True story: A contractor was in trouble from a cash perspective. Great company. Great value provided to the customer.

They had a good gross margin — from their perspective — so why were they having cash problems, they wondered.

I asked them to calculate their overhead cost per hour for each department. I was shocked at the result — every department’s overhead cost per hour was outside of normal ranges for the HVAC industry. This was the problem. Now we could address the productivity issues and sales issues to lower their overhead cost per hour and increase their profitability.

Many contractors have realized that dividing by 1 minus the gross margin to arrive at a selling price is not the best way to calculate it unless labor and material expense are equal. With high-material projects — which are where most replacement jobs are — you are safer because you’re overpriced against most of your competition. With high-labor jobs, you’re underpriced and are likely to have unprofitable jobs.

So, instead of using gross margin, many contractors started calculating the gross profit per man-hour or gross profit per day needed. This is also dangerous because you are still ignoring overhead costs.

Without knowing your overhead costs you are sticking your head in the sand. You could have the best gross margin in the world and still be “losing your shirt” because your overhead costs are higher than your gross profit.

Cash, cash, cash

Personally, I don’t care what your gross margin is. I don’t care what your gross profit per hour is. I want to know your net profit per hour. That’s the number that really counts.

The best way to price is to know your overhead cost per hour, know your material costs, and have a good estimate of the number of hours it will take to do the job. Then you can add the profit per hour you desire to arrive at a selling price.

Never forget that cash is the lifeblood of your business. You cannot operate without it. You have to protect it. Your financial statements can tell you when something is wrong — and often that someone is stealing from you. 

In all the years that I’ve worked with contractors in the HVAC industry, the second-worst thing I ever had to do was to tell two partners of a three-partner company that the third partner was stealing at least $50,000 per year from their business.

I’ve seen small theft. I’ve seen creative theft. I’ve seen stupid things that bookkeepers do when they aren’t thinking straight. Many times owners are the last to find out because they don’t pay attention. Sometimes I get the unpleasant job of telling them.

Most people are honest and wouldn’t cheat their company. However, trusted employees may suddenly have a cash or credit problem. It’s especially common in this economy. They aren’t thinking straight. If you have loose cash procedures it might be very easy to take the money with their hope that no one notices.

The job of a good embezzler is to become the trusted bookkeeper. Never — one of the few times I use this word — completely trust your bookkeeper. Accounting procedures with checks and balances must be followed.

Rules to prevent theft

Follow these seven rules:

1.  Get timely and accurate financial statements each month. Look at them. If something looks wrong, start questioning. If your bookkeeper always has an excuse about why the financials are not on time or are wrong, then find another bookkeeper. The one you have is incompetent or stealing — and you can’t have either situation.

2. Check your gross margins. If they are not consistent, then something is wrong. It might be a simple “revenues in one month; expenses in another” — or someone is slowly draining money from your company.

3. Check your inventory. Use this rule: Beginning inventory plus purchases minus ending inventory equals cost of goods sold. If these two sides of the equation don’t balance, something is wrong. Check it out.

4. Ensure your bookkeeper is not a signatory on your checking account.

5. Watch the petty cash fund. This is a very easy place to steal a few dollars each week. 

6. Do not use signature stamps. Even if two people must sign checks, if one of the signatures can be a stamp, it leaves you open to theft.

7. Send your bank statements home. This is critical to see what cash has come in and gone out of your business each month. Look at the checks to see if something isn’t right.

Cash is the lifeblood of your business. Protect it.

Copyright Ruth King. All rights reserved. Write to Ruth King, 1650 Oakbrook Drive, Suite 405, Norcross, GA 30093. Call (800) 511-6844; e-mail ruthking@hvacchannel.tv.