When small businesses raced to access Payroll Protection Program (PPP) loans, the prize mostly went to those with the best-organized financial statements. Unfortunately, many HVAC contractors ignore financial statements until they have to pay attention.
Clay’s Climate Control in Linwood, New Jersey, was among those that received PPP funding, and co-owner Jen Pierce said the HVAC contractor’s financial statements played an extremely important role.
“Clean financials give you a clear assessment of the financial strength and sustainability of the company,” Pierce said. “Had our financials not been in order, it would have been very difficult to determine what our cashflow situation was and what we were able to handle, given the uncertainty of the situation.”
The economic crisis brought on by the coronavirus pandemic is an extreme example, but Ruth King, profitability master with HVACChannel.TV, said problems arise all the time, such as an inability to pay bills or meet payroll. Proper financial statements help avoid these situations.
Financial statements must be accurate and timely, King said. HVAC contractors need monthly profit and loss (P&L) statements and balance sheets. All information must be entered on an accrual basis rather than a cash basis, meaning when they occur rather than after an actual cash exchange. Then they need complete year-end statements. The balance sheets need to actually balance, King said, and the goods sold need to be accurate, such as including the cost of labor rather putting that in overhead.
The business owner needs to spend at least a half-hour a month on the financials, King said. They need to know what they are looking at, which means knowing the difference between a balance sheet and a P&L statement. The balance sheet shows a company’s current assets and liabilities, while P&L statements show a company’s income and expenses over a certain period of time. The balance sheet provides a snapshot of where a company is at, and the P&L statement points to where it could go by increasing revenue or controlling costs.
Contractors often rationalize ignoring their financial statements because they are too busy with a growing business. Often, the reality is they don’t want to know how much that growth costs, King said.
“The hardest and most painful thing for a $2 million contractor is to put inventory on the balance sheet,” King said. “It’s painful but also necessary.”
Creating proper financial statements is a habit best picked up early so an HVAC contractor can make better business decisions. There is a learning curve for many in the business. The methods often seem complicated, and the terms seem like a foreign language. King tries to ease HAVC contractor’s concerns by reminding them they mastered technical processes to get where they are. She compares understanding financial statements to learning to read a wiring diagram. She asks contractors how easy that was at first. For most, it was difficult.
“It’s the same thing with financials,” King said. “The first time you look at them, it looks like gibberish.”
It’s still a very specific skill, regardless of a person’s technical background. Pierce has a degree in biochemistry. She still struggled early on due to a lack of knowledge beyond income and expense. Pierce said she made entries in QuickBooks without really knowing why.
“I knew how to balance a checkbook and that was about it,” Pierce said.
When she started working with King, Pierce started seeing the impact mistakes had on financials and how to correct them. She also learned to avoid what King calls “fruit salad,” which means trying to compare unlike items.
Bob Barnes, president of Western Heating and Air Conditioning in Boise, Idaho, came into the HVAC business with some business background. He earned a two-year degree from the Boise State School of Business before joining the family firm and then worked in all aspects of the business, including managing the installation department, where he oversaw hiring, performance reviews, job costing, and buying inventory and trucks. This gave him a good understanding of how the business works, but putting together financial statements to truly reflect how the business performed required more training.
Barnes took King’s online course and joined one of her peer groups. His earliest experience with basic financial statements, however, came from his time as treasurer for the local building contractors’ association. He had to provide a monthly financial report. It was an easy-to-understand budget. Barnes reported on any variances and answered questions from the group of veteran business owners.
“It was really stressful, but it was a real learning experience,” he said.
Today, Barnes uses his financial statements for general forecasting and budgeting at the beginning of the year. He develops a monthly plan and then compares the results each month. Barnes wants accurate, current information on Western’s seven profit centers. He likes a report that tells him comparisons between the current month, prior month, and previous year’s month. He also like year-to-date and prior year-to-date reports.
Right now, Western is struggling a little in service. He and the service manager will sit down and look through the financials. Financial statements show where Barnes can shift work if needed, which he did during the outbreak.
“It’s stuff you can’t see just by watching the business work,” he said.
Sometimes a financial statement shows factors mostly out of an HVAC contractor’s control, such as weather, Barnes said. Other times, it helps an HVAC contractor at least manage outside factors. Pierce said an analysis of the financial statements for Clay’s showed how large a role seasonality played and the company shifted its focus to meet that challenge.
Pierce and her husband, Clay, uses financial process to help their company grow. They know where they should invest and when they can afford to grow. It also helps better deploy marketing dollars.
Good financial statements also help an HVAC contractor when the time comes to sell the business. King said negotiations get into areas such as maintenance agreements and goodwill, but the process starts with financial statements. An understanding of financial statements proves crucial on the other side, according to Dan Griffin, president of Weather Engineers Inc. in Jacksonville, Florida. Griffin acquired several companies in the past few years and has seen all sorts of unorthodox financial statements.
Griffin’s most recent purchase was a company that had been around for 60 years. For the last few years, the company had been unprofitable and had little value beyond its loyal customers and some service agreements. The owner had lent money to his own company earlier and was now taking repayments rather than a salary. That made the P&L look better, but failed to reflect the real state of the business. Griffin wound up paying the owner to close the business and made an agreement to pay off gross revenue from the customer base.
Griffin understands the difficulty of learning the proper way to create financial statements. His father started company in 1963, and he joined in 1979. Griffin said he didn’t know a debit from a credit, an asset from a liability, or a cost of sale from an income account. The firm had just bought a computer system from Radio Shack to help them manage the books, which were kept by a secretary with little more knowledge than Griffin had.
Eventually, Griffin learned the meaning of journal entries, then double-entry accounting and other more sophisticated measures. He learned from trial and error, a method he recommends against. Griffin’s daughter, Kayla, works for him, and she’s getting that more formal training.
“Maybe her learning curve won’t be as steep,” Griffin said.
The software uses Weather Engineers for bookkeeping today is a definite step up from the Radio Shack days. King said software makes generating good financial statements only slightly easier. Someone still needs to input the right data. King said an HVAC contractor should hire a good bookkeeper to handle day-to-day entry, but shouldn’t abdicate responsibility for the financials.
Barnes said the best advice for other contractors is to know what they want to get out of their financials. Cost increases are one of his primary concerns. He wants to know when they happen and why. Other HVAC contractors have their own concerns. Barnes said financial statements are very personal, almost like choosing a life partner.
“What do you want from your financials?” he said. “What do you want from your business? Not everybody’s goals are the same.”
Whatever those goals, reaching them without proper financial statements proves as difficult as getting to a destination without a map. A firm can seem like it’s doing well with lots of business on the books and everyone busy. The financials might tell another story.
“You have to be honest with yourself,” Barnes said. “You can’t play a lot of games.”