Stress Test Your Business It s about the Numbers

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1 It s about the Numbers Presented by: Vital Learning Experiences Vicki & John La Plant vicki@vleishvac.com john@vleishvac.com

2 It s about the Numbers As with any Stress Test, Numbers must be in the Right Range for SURVIVAL & GROWTH Too High or Too Low, We Have Problems Some are Immediate Some May be Long Term According to the June 30, 2010, CFO Smart Brief: 47% of Business Owners are Concerned about Growth Strategy 22% are Concerned about Cash Flow

3 It s about the Numbers The List of Traditional Measurements is Endless Profitability Return on Assets Return on Net Worth Return on Sales Solvency Working Capital Current Ratio Quick Ratio Current Liability to Net worth Current Liability to Inventory Total Liability to Net worth Fixed Assets to Net Worth Adequate Investment Efficiency Collection Period Inventory Turnover Sales to Assets Sales to Net Working Capital

4 It s about the Numbers Traditional Ratios List of Traditional Measurements Financial Performance Measurement Formula What it Shows about a Company Targets Return on Assets net profits / total assests utilization of assests to generate profits 20% Return on Net Worth netprofits / average net worth how productive company is in generating profits for ownership 30-35% Return on Sales net profits / total sales efficiency of operation 10-17% Working Capital current assets - current liabilities money available to pay for unexpected situations or to fund growth 10-15% Current Ratio current assets / current liabilities ability to meet short term obligation from current assets 2 to 1 Quick Ratio (cash + accounts receivable) / current liabilities ability to meet short term obligations without inventory 1 to 1 Current Liability to NW current liabilities / net worth ability to meet current obligations from owner's investment.67 to 1 Total Liability to NW total liabities / net worth if ownership investment is equivalent to outside creditors investment Less than 1 to 1 Fixed Assets to NW Collection Period Sales to Assets Total Sales to Field Labor Cost Field Labor Cost to Total Company Sales fixed assets / net worth ((average accounts receivable) / yearly or monthly sales)) / # days in year or month sales / total assets sales / total field labor cost total field labor cost / sales whether ownership investment in fixed assets is working hard enough to generate profits.33 to 1 how many days company takes to turn invoices into cash 30 days how effectively assets are generating revenues $4+ how effective company is at bundling - selling upgrades $7 to $11 effectiveness of systems and procedures in maximizing usage of available labor 12% of total sales Field Labor Cost of RR to $Sales RR total field labor cost in RR / $RR sales effectiveness of bundling & procedures 8 to 10% of RR sales effectiveness of selling accessories & Field Labor Cost of Service to $ Service Sales total field labor cost in Service / $Service sales procedures 20% to 22% of service sales Sales / Employees total sales / # of employees appropriate # of employees to be productive $130,000 to $140,000 per employee Service Sales / Service Vehicles service sales / # service vans effectiveness of selling accessories $160,000 to $180,000 per service vehicle $ Sales/Salespeople $ sales per individual sales person effectivess of bundling & selling value $1,000,000

5 It s about the Numbers Total Company % Total Installation % Service % Sales $740, % Cost of Sales Labor $126, % Materials/Parts $114, % Equipment $231, % Other Direct Cost $4, % Fringe Benefits - Direct $18, % Payroll Taxes and Ins.-Direc $7, % Total Costs $502, % Gross Margin $237, % $500, % $67, % $44, % $231, % $4, % $9, % $4, % $362, % $138, % $239, % $58, % $69, % $0 0.00% $0 0.00% $8, % $3, % $140, % $99, % Overhead Expenses Compensation Salaries - Officers $43, % Salaries - Office $19, % Fringe Benefits $3, % Vacation and Holidays $4, % Payroll Taxes and Insurance $5, % Unapplied Labor $11, % Operation Expenses Tools and Supplies $2, % Office Supplies $5, % Vehicle Expenses $11, % Bad Debts $2, % Interest $3, % Charge Card Fees $ % Advertising $14, % Travel and Entertainment $ % Training $ % Freight $ % Dues and Subscriptions $3, % Contributions $ % Legal and Professional $4, % Telephone $3, % Utilities $2, % Insurance - General $39, % Taxes and Licences $16, % Uniform Expenses $1, % Lake Heating & Air Income Statement 2008 Fixed Expenses Depreciation $8, % Rent - Building $9, % Bldg. Maint. And Repair $1, % Total Overhead $219, % Operation Profit $17, % Other Income $1, % Net Profit Before Taxes $19, %

