Financial Structure: From Novice to Expert

By Gary Elekes - October 1, 2018

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Many of our contractors came up through the school of hard knocks, learning the trade from the ground up, studying the mechanical aspects of the trade. It is a fantastic way to be sure the technical aspects of our business are covered; after all, what we do requires us to be able to solve mechanical issues and application work.

However, as many companies grow due to the Michael Gerber "E-Myth Contractor" model -- that the better we are technically, the more referrals and growth we get, causing us to reach our own Peter Principle -- our inability to control the new business as well when we hire folks.

The E-Myth is classic text, defining the very idea of why a company can prosper in one phase then struggle in the next phase, and therein lies what this material is all about. The technical phase is where we start, growing as an entrepreneur, then finally becoming more of a managerial company -- IF we make the steps of the progression happen.

The business of business requires us to layer on in that growth phase (and even BEFORE the growth phase) financial structure. The growth (entrepreneurial) phase is where many get into trouble.

The idea of financial structure is simple: have the company's accounting and reporting capability such that an owner gets the right information, on a timely, accurate basis.

The PURPOSE of financials is: to give a clear indication of how a company's operational practices are performing in reality.

This sounds simple in the vacuum of a business article. Timely, accurate, interpret -- simple words but rather tough to execute day in and day out in the real world, where so many areas of static are attacking the business like cruise missiles coming in one after another.

Financial structure starts with knowing there are three financial statements:

  1. The Income Statement
  2. The Balance Sheet
  3. The Projected Cash Flow Statement

Now most all basic software packages have these as statements which need to be set-up, but they do NOT come organized for the homes service trades. In fact, it's all ordered by the alphabet and, well, we don't run our business by the alphabet, so we have to take the 1st step:

Configure your chart of accounts

This is one of the biggest challenges we see. It is a recipe of sorts, and we use the GAAP (Generally Accepted Accounting Principles) to define it. What is crazy is they rarely conform to the GAAP standards, thus making it very difficult to review KPI's and compare your company to other great companies for operational changes.

Review the EGIA suggested chart of accounts for each statement. They exist based on GAAP and an example is the burden (benefit costs for field labor) – these costs are a "cost of goods sold (COGS)", and most companies do not have them attached as a chart of accounts in COGS. FICA, FUTA, SUTA are all attached to payroll, and are part of the benefit burden along with Dental, Medial, Vacation, Holiday Pay, Paid Time-off, etc.

A basic income statement example may look like this, given that revenue (sales) is simple and already understood:

Revenues (sales)
Cost of Goods Sold
Gross Profit $
Overhead (operating expenses)
Earnings Before Interest and Taxes (EBIT)

Now if you have this in your company operating expenses and not as a cost of goods sold, your gross profit is all wrong, so the accuracy issue is now a problem. Your data is misleading you, and this affects your pricing and even operational discussions.

The basis of having a properly organized chart of accounts is to be sure that our reporting and data are telling us what OPERATIONS are actually performing. A more refined version of the Income Statement may look like:

Revenue 100
Cost of Goods Sold
Direct Labor 9
Burden on Labor 3
Permits 1
Equipment 25
Parts/Materials 7
Subcontracts 1
Rebates/Financing-Promotions 2
Extended Warranties 2
Warranty Expense Plan 1
Sales Commissions 6
Total Cost of Goods Sold 57
Gross Profit Dollars 43

This of course is over simplified, but we are talking about structure. The next layer is the operating expenses. These expenses are very different than cost of goods sold-type expenses, in that they exist whether we sell anything or not. Rent is an example. It's due even if we have a poor sales month.

We should group those into 5 categories and make them sub groups.

Marketing Expenses
Employee Related Expenses
Vehicle Related Expenses
Plant & Equipment Expenses
Administrative Expenses

These five areas are called functional areas of operating expenses: we function to make a sale happen and then produce it.

Once again, we can review the EGIA chart of accounts and budget tools to help us define these accounts. When we allocate our costs in real life to the proper areas, we begin to see a picture emerge of our operating practices.

The second major lesson in this discussion is departmentalization. Once a company has the basic structure of what the accounting should look like, we need to execute the same idea across all business segments. So add-on is an income statement; service will have its own income statement; as will maintenance, light commercial, and so forth. Any business segment a company has that is important to its success needs to be accountable and tracked as a part of a departmental statement. Once again, giving clear, timely, accurate, and interpreting meaning for each segment.

And once we have this, we can effectively use "Key Performance Indicators" (KPI's) to compare our operations to the best of the best and make adjustments.

The KPI's are broken down by each business segment so we can analyze operations and be very definitive about our patterns of success and what may need to adapt.

There is a great deal more to all these conversations, and ideas, so feel free to reach out to EGIA and learn more. The model of success exists and is waiting for you as a contractor to take action. Get control, get timely, get accurate, and learn the next phase of how to grow by becoming more effective at being a manager not just technically superior.

ABOUT THE AUTHOR

Gary Elekes

President, EPC Training

Gary Elekes is serial entrepreneur with a passion for helping others become more successful by sharing what he has learned over the past 3 decades working closely with all facets of the contracting industry. During his career, Gary has held senior management positions at Lennox and Service Experts. In 2000, Gary moved into entrepreneurship and started his training and consulting business EPC. Today, EPC continues to support growth oriented businesses aspiring to reach 20% EBIT. He also designed the very first web based learning platform for the residential contracting industry, which acts as a support system for training and learning in HVAC and plumbing trades, and has over 5,000 subscribers.

In 2003, Gary began acquiring contracting firms with a focus on developing turn-around opportunities. He also opened and operated several start-up businesses. In 2010, he added web design/SEO and online marketing to his company portfolio starting Imarket Solutions as a co-founder. Gary graduated from Ohio State University with a BSBA and also holds a Master's Degree in Business and Finance.