In most service businesses, 70% of a company’s costs of doing business will be consumed by only five expense categories. One of them is labor. This article will focus on arguably the number one expense you need to manage—Direct Labor.

When you look at your profit and loss statement every month, I assume you have a minimum of two columns. One column shows you the actual cost in dollars; the other column presents the actual cost as it relates to net sales, as a percentage. Something like this—

The following story is true. The names have been changed to protect the innocent. If you think this story is about you…you are probably right.

The Martyr and The Intimidator

Leslie is the owner of a roofing company, a business she inherited from her father. Back in the day, her father managed a small crew and operated with handshake-contracts and stacks of cash. Now that her dad has retired, ambitious Leslie sees a different future. She wants to grow her company so that she can make a fortune…and provide career opportunities for her beloved team. And she wants to build on her (and her father’s) reputation for taking great care of her customers.

Last eBuzz, I pointed out some problems with the format of an actual profit-loss statement from a Midwestern service contractor. You may wish to re-read “Numbers Tell a Story” article to refresh your memory. This edition I’m going to take it a step further by reconstructing the format and plugging in some new numbers that make more sense. The line items highlighted in bold face on the chart are the ones we concern ourselves with.

First, look what I have done with the revenue side. The numbers are higher because I factored in modest 9.62% increase in selling prices for this firm. This was an arbitrary percentage that I came up with to achieve a reduction in direct cost of sales from 44.5%, which was too high, in my opinion, to a more reasonable 37%. I believe that this firm could raise its selling prices and revenues by much more than 9.62%. However, for the purpose of this article, I wish to make the point that even a modest increase in price can reap great benefits.

If you were driving 80 miles an hour, in the dark, with your lights off, heading towards a cliff, would you like someone to yell, “STOP?”

OK. Stop!

Do you produce financial reports – the balance sheet and income statement – every week? Do you analyze sales, costs, cash flow, and debt every week? If not, you may be heading for the cliff.

STOP. And find out. This is the year. This is the day. From here on out…you are going to KNOW.

The 2002 and 2003 profit and loss statements attached reflects an actual case for a Midwestern plumbing and drain cleaning firm. In 2002, the business was a partnership jointly owned by a plumber and a realtor. The realtor bought out his partner and, after attending one of my seminars, revamped the business in a way that resulted in revenues almost tripling. The 2003 financial statement was also much improved, though, as I will explain, it still falls short of the ideal.

The most glaring problem with the 9-month statement for 2002 is in the Cost of Sales category near the top. All it shows is a single line item for Plumbing – $19,115, amounting to 8.7% of sales. I don’t remember what this was supposed to measure, probably materials. In any case, it is an inadequate breakdown. (I was told that this statement was prepared by a CPA, which goes to show how little many accountants know about our industry.

As you see with the revised 2003 format, the Cost of Sales category was expanded to include several items that previously were tallied, mistakenly, under Operating Expenses. We see wages broken out for both plumbers and drain cleaners, as well as subcontracting costs, commissions, parts & materials, permits and payroll taxes. All of these are direct costs, or what we call overhead.