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Business Accounting: the Truth is in the Numbers

May 09, 2011
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"Know the numbers...emotions don't tell the whole story."

I first heard this several years ago in a meeting with Bill Berry, president and CEO of American Tire Distributors. It struck home because it seems that so many tire dealers run their businesses by what they think is the right thing to do (emotions), and don’t take the time to analyze the business (numbers).

To a great degree, that may stem from a lack of basic understanding of accounting, knowing where to go to look for the numbers and knowing what they mean.

It all starts with having a good certified public accountant who can provide you with timely information and advice. Alan Roth, managing partner of the firm of Offit and Roth, P.A., in Owings Mills, Md., has been working with tire dealers in the mid-Atlantic area for over 35 years. He firmly believes that, “For a business to succeed, the owners need to review their financial results monthly. The basics are not that difficult and if you can read the box scores in the Sunday paper, you can learn to read and understand financial statements.”

Roth also stresses the importance of establishing a budget with his clients each year – a basic plan that outlines the company’s financial and operational goals. This is an action plan to help allocate resources, evaluate performance and formulate plans. While planning a budget can occur at any time, it should be performed on an annual basis. In addition, the actual results should be compared to the budgeted figures to determine deviations from the year’s original estimates; this allows dealers to take corrective measures immediately.

Greg Moore from Discount Tire and Service in Terrell, Texas, agrees. “I strongly recommend preparing a budget and setting goals for your salesmen and service managers, and compensating them via a bonus if they hit them,” he says.

“It’s important they know how to track the performance against those goals, but more important is that they must be trained on how to correct things if the numbers aren’t adding up,” he continues. “We empower them to make the necessary changes and decisions to hit the goals. Waiting until the end of the month is too late to correct. Giving them the tools to correct as the month goes will almost guarantee that their goals are achieved.”

The Basics
Let’s begin by looking at three main financial statements:

1. Balance sheet. A balance sheet is like a snapshot, providing detailed information about a company’s assets, liabilities and shareholder equity. It does not show the flows from operations of the business for a specified period of time. It derives its meaning from the basic business premise that Assets minus Liabilities equal Retained Earnings or Owner’s Equity in the business. On the left side of the balance sheet, companies typically list their assets. On the right side, they list their liabilities and shareholder equity.

• Assets are items a dealer owns that have value. This includes physical property – buildings, trucks, equipment and inventory – as well as trademarks, cash, receivables and the investments a company makes. Assets generally are listed based on how quickly they will be converted into cash. Current assets are items a company expects to convert to cash within one year (inventory, cash and receivables). Noncurrent assets are items a company does not expect to convert to cash within one year or would take longer than one year to sell. Noncurrent or fixed assets include those assets used to operate the business but are not available for sale, such as trucks, office furniture and other property.

• Liabilities are amounts of money that a company owes to others. This can include all kinds of obligations like rent, supplier bills for inventory, payroll, taxes and loans. Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due more than one year away.

• Shareholder equity (or retained earnings) is also referred to as net worth. It’s the cash or cash equivalent that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders or the owners of the company. Shareholder equity is the amount owners have invested in the company’s stock plus or minus the company’s earnings or losses since inception.

2. Income statement. Also referred to as a profit and loss statement (P&L), this is a report that shows how much revenue a company earned over a specified time period (usually for a month or year). An income statement also shows the costs and expenses associated with earning that revenue. This tells how much the company earned or lost over a designated period, and is known as “the bottom line.” To understand how income statements are set up, think of them as a set of stairs. Start at the top with the total amount of sales made during the accounting period, then descend one step at a time. At each step, a deduction for certain costs or other operating expenses associated with earning the revenue is listed. At the bottom of the stairs, after all of the expenses have been deducted, the bottom line (step) reveals how much the company actually earned or lost during the accounting period…(example below)

• Sales
– Less cost of goods sold (can include parts and possibly labor)
= Equals gross profit
– Less company overhead including general and administrative expenses. Included in company overhead are interest, taxes, depreciation and amortization.
= Equals net profit
 
3. Cash flow statement. This statement reports a company’s inflows and outflows of cash, which is important because a company needs to have enough cash on hand to pay its expenses and purchase assets. While an income statement can tell whether a company made a profit, a cash flow statement can tell whether the company generated cash. A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It uses and reorders the information from a company’s balance sheet and income statement. Most tire dealers will not utilize a cash flow statement on an ongoing basis. Cash flow statements are always included in review and audited financial statements and are optional in compilation reports.

