Measuring performance

By Ron Coleman

Each year since 1996 I have undertaken a financial analysis of contractor members of the Heating, Refrigeration and Air Conditioning Institute of Canada (HRAI). The participation is voluntary and only the participants receive a copy of this industry report. In addition, each company receives an analysis of their business compared to their competitors.

Anywhere between 15 and 56 companies participate and provide their financial information annually.

In 1996, the average company was losing money. By 2005 the average was recording over five percent operating profit, after all expenses. Since then, it has ranged from five percent to a high of 8.2 percent this year, except one year where the average was 4.7 percent.

This year we had 22 participating companies. The profit, after all expenses, was as follows:

Nine of the companies had operating profits (after all expenses) ranging from 10.5 to 19.9 percent. Five had profits below five percent and one company showed a loss.

The average company had sales of $4.3 million with an average operating profit of 8.2 percent and other income-generating a further 0.3 percent. The return on equity was 60 percent.

Most of the companies were very well-financed. The average level of debt was low at $1.25 for every dollar of equity. This is well within acceptable levels.

Different approaches for profit

The range in profits is, in my opinion, very much related to how the owners run their businesses. Those that do more service and retrofit work tend to have better and more consistent results than those who rely more on new construction. The companies that focus on planned maintenance and good customer service do tend to get very good results.

There is no idea that guarantees success. Companies in smaller regions tell me they can’t put their prices up because the community is too small and those in large urban regions say the same thing, except their reason is the level of competition.

When you look at the results, you have to admit that these arguments are not valid. Some of the companies in the program have been in it for many years and they consistently show very strong results.

Does size matter? At the top end of the scale, we had companies with annual revenues well in excess of $12 million. They were not the most profitable. The most profitable had annual sales between $3 million and $6 million. Traditionally, companies with revenues under $1 million find it hard to make a profit. There are exceptions and these businesses tend to work in specialty areas.

Accurate records critical

One of the major issues I have with most of the participants is their lack of solid financial reporting. The vast majority of the financial statements I review are not laid out correctly from a management accounting perspective.

The breakdown between direct job cost and overhead is rarely done accurately. Without allocating costs correctly it is difficult to calculate the real gross profit on a job and to calculate the level of sales the business needs in order to break even.

Break-even sales are calculated as overhead dollars for the year divided by average gross profit percent. If you get either of these wrong, you will get the wrong answer for break-even sales. I encourage the participants to revisit their method of allocating costs in order to improve the ability to manage their operations. How can you run a business if you don’t understand the numbers? Monitor; Measure; Manage is the mantra.

I interviewed three of the top performers this year and they are all businesses that have been in operation for many years and get consistent results each year. They all have difficulty growing their sales because they can’t find good manpower to do the work. That is their limiting factor – not getting the work but doing it. I recommend to them to up their prices so that they can afford to pay their people well and provide the level of service that their customers want.

Retirement strategies

I mentioned earlier that the level of debt is, on average, very low. This is partly due to the fact that some companies have very significant levels of retained earnings. I recommend to those companies to form holding companies and move the earnings out of the operating company and loan back what is needed and take security against those loans.

The average level of inventory was around $100,000. This is not excessive, but some had inventory well over $250,000 and others carried virtually no inventory except what was in their trucks. Supporting a high level of inventory requires working capital. That means the company with a lot of inventory compared to one with no inventory requires more investment.

As many of the owners are now looking at retirement strategies, they need to streamline their company’s financial position in order to make their businesses more saleable. Thus, moving out retained earnings and lowering inventory will make the businesses more attractive to a potential purchaser.

Here are four of my top recommendations to the participants in the program this year:

• Establish how to monitor your labour productivity
• Review pricing strategies and where possible implement menu pricing for common repairs and, if appropriate, consider flat-rate pricing.
• Grow your planned maintenance base.
• Start planning your exit strategy.

There is nothing very magical in these recommendations, but it is surprising how few contractors really give these four areas priority.

And as Apple’s Steve Jobs, would say (if he was still with us), one more thing….

Without action, there is NO Change!