6 It s about the Numbers BALANCE SHEET FOR LAKE HEATING & AIR CONDITIONING FOR END OF YEAR Percent Change Current Assets Petty Cash $50 $ % Cash in Bank $30,708 $35, % Accounts Receivable - Trade $103,353 $92, % Accounts Receivable - Employee $823 $ % Inventory $25,463 $43, % Inventory - Work-in Progress $12,675 $23, % Prepaid Insurance $2,812 $3, % Prepaid Rent $784 $ % Prepaid Federal Income Tax $3,756 $2, % Total Current Assets $180,424 $203, % Fixed Assets Autos and Trucks $48,981 $71, % Less: Accum. Depreciation -$33,623 -$39, % Equipment and Fixtures $15,566 $18, % Less: Accum. Depreciation -$6,785 -$9, % Computer Equipment $3,899 $13, % Less: Accum. Depreciation -$1,579 -$2, % Total Fixed Assets $26,459 $52, % Other Assets Cash Value - Life Insurance $50,000 $53, % Lake Heating & Air Year-End Balance Sheet 2007 & 2008 Total Assets $256,883 $308, % Current Liabilities Notes Payable $26,184 $36, % Accounts Payable $30,354 $35, % State Sales Tax Payable $1,954 $2, % Total Current Liabilities $58,492 $74, % Long-Term Liabilities Notes Payable $38,548 $60, % Total Long-Term Liabilities $38,548 $60, % Total Liabilities $97,040 $134, % Net Worth Capital Stock Outstanding $25,000 $25, % Retained Earnings $122,734 $134, % Net Income for Year $12,109 $13, % Total Net Worth $159,843 $173, % Total Liabilities + Net Worth $256,883 $308, %

7 How Well are You Sleeping Ratios Cash Crunch Break-Even Analysis Cash to Current Liabilities Just Do It Ratios - Conversion Average Service Ticket Average Installation Ticket Service Calls that Generate Replacement Leads # Maintenance Agreements per $1 million in RRS Bundling Ratio - # Value Adder Jobs per # Total Installation

8 Am I Charging Enough Ratios EBIT + Owner s Salary Low Labor versus High Labor Jobs Gross Margin $s per Day per Type of Work Closing Rate Am I Building Value Ratios EVA Momentum Value of Maintenance Agreement Customer Value of Customer Data Base Value of Active Customer versus Inactive Customer Base % of Active Customer Base with Maintenance Agreements

9 Cash Crunch Overhead + Payroll Cash required to cover Operating = Operating Expenses = $219,786 = $602 per day Expenses in 30 Days 365 days 365 Cash required to cover Payroll (office + Field) = ½ of overhead = $301 per day Recommended 10 days of Cash on Hand = $602 + $301 x 10 days = $ 9,030 Cash required for 10 Days = $9,030

10 Overhead is like a Giant Piggy Bank Some % of Every Dollar Sold Must be Contributed to Overhead Overhead Coverage Measures how many days of cash available to meet overhead requirements Break-Even Analysis Measures what day of the year or month, the company pays for the 12 months of overhead that will be accumulated

11 15 Measurements that Count What is Break-Even? u When the company has generated enough sales volume to cover overhead and all direct costs incurred to that date. Zero profit. u Gross Margin $ = Overhead $ u Can be calculated on a monthly and annual basis u Measurement reach break-even as early in the month or year as possible

12 Maximizing Profit - It s about the Numbers Formula for Break-Even $ Overhead % Gross Margin Lake Annual Break-Even = $219,876 = $685,

13 Maximizing Profit - It s about the Numbers Formula for Break-Even $ Overhead 12 Months = $ 219, = Lake Monthly Overhead = $18,323 $ Monthly Overhead Gross Margin % = $ 18, Lake Monthly Break-Even Sales Volume = $57,099

14 Maximizing Profit - It s about the Numbers Break-Even Analysis Projected Annual Sales for Current/Next Year $740,000 Projected Annual Overhead for Current/Next Year (Minimum Last Year + 10%) $219,000 Gross Margin % for Year End of Previous Year 32.09% Annual Sales Volume Break-Even $682,456 Day of Year Company Will Break-Even Based on Above Projections Monthly Sales Volume Break-Even $56, Change the Numbers Enter New Projected Gross Margin % New Projected Annual Sales Volume Break-Even New Projected Monthly Sales Volume Break-Even New Annual Break-Even Sales Volume if Gross Margin is changed to 33.09% $661,831 $55,153 Enter New $Overhead Amount New Projected Annual Sales Volume Break-Even New Projected Monthly Sales Volume Break-Even New Annual Break-Even Sales Volume if Overhead is Changed to $209,000 $651,293 $54,274 New Annual Break-Even Sales Volume if both Gross Margin & $Overhead is Changed as Above $631,611 New Monthly Break-Even Sales Volume if both Gross Margin & $Overhead is Changed as Above $52,634.23

15 Maximizing Profit - It s about the Numbers One More How are You Sleeping Ratio Cash to Current Liabilities $ Cash $ Current Liabilities = $ 35, 785 $ 74,022 =.48 or 48% 10 to 20 % of Current Liabilities should be Available in Cash Why? If more than 20% available in Cash, what might that suggest?