Keep in mind that all three statements are related. No one financial statement tells the complete story. But combined, they provide very powerful information for business owners.

The Daily Numbers
It’s the 15th of the month, and you’re sitting at your desk looking at last month’s income statement, wondering why your bottom line is not where it should be. As you look through the numbers, you start to see the picture unfold and realize that there’s nothing that can be done to change what has already happened. You scratch your head and start to make the necessary changes to correct the problems.

Has this ever happened in your dealership?

Keeping tabs on your business every day is essential and should become part of your daily routine. If you wait until the middle of next month to evaluate what happened this month, you’re too late.

“Look at your numbers every day, know exactly what it costs to open the doors and share that with your employees. Know what total sales and gross profit is needed to make the profit you desire,” says Mike Upton from Upton Tire Pros in Brandon, Miss. “We focus daily on total and service sales, tire units month-to-date vs. last year, total alignments to total tires (we budget for 30%), and productivity of service techs (clock hours vs. flag hours).”

Below are some daily numbers to keep in mind:

• Review yesterday’s invoices. This may seem like a small thing, but it’s a barometer on the business. It provides you with a wealth of information:

- Is your staff performing courtesy checks on every vehicle?
- Did everything get billed on an invoice?
- Are your pricing guidelines being adhered to by your staff?
- Are numbered invoices missing?
- Is your team buying parts outside those you have in stock?
- Are premium products being sold, or are they taking orders? How about add-ons?

The list goes on and on. This routine keeps you on top of the business and sends a strong message to your employees. It provides you the opportunity to confront a problem immediately, to coach a salesperson on their selling skills and to keep your staff motivated and focused.

• Do you know the cost of “turning the key” to your store every day? This is essential. If you have a budget, it’s an easy process to calculate. If not, then all you need is the average monthly expenses, the average gross profit percentage and the number of days you’re open during the month. Divide the average expenses by the gross profit percentage to get your break-even point, and then divide by the number of days to get your daily number. Share this number with your people so everyone is focused and update it daily. Post the number near your time clock so there is no excuse for not knowing what has to be accomplished.

• Do you know how much business you need to do every day to make money? If not, you should. This circles back to why you need a budget. What gets measured gets achieved. Harvey Rudnick from Windsor Tire Co. in Windsor, Mass., reviews the numbers daily with each of his stores. “We have established what we call key profit indicators with our managers. Each manager looks at his numbers every day, and has access to the other locations to compare and benchmark his performance. The core numbers are sales, margins and expenses, but we will add additional items throughout the year to keep them focused. We compare this year versus last year.”

• What is your daily car count? This allows you to gauge the effectiveness of your advertising, track performance against previous periods, and points you in the right direction when it falls off. This is the owner/manager’s responsibility. Your staff is expected to produce sales and look for needed work, but if the cars are not coming in the store, it’s hard for them to achieve the numbers.

• What is your average repair order (ARO)? This is easy to calculate (total sales divided by total invoices). This also should be tracked daily and shared with your staff. The benchmark will vary depending on your sales mix, but the target should be $225 to $250 per vehicle. If it falls off, it might tell you that the staff is not performing a courtesy check on every vehicle and/or not selling add-ons.

None of these will give you the complete answer, but all will help point you in the direction to find one. “It’s like pulling an engine code. It doesn’t tell you the answer to the problem, but lets you know what part of the vehicle is having the problem and where to look,” says Stacey Bair, who co-owns Ocean Air Auto Repair in Virginia Beach, Va., with her husband, Ken.

