the lowest common denominator for

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comparisons.

As for gross profit percentage (GP%), this is simply your GP$ divided by the income for that item, which can be done on individual items, such as each part; all items grouped for the job, such as all parts; all items, such as parts, labor or sublet for a set period, i.e. monthly; or overall by job and/or period of time.

Gross Profit Dollars divided by Income = Gross Profit Percentage.

Using the prior example: $30 GP$ divided by $100 income = a GP% of 30%.

Benchmarks to Consider
Many industry sources provide benchmarks for target profit percentages, and many suppliers and organizations also offer a benchmarking service in their value-added programs to monitor your profit centers.

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To familiarize yourself with benchmarks, the following are accepted gross profit targets that have been obtained by others in the industry. Keep in mind, this list doesn’t mean all the figures have been achieved at the same time by the same company. Each area needs to be analyzed to obtain an achievable goal for your operation.

Profit Center

GP%

Parts

30 to 34%

Materials

25 to 40%

Metal Labor

60 to 65%

Paint Labor

60 to 65%

Mechanical

60 to 65%

Frame Labor

60 to 65%

Sublet

20 to 25%

After looking at these numbers, you’ve probably noticed areas of your operation that need improvement. So now what do you do? It generally comes down to what you want to invest — how much time, how much money — and how much change you’re willing to accept.

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Many seminars and 20 groups can assist you in looking at these figures globally, but this requires a time commitment and attendance costs. Although they generally can’t get too organizational specific since your business isn’t thoroughly analyzed at the meetings, they can be very valuable in identifying some needed changes and possible solutions for you to consider.

Another option: You can have a consultant analyze your business and provide solutions that require implementation and change. This is where I’ve found the greatest challenges. It’s one thing to identify the problems and even the solutions, but it’s a completely different animal to implement, monitor and follow up to ensure these changes begin and stay in place. In most cases, it takes a long period of time making small successes to achieve what can be identified in a short analysis session.

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The Problem with Gross Profit Percentage
One important thing before you start making changes in your business: Most of today’s business owners have been conditioned to look at GP% as their only indicator for business health. This is, unfortunately, very dangerous and can be detrimental to future success. Why? A favorite expression I’ve used for years is, "You can’t spend percentage!" Unless it’s converted into dollars and amount of impact, relying too much on percentages can lead a business into a downward spiral that hinders growth and success. GP% is only a piece of the profit puzzle.

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To better understand GP%, consider this: It’s better to have 1 percent of $1 million than 100 percent of $1,000. What I’m saying here is that it’s easy for GP% to be overused and abused when the dollars that the operational change causes aren’t analyzed and the impact of the change isn’t considered in the overall operation. For example: What good is it to increase your material profitability per job to 40 percent if your cars per day decreases by one or two? Or, why concentrate on a profit center that’s only 5-7 percent of sales to gain 10 percent in gross profit percentage, when another profit center could easily be improved — resulting in a greater increase of gross profit dollars but only a few points in percentage? I believe it goes back to what plagues many shop owners: little formalized training on profitability and a general resistance to getting help in this area.

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Gross Profit’s Greatest Fallacy
Even when GP$ is considered, there’s still a fallacy regarding gross profit in general. Gross profit dollars or percentage don’t consider time spent. In other words, you can receive a great gross profit percentage — producing high gross profit dollars from a job — and still not make enough money to pay the bills because it takes too long to produce it.

For shops paying technicians a flat rate or commission percentages, this can easily be the case. Many believe that since technicians paid using these methods are only paid on what they produce, the business is protected from overpaying for labor. What they don’t consider is that the cost of doing business continues whether one car is produced per day or three.

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The next generation of job costing will certainly consider this factor by analyzing job profitability by gross profit dollars per hour, not just dollars received. And this will certainly disprove one of the oldest-held beliefs in collision repair: that repairing panels is more profitable than replacing them. Why do I bring this up? What does this have to do with analyzing profits? Everything. If shop owners knew as much about profits as they think they do, they wouldn’t believe repairing is more profitable than replacing.

I’ve used many examples in seminars to demonstrate this concept, and each time I’ve struck a nerve in shop owners. The repair of a panel costs a shop money in both added material costs and efficiency; it also requires a different skill set for technicians, which we consistently say is declining. So, if it loses money comparatively and requires a skill set that’s difficult to find and keep, then change the game.

