Looking for Big Profits? Follow the Numbers
July 2, 2007
Successful HVAC contractors are those businesspeople who are good with numbers. They know what they have to do to make a profit. This allows them to reinvest in their business and employees while maintaining their own comfortable standard of living. They don’t succeed by pulling numbers out of thin air or by setting unreasonable goals for their business.
They do succeed by following the key numbers affecting their business. Having accurate P&L sheets and tying them into a planned budget can mean the difference between double-digit profits and barely making it.
But which numbers need to be studied closely?
The NEWS wanted to know and recently sponsored an online survey asking readers and Website visitors to list the items that have the biggest impact on profitability and just what percentages constitute a healthy profit margin.
The questions included:
1. Besides labor and equipment costs, what are the biggest expenses in an HVAC business?
2. In a best-case scenario, what percentage of sales should the following costs be: labor (including benefits), equipment (including supplies), mortgage/rent (including capital improvements), marketing/advertising, training/education, professional dues/license fees?
3. In your opinion, what percentage of net profit after taxes would define a successful contractor?
KEY OVERHEAD ITEMS AND PERCENTAGESIn order to correctly price a job, it is important to know all of the related costs ahead of time - or at least as many of the predictable costs as possible. Going blindly into a bid situation can result in no profits and possibly a negative cash flow.
“It is important to know your costs beforehand,” said Elaine Powers of Powers Heating & Air, Peachtree City, Ga. “This allows you the insight to make adjustments to pricing depending upon workload, seasonality, etc. and still maintain a viable gross profit margin.
“We always try to get our full margins year-round, but there are times when it is necessary to make price adjustments. When this happens, you need to know how you can adjust your pricing structure. I am not a proponent of as long as it hits break even. I believe that a successful contractor does not have to compromise to break even. However, if the person approving the final quote price does not know break even (direct costs + overhead burden), then they are just shooting in the wind for pricing.”
Eric Woerner of RES Services, Dayton, Ohio, said that knowing costs also is good for the HVAC industry as a whole. “You have to know your costs before quoting a job,” he said. “The industry gets a black eye from the contractors that don’t know their costs and throw out below market pricing. Everyone loses. Profit is determined by how efficiently you run your operation, if you can control your direct costs and what the market will bear.”
So what are the key items, besides labor and equipment, that contractors must factor into their job costs?
According to the 78 responses to that question, 72 percent felt that insurance was the key cost, both personal and property. Insurance was followed closely by transportation expenses, i.e., vehicle loans, maintenance, and fuel, which appeared on 65 percent of responses.
Other responses in the double-digit percentile included advertising (27 percent), mortgage/rent (24 percent), and wages/benefits of indirect labor (20 percent). (See Figure 1.)
John McCarthy Sr. of McCarthy’s One Hour Heating and Air Conditioning, Omaha, Neb., cited a good reason why he listed insurance as a key cost. “If you have someone who works for you for three years and is always in poor health, your workmen’s comp rates just skyrocket,” he said.
One respondent to the survey also felt the brunt of insurance costs. “My insurance has been the cause of this year’s downfall,” said Dave Mitlyng of Mitlyng Electric & Refrigeration, Montevideo, Minn. “I cover all my employee health insurance and in the last four years it has gone up 44 percent.”
Contractor Jimmie Johnson of S.A. Sloop Heating & Air Conditioning Inc., Landis, N.C., listed training as a job cost. “We have to continually educate and purchase education material for the team,” he said.
The added benefit of knowing job costs on a daily, weekly, or monthly basis allows HVAC contractors to understand where their breakeven point is in each month too - the day that all monthly expenses have been paid and everything after that is gravy. It also gives employees a sense of empowerment, that they have an impact on the company’s profitability because of their shared knowledge.
“You have to know your breakeven point on a monthly basis in each department,” said Jeffrey Ford of Columbus/Worthington Air & Columbus Mechanical, Hilliard, Ohio. “If your business model is not being adhered to by all management, and your field has no idea where you stand on a monthly basis, how do you expect them to understand that changes need to be made?
“Allow your field personnel to take ownership in what they do for you. They are each independent businesses within your business. Keep charts to let them know where they stand on a weekly, monthly, and quarterly basis. Reward those who live up to the high expectations you desire.”
DETERMINING BEST PERCENTAGESSuccessful contractors who know their costs and how to break them into manageable percentages are those with good profit margins. John Richardson of Richardson’s Heating & Air Conditioning Inc., Chapin, S.C., breaks his numbers down between his various departments with the ultimate goal of being able to give part of the profits back to each employee.
“I believe it is imperative that you have a reasonably reliable idea of what your labor cost is,” he said. “We know that our labor cost for an install crew of two is approximately $70 per hour. We also know that our overhead associated with material is 31 percent. I believe that by knowing this we are able to price out jobs in a profitable manner.