16 Just Do It Ratios Conversion Ratios Average Service Ticket Average Installation Ticket % Service Calls that Generate Installation Leads # Maintenance Agreements per $1 million in RRS Bundling Ratio - # Value Adder Jobs per # Total Installs

17 Average $ Amount of Service Ticket $ Total Service Sales / # of Service Invoices Industry Average = $135 Industry Target = $185+

18 Average $ Amount of Installation $Total Installation Sales / # of Installation Invoices Industry Average = $4,500 VLE Target = $6,500 minimum

19 % Service Calls that Generate Replacement Leads Total # of Service Invoices Divided by # of Replacement Leads Credited to Service Industry Target - 25% One out of Every 4 Service Calls Should Lead to Proposal for Replacement Installation

20 # Maintenance Agreements per $1 million in RRS Total # systems covered by Residential Maintenance Agreements to $ Residential Replacement & Service Sales Industry Target 800 to 1200 systems per $1 million RRS

21 Bundling Ratio - # Value Adder Jobs per # Total Installs Installs with Upgrades / Total Installs Upgrades = Increased Efficiency Geothermal Accessories Air Distribution Upgrade Zoning Duct Cleaning Blown Insulation Ductless to Ducted System Recommended = 60% of Installations should have Upgrade(s)

22 System Efficiency Bid Selected and Amount Spent on Home Comfort System Standard Efficiency High Efficiency 14% 15% 25% Low Bid Middle Bid High Bid 67% 74% 65% Customers who purchase super high efficiency are more likely to accept the high bid. Standard efficiency customers are more likely to accept the low bid. 8% Super High Efficiency 12% 20% 0% 10% 20% 30% 40% 50% 60% 70% 80% % of Replacement Buyers Source: American Home Comfort Study 2006 Conducted by Decision Analyst

23 Am I Charging Enough Ratios EBIT + Owner s Salary Low Labor versus High Labor Jobs Gross Margin $s per Day per Type of Work Closing Rate

24 15 Measurements that Count Owner Owner/ Manager Owner/Employee Owner/Salesperson If Owner wears Different Hats, Should be Paid for each One.

25 15 Measurements that Count Owner Owner/ Manager Owner/Employee Owner/Salesperson Example 2.40% Target 10% of Sales 5.88% 7% of Sales $0 0% of Personal Sales Experienced Tech 8% of Personal Sales If Owner wears Different Hats, Should be Paid for each One.

26 EBIT + Owner s Salary Earnings Before Interest & Taxes + Salary for Jobs Owner Performs in Company Lake Heating & Air EBIT + Salary for Jobs Owner Performs EBIT = $19,206 + $3,117 + $43,550 = $65,873 $65,873 / $740,514 = 8.89% of Sales Minimum Recommended = 17% (10% of Sales for Profit + 7% of Sales for GM Salary

27 Low Labor versus High Labor Jobs Compare High Labor Installations / Total Installations Cost Smith Job % of Job Cost Jones Job % of Job Cost Equipment $775 $1,075 Material $170 $100 Labor $ % $ % Labor benefits $75 $45 Other direct costs $50 $50 Total of direct costs $1,470 $1,470 If Labor Costs are 20% or More of Total Job = High Labor Job

28 $ Gross Margin per Crew Day by Type of Installation $ Gross Margin Residential Replacement / # Payroll Crew days for RR Installations $ Gross Margin RNC / # Payroll Crew days for RNC Installations Industry Targets: Residential Replacement = $1,400 to $1,600 GM per crew per day Residential New = $900 to $1,200 GM per crew per day Commercial = Similar to Residential New Construction

29 Closing Rate # Qualified Leads / # Closed Jobs VLE Recommended Closing Rate 80% for Maintenance Agreement Customers 65% for Non-Maintenance Agreement Customers

30 Am I Building Value Ratios EVA Momentum Ratios EVA Momentum Value of Maintenance Agreement Customer Value of Customer Data Base Value of Active Customer versus Inactive Customer Base % of Active Customer Base with Maintenance Agreements

31 Definition of EVA Momentum EVA = Economic Value Added = Ratio of change in company s economic profit in one period of its sales to its sales in the prior period. Annual EVA Momentum = Current Year s Operating Profit Real Capital Cost (for the current Year) / Previous Year s Sales Example Lake Heating & Air 2008 Operating Profits = $17,748 - $10,000 (cash outlay for truck + $5,000 for computer / $640,000 (2007 sales) =.0035 Target = Minimum of 5+% and number should increase each year

32 $ Value of Maintenance Agreement Customer ($ Sales to Maintenance Agreement Customers + $ Sales to Customers Referred by Maintenance Agreement Customers) Divided by # Maintenance Agreement Customers (Agreements) Important Note Maintenance Agreement Customer = Someone who has a documented maintenance agreement with your company