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To prove my theory that replacing is more profitable than repairing and that analyzing gross profit without analyzing time spent is futile, let’s analyze the profitability of two jobs, using gross profit dollars per hour. Keep in mind, the following examples are based on a $35-per-hour door rate and $18-per-paint-hour material rate. We’ll also use a 25 percent GP% for parts and materials with a 65 percent GP% on labor. Since in both cases we’d have the same blending and other charges, they’re not needed for this example.

To determine dollars per hour, we’ll use a 200 percent efficiency per labor operation, even though painting a new part vs. painting a repaired panel generally takes less time. Even with this, the results will surprise you:

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Scenario: A customer comes in and needs an estimate for the damage caused by a tree branch hitting his hood. The vehicle is a late model, so a new hood is estimated.

Original Estimate: Replace Hood

Parts

Metal

Labor

Paint
Labor

Materials

Sale

     

$232

1.0

3.2 + 1.6

(underside)

$86.40

       

GP%
25%

65%

65%

25%

       

GP$
$58

$22.75

$109.20

$21.60

The replace total gross profit percentage would be 41 percent (total GP$ of $211.55 divided by the total gross sale of $521.40).

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Dollars per hour is calculated by dividing the total gross profit dollars of $211.55 by the actual time spent by the technicians: 2.9 (5.8 hours @ 200 percent efficiency). The result is $72.95 per hour gross profit.

After giving the customer this estimate, he leaves, only to return a few days later to ask you — since he’s decided not to go through the insurance company — if you can fix the hood instead of replacing it.

Revised Estimate: Repair Hood

Parts

Metal
Labor

Paint
Labor

Materials

Sale

     

0

6.5

3.2

$57.60

       

GP%
0

65%

65%

25%

       

GP$
0

$147.88

$72

$14.40

The repair total gross profit percentage would be 59 percent (total GP$ of $234.28 divided by total gross

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sale of $397.10).

Dollars per hour is calculated by dividing the total gross profit dollars of $234.28 by the actual time spent by the technicians: 4.85 (9.7 hours @ 200 percent efficiency). The result is only $48.31-per-hour gross profit.

Another area of potential loss: Your actual cost of materials will normally be greater to repair than replace a bolt-on panel when body fillers, sandpapers, grinding discs, stud-welder nails, primer surfacers, etc., are considered shop supplies and a cost of doing business. In fact, since paint materials are often calculated from estimated paint hours if you repair a panel, you’re generally unable to add paint time for the underside/edges — hence your income is generally reduced as well.

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The Bottom Line
After all the gross profit calculations are complete, the overhead is then deducted, resulting in a net profit.

Many in the industry claim to achieve a 25 percent net profit, but what does that really mean? An average shop’s overhead can vary based on many factors — one is how much the owner pulls out. Balancing owner salaries, benefits and perks is the greatest challenge of a good financial adviser.

Normally, overhead ranges from 20 to 22.5 percent when owner salaries, benefits and perks are removed. This will, again, vary greatly on a number of factors. Each individual overhead cost can be compared and can be very beneficial to analyze. Even in this example, a normal shop could vary its net approximately 13 to 25 percent based on a gross profit of 35 to 45 percent. For this reason, comparing a company’s net profit to another’s in small business is almost impossible due to all the variables.

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Perplexed by Profits
For many years, looking at gross profit percentages and/or just total gross profit dollars have persuaded many owners and managers to repair whenever possible. But how many more jobs can be put through a facility if panels are replaced rather than repaired, how much can profitability improve when this is done in an efficient manner, what labor force is needed to replace panels rather than repair, and how much better can your turn rate be if panels are replaced?

But the point here isn’t to replace rather than repair (although you’ll make more money if you do and insurers will be happy with your faster turn rate). The point is to know what profits are and how they’re made. After all, how can you possibly run a successful business in the future when you have no idea where your profits come from in the present?

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Contributing editor Tony Passwater is a long-time industry educator and consultant who’s been a collision repair facility owner, vocational educator and I-CAR international instructor; has taught seminars across the United States, Korea and China; and is currently an industry consultant. He can be contacted at (317) 290-0611 or [email protected]

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