“We use these two figures religiously when figuring retrofit or changeout jobs and shoot for 20 percent profit. On new construction we cookbook price by the ton, and on service we have a set diagnosis and trip charge, which we flat rate. We hope in the end that somehow the mix of business will be right, the sales will be high enough, the unapplied time will be controlled, and at the end of the quarter and end of the year we will once again have somewhere in the neighborhood of 5-15 percent to share with our coworkers.”
A total of 16 percent of survey respondents were in the same ballpark as Richardson, believing that labor should comprise 30-34 percent of sales. A total of 28 percent of respondents thought that labor should fall into the 25-29 percent range, the most popular reply (see Figure 2).
There was no clearcut popular reply when contractors broke down the percentage of equipment costs. The leading reply, 24 percent, came from respondents who felt that equipment costs should fall into the 30-34 percent of sales range. But that number was followed very closely by respondents who said equipment costs should fall into the 25-29 percent range (22 percent of respondents).
Eric Woerner said, “Profit margins continue to shrink due to commodity cost increases, insurance increases, etc. We are looking to purchase materials offshore to help lower our costs.”
Other costs and their popularity among survey respondents include: mortgage/rent (2-3 percent of sales); marketing/advertising (4-6 percent of sales); training/education (0-3 percent of sales); and professional (0-1 percent of sales).
John Sedine of Engineered Heating & Cooling, Grand Rapids, Mich., said costs such as marketing can vary widely. “Percentages vary greatly depending on the type of sale and how much the sale was,” he said. “There are high labor jobs and low labor jobs. Your marketing percentage is not necessarily the same for a $100 job as it is for a $10,000 job.”
Based on the survey, the “ideal” breakdown of percentages would be (in descending order):
• Equipment: 32 percent;
• Labor: 27 percent;
• Marketing/advertising: 5 percent;
• Mortgage/rent: 2.5 percent;
• Training/education 1.5 percent;
• Professional dues/license fees: 0.5 percent.
Even knowing this, one contractor said - and many others agreed - there is no ideal breakdown because of various factors.
“Percentages would vary depending on the mix of the work, i.e., service, residential & commercial, new or replacement, plan and spec, design/build/negotiated work,” said Dennis Morgan of Modern Aire Inc., Havre, Mont.
“In an ideal mix of the above (this certainly would not be real world), the following may apply, but would not be reliable data to consider: labor: 38 percent, equipment: 27 percent, and overhead: 35 percent.
Morgan also felt that a 4-6 percent profit margin would be healthy. This leads up to the question: What is a healthy profit margin?
THE â€˜IDEAL' PROFIT MARGIN/PERCENTAGETrying to determine the best profit margin for an HVAC business is like trying to find an identical set of twins - very difficult, if not impossible. Each business has its own infrastructure based on its location, market, size, and fluctuation of the economy. The latter is something that no one can predict but that some say can be controlled. Some contractors have built-in safeguards, which ensure fewer peaks and valleys in annual profit margins.
One respondent said his safeguard is built into software programs. “Our margins are maintained by watching the numbers,” he said.
Another respondent said that a healthy profit margin could be all over the board. He said, “Everyone tells me that 3-5 percent net is good. We perform at approximately 20-24 percent at the end of every year. I have a friend that operates a company with six people and he has been operating at 5 percent over the last two years.
“We perform residential, commercial, institutional, and industrial services. We operate at what are considered modest markups. And we retain our customers because of few callbacks, which helps cut costs.”
One contractor broke down profit margins into categories. Phil Frasier of Frasier’s Plumbing & Heating of Rhinelander, Wis., wants to be a rock star. He said,
“One percent is normal; 2-10 percent is above average; 11-15 percent is successful; and 16 percent and above is life changing, being a rock star.”
Using Frasier’s breakdown, the majority of survey respondents would fall into the successful category (see Figure 3). The overwhelming majority (50 percent) felt that a 10-15 percent profit margin would define a successful contractor. The numbers drop off significantly after that with the next highest percentage of respondents (19 percent) saying that profit margins of 15-19 percent define a successful contractor.
Will benchmark numbers help every HVAC contractor understand the difference between success and failure? They can help, but it takes a lot more work and understanding of processes, at least that’s according to Wendell Bedell of Building Services Institute, Nashua, N.H.
“Industry benchmarks are only good to help contractors identify potential business processes and change profit gain opportunities,” he said.
“The secret to a well-run HVAC company is to manage processes. When you manage by benchmark, each process enables you to continuously drive your business towards efficiency.”
Rock star or average Joe? The choice is yours.
As Hurtekant said, “These types of studies and surveys will hopefully start to open the eyes of owners in this industry. We are just a small (six to eight) man shop, but once you start knowing your costs you can really start to make a profit.”
Publication date: 07/02/2007