33 Example of $ Value of Maintenance Agreement Customer / Base Annual Maintenance Agreement Selling Price = $185 MA Customers Purchased $50,000 in installations & accessories 300 MA 85% Annual Renewal 45 New MA Customers Purchased MA No System to Document $ Purchases Referred by MA Customers $ Sales to Maintenance Agreement Customers + $ Sales to Customers Referred by Maintenance Agreement Customers Divided by # Maintenance Agreement Customers (Agreements) $ Value of Maintenance Agreement Customer = $351 $ Value of MA Customer Base = $105,500

34 Efficiency Level 2004 vs % of Replacement Buyers 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 37% 58% 26% 70% 20% 72% 5% 4% 8% Owned Service Contract Did Not Own Service Contract Don't Know Super High Efficiency High Efficiency Standard Efficiency

35 $ Value of Maintenance Agreement Customer Industry Target for the $ Value of Maintenance Agreement Customer = $500 Active Customer = Purchase from Your Company in Last 12 to 18 months Active Customer = Value of maybe $200 to $300 Inactive Customer = Value of $0

36 % of Active Customer Base Who Are Maintenance Agreement Customers Minimum Recommended Target = 50% of Active Customer Base Should Have Maintenance Agreements % Should Increase Each Year + +

37 Value of Accessible Customer Data Base that Can be Sorted Industry Average to Generate Lead = $250 to $350 Customer Data Base Should Produce Lists: Name, Address, Zip code, Maintenance Agreement Type of Equipment Age of Equipment Date & $ Amount of Last Service Call If can sort and access customers by equipment, age, and last call, VLE adds value of $50 to $100 per name.

38 Non-Traditional Ratios Performance Measurement Formula What it Shows about a Company Targets Cash Crunch (($ operating expense / 365 days) + 1/2 of cash to cover overhead for payroll)) x 10 days enough available cash to meet immediate overhead and payroll 10 days Company Break-even Cash to Current Liabilities $ overhead for year or month / % gross margin $ Cash / $ Current Liabilites when overhead has been covered for month or year so pricing strategies can be adjusted enough available cash to meet immediate current liabilities as early in year or month as possible 20% of current liabilities available in cash Average Service Ticket total service sales / # of service invoices effectiveness of selling accessories & procedures $185+ per invoice Average Installation Ticket total installation sales / # of installation invoicies effectivess of bundling & selling value $6,500 + per invoice Service Calls that Generate Replacement Leads # Maintenance Agreements per $1 million in RRS total # service invoices / # of replacement leads created total # systems covered by maintenance agreements / $ total of residential replacement + service sales effectiveness of service techs in educating customers, incentives & training effectiveness of procedures, training & incentives to obtain maintenance agreements 25% of service invoices should lead to proposal for replacement 800 to 1200 systems per $1 million RR + Service Bundling Ratio installs with upgrades / total sales effectiveness of educating customer 60% of installs should have upgrade(s) EBIT + Owner's Salary to Sales Low Labor Installations to High High Labor Installations $GM Service per Service Vehicle/day ($earnings before interest & taxes + owner's salary from company) / $total company sales installation jobs with 20% or less labor cost to total cost / installation jobs with 20% or more labor cost to total cost $GM Service / # Service Vehicle / #days ability of company to generate fair return & salary compensation for ownership ability to bundle, sell value & effectiveness of procedures effectiveness of selling accessories & procedures minimum of 17% of total sales without sales commission 1+ low labor job to every 1 high labor job $400 to $600 per vehicle per day $GM for Residential Replacement per crew per day $GM Residential Replacement / # crews / # days effectiveness of bundling & procedures $1400 to $1600 per crew per day effectiveness of procedures & working with $GM for Residentia New Construction per crew per day $GM RNC / # crews / # days homeowner $900 to $1,200 Closing Rate Annual EVA Momentum Value of Maintenance Agreement Customer Value of Accessible Customer Data Base # Active Customers #closed jobs / # qualified leads % of Active Customer Base with MA # MA Customers / # Active Customers effectivenss of educating customers, sell value & training 80% for maintenance agreement customers 65% for non-maintenance agreement customers ((current year's operating profit - real capital cost for current year) / previous year's sales improvement in company value 5+% and increase in % every year (($sales to MA customers + $sales to customer referred by MA customers) / # MA agreements increase in company value $500 ability to effectively & economically market to existing customers $50 to $100 per name # customers in data base made a purchase in last 18 months increase in sales & company value more is better ability to sell value and increase in company value 50% and increase in % every year

39 To Pass Your Business Stress Test You Should be Able to Sleep You Need to Just Do It You Must Constantly Ask, Am I Charging Enough? You Must Consistently Build Value