“We look at the numbers every day and share them with our people. We set goals, post the results so our people know the numbers and hold huddle meetings with the staff to update everyone on where we stand. All vehicles need some type of service (or tires)…our job is to find it and sell it.”

Monthly Analysis
Income statements should be reviewed monthly to make sure costs are not out of control. This is the summary of last month’s performance. Make sure the sales are recorded properly, and that the cost-of-goods-sold reflects the proper gross profit.

Review the expenses and make sure they are in line. Look at payroll expense and compare the results to industry benchmarks. If you have an annual and monthly budget, make the comparisons. Look at how results compare with last year’s and last month’s, and look for trends that may point to potential problems. Share the information with your staff and discuss areas that need improvement, and reinforce strong performance.

“I do in-house financials from QuickBooks every month and sometimes weekly,” says Mark Hornsby of Hornsby Tire and Service in Newport News, Va. “I look at several things, but I like using the monthly comparisons. I always compare the previous month with the present month, as well as the same month last year, so I can track how things compare since we are somewhat seasonal in this market. Be consistent in whatever you are tracking. It does no good to track one thing this month and another next month.

“Set goals and numbers and track them with your management team, and then establish goals with your mechanics and general service technicians,” he continues. “Every-one needs goals. If you don’t have any, how will you know where to target your efforts?”

“The income statement should be provided by your accountant on a monthly basis – the 15th of each month is the standard,” says Stacey Bair. “The longer it takes to receive the information, the less valuable it becomes. We look at numbers throughout the month, and the income statement is my check-and-balance to ensure everything was recorded properly and nothing is out of line.”

The balance sheet is a snapshot at month’s end. This may not be as necessary to review every month, unless your business carries a lot of payables or receivables. If so, check balances and make sure totals don’t creep up on you. Look at the receivables and make sure that past due balances are collected. Make adjustments as needed with your accountant.

Are you taking monthly inventory? If not, you better start. This can be as simple as using a piece of tire chalk and a Sharpie. Take a total unit count and compare it against what is on the books. Draw a line on each tire or parts box to show the count. Doing so has two purposes – it lets employees know you’re on top of things and it helps you control inventory. If after a few months you start seeing several lines on the tire or box, it’s time to move it out so as not to tie up cash flow with slow-moving inventory.

If the numbers match, life is good. If they don’t, find out why. Over- and under-counts can point to either a theft problem or sloppiness with bookkeeping. On a quarterly basis, you’ll want to match dollars and unit counts to correctly state the cost of goods sold.

Yearly Review
If you’ve been looking at the operational numbers daily and reviewing the monthly performance, then the year-end income statement will not be a surprise. There will certainly be adjustments made by your accountant. Enhancements and program rebates will be applied where applicable, and any loose ends will be tied up.

Once again, you’ll want to make sure that the numbers are in line and be sure to look for any trends that might indicate a problem on the horizon.

“I would advise dealers to not only look at sales dollars, but also units. In today’s market with ongoing price increases, a dollar sales increase does not always mean you are moving forward,” says Rich Hoffman from Hoffman Tire in Fayetteville, Ga. “Today’s costs do not allow for sloppy bookkeeping and it doesn’t take long to get behind. I highly recommend that all dealers have an up-to-date POS system that is capable of giving them the ongoing information needed to be successful.”

Your budget for the upcoming year should already be in place, so advancing into the next year should be pretty seamless from the operational side. You’ll want to spend some time going through the balance sheet. The retained earnings number is a key number that represents a value that the business can borrow against. Lending institutions will look at this number to ensure the business is solid and not under-capitalized. Look at the receivables and make sure that past due balances are collected. Take a physical inventory and make adjustments as needed.

Tire dealers face ongoing challenges and it’s certainly not an easy business, but it is one that can produce a solid profit if managed properly. This is a very basic view of Accounting 101, and looking at the numbers shouldn’t scare you.

A good CPA should make this as easy as reading the box scores, as Roth stated earlier. It begins with establishing a yearly budget, then looking at daily results. A monthly review will keep things on track and help direct you to trends.

Know the numbers – it’s paramount to running a successful business today.