Editor's Note: As part of her presentation at HVAC Comfortech 2011, in Baltimore, MD, speaker Vicki LaPlant provided HVAC contractors with some tools on how to measure the success of their companies. She called these tools, Stress Test Financial Ratios. Two not covered in the original article published in the July 2011 issue Contracting Business.com magazine are the “Am I Charging Enough?” ratio and the “Am I Building Value?” ratio. This sidebar highlights these two ratios.
“Am I Charging Enough?” Ratios
The key measurement of whether a company is charging enough for its goods and services is if ownership is satisfied with its bottom line profitability. But many factors, in addition to pricing, impact net profit. As a result, several other performance factors should be evaluated including:
- Gross margin dollars per day
- Gross margin dollars per crew
- Gross margin dollars per type of work
- Gross margin dollars per service technician.
Closing rates should also be tracked. Depending on the source of the lead, a closing rate that’s too high indicates prices are too low. Closing rates that are too low can indicate prices being too high.
But we believe one underused measurement is the percentage of low labor installations to total installations. If your company must choose between an installation requiring double the labor cost versus one requiring less labor cost, which one do you want? If you’re like 99.9% of the contractors to whom we ask that question, you want the lower labor cost job, because you can get a second installation with the extra labor, producing an increase in sales, gross margin, and net profit dollars.
We define a low labor installation as one where the actual payroll cost for the installers to complete the installation is less than 20% of the total direct cost (equipment, material, and labor) estimated for the job.
A low labor job allows more pricing flexibility.
If your street rate for service labor is set at a 60%+ gross margin, then the gross margin on a low labor job can be set at as low as 35% with 13 to 15% of that going to net profit. Low labor jobs can be used to grow top line sales quickly and profitably. A strategic pricing strategy allows that to happen.
Our recommendation is that 50% of your total residential/replacement installations should be low labor. This target means better management of the installation and service job board.
“Am I Building Value?” Ratios
Determining the value of a company involves many factors. A common misconception is that the value of a contracting business can be determined as some multiple of earnings or sales — I believe that just isn’t a fair method for either the buyer or seller.
As an owner, building value in your company involves numerous factors, including accessibility of your data base, recurring revenue streams, revenue stream guaranteed by maintenance agreement customers, percentage of your active customer base versus total customer base, and percentage of total sales from the active customer base. By the way, an active customer is defined as one who has spent money with your company in the past 12 months.
Of these, the one that’s most important in determining the value of an existing company is the annual revenue from the maintenance agreement customer base.
First, this measurement means that having a large percentage of your customers tied to the company through maintenance agreements is critical for its long-term value.
Next, it means your company must have systems in place that actually track, not only purchases of maintenance agreements in a 12-month period, but also the purchases of customers recommended to your company by maintenance agreement customers.
After all, maintenance agreement customers actually know your name, like your company, and continue to desire your service on an annual basis. This means they actually recommend you to friends, neighbors and relatives. Customer incentives certainly help facilitate this process.
To determine the revenue from your maintenance agreement customer base on an annual basis, add the total purchases from your existing customer base plus the purchases from customers referred by maintenance agreement customers.
This dollar amount, particularly if it can be verified for two or three years, is a good guarantee of the sales revenue that can be generated each year from your maintenance agreement base before any additional marketing and advertising is implemented. This is a strong indicator of a company’s value.
In the end, your age (translate as where the company and its ownership are in their life cycle) will determine which ratios are most important in your business. The key to stress testing your business is to choose those numbers that are most important for the next five years of the company’s life cycle and focus on determining and improving those.
Vicki LaPlant has been working with HVAC contractors for the past 30 years as a trainer and consultant. She is expert in helping people work better together for greater success. She is a Contracting Business.com editorial advisory board member and can be reached by email at firstname.lastname@example.org, or by phone at 903/786-6262.