Taming The Overhead Monster

John Edson tells attendees of his Nexstar seminar that understanding business costs can be made easier by measuring and managing overhead.

MINNEAPOLIS - According to John Edson, a CPA for Blanski Peter Kronlage & Zoch, P.A., "running a profitable business should be second nature." But Edson, who recently spoke with attendees of the Nexstar Super Meeting in Minneapolis, was quick to point out that a lot of business owners don't understand profitability because they "take all of the financial information and dump it on their accountant's desk, believing that is all they have to do."

In order to run a successful business, Edson said it is imperative that business owners know how to manage information. The process begins with having up-to-date financial statements and a budget - and constantly monitoring both.

Paperwork goes beyond financial statements and a budget, it is important to keep monthly and annual statements, too. These statements are necessary for tax purposes, controlling bank accounts, and managing a budget.

Sadly, too many owners and managers spend too much time putting out fires and not enough time looking at financial statements to determine why they made a profit or had a loss, he noted.

Knowing basic financial information is the first step, knowing what to do with it is the second step. That translates into performance measurement, which Edson said links a company's financial goals and performance to the activities performed by employees.

"What you measure, you can manage," he said. "It's also true that what gets measured gets noticed and what gets noticed gets done."

Effectively Measuring Cost

All good business owners know (or should know) that measurement begins with understanding costs. Edson listed three categories of cost: materials, direct labor, and overhead. He said that each of these costs could be classified by certain behavioral characteristics:

Fixed is a cost that does not change as sales or productivity changes. The cost is constant throughout a specific period of time.

Variable is a cost that changes as sales or productivity changes.

Activity is a cost that changes as the frequency of a particular activity increases or decreases.

Edson used a sample "statement of operations" from a service company over a two-year period to compare how the company identified and managed its costs. While the company increased its gross profits from one year to the next, its net income actually decreased due to proportionately higher operating expenses. There was a 1 percent jump in salaries, something that could possibly be addressed by hiring temporary workers or "leasing workers," according to Edson.

He said that many business owners throw some of their costs into miscellaneous expenses, which can be a dangerous practice because it is hard to manage them.

"Once you identify the expenses, you can figure ways to make improvements," Edson noted. "Having this information allows you to review and analyze your financials - now you can come up with solutions."

It is easy to conclude that the objective of HVAC service contractors should be to become a "lean service machine," being able to establish benchmarks, analyze problems, and systematize the business. By doing that, it becomes easier to run the business on a day-to-day basis - profitably.

"You need to understand the different drivers of cost," Edson said. "You need to know what your numbers mean. For example, which is more profitable - selling more jobs at a lower price or fewer jobs at a higher price?"

Knowing the cost of doing business goes a long way in determining what jobs to accept and what jobs to walk away from. Edson said contractors must know what their breakeven point is.

"For example," he noted, "if you achieve your monthly breakeven point, you may be able to take on some lower-priced jobs after that to keep the work coming in."

Publication date: 11/28/2005

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