If you watch Key Performance Indicators (KPI’s), you may lull yourself into a false sense of security that your business is doing well because your numbers are better than industry averages. However, it is the trends that are important - are those numbers increasing or decreasing? The trends tell the real story as to whether your business is on the right track.
The five most important trends to watch are
- net profit per hour
- current ratio
- productivity ratio
- receivable days
- inventory days.
When these ratios are trending in the right direction, your business is becoming more profitable.
Net Profit Per Hour
Net Profit Per Hour = Total Operating Profit ÷ Billable Hours
Do not include meeting hours, training hours, vacation, holiday, or sick hours. The only hours that should be included are those hours that your employees billed customers for. This calculation should be done annually. If you calculate it monthly, the net profit per hour will vary depending on the number of billable hours that month, i.e. seasonality.
Each year, the company’s net profit per hour should increase. This can be accomplished by raising prices. However, greater increases in net profit per hour result from managing labor and inventory well. For each unapplied hour that turns into a billable hour, the net profit per hour increases. Keeping field labor out of the office and on jobs as well as proper routing of service technicians can increase billable hours.
Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities
Current ratio answers the questions, is my company becoming more or less profitable and can I pay my bills?
For most HVAC companies, current assets are cash, accounts receivable, inventory and prepaid expenses. Current liabilities are accounts payable, taxes payable, current portion of long term debt, and other liabilities due within one year.
This ratio must be one or higher. If not, your company does not have enough cash to pay its bills and probably is experiencing a severe cash crisis. If the current ratio is less than one, the best thing to do is increase profitability. As profits increase on a monthly basis, the current ratio increases on a monthly basis.
As a rule, increasing current ratio means increasing profitability. Decreasing current ratio means decreasing profitability. The major exception is when a company purchases or sells assets (trucks) for cash or has large tax bills. If your current ratio is decreasing over a two to three month period, this should be a warning sign that profits are decreasing, even if you cash in the bank. It might be warranty issues, jobs going over estimates, lack of productivity, or some other issue. Find out why profits have decreased and fix the problem.
Productivity Ratio
Productivity Ratio = Total Payroll Plus Payroll Taxes ÷ Sales
The productivity ratio answers the question, for every dollar in revenue that the company earns, how much is it paying in payroll and payroll taxes?
Sales
Include all payroll, field, office, and officers, FICA, medicare, state unemployment and federal unemployment. Do not include bonuses, worker’s compensation or any other benefits.
On a monthly basis, the productivity ratio may rise and fall depending on seasonality. However, the long term trend should be downward or constant.
If the productivity ratio is greater than 100%, the company is spending more on payroll, etc. than it is generating in revenues. This can happen in slower times of the year. To avoid this, have a thriving maintenance agreement program.
Receivable Days
Receivable Days = 365 ÷ Annualized Sales / Accounts Receivable
Receivable days answers the question, how many days pass between the time the company sends an invoice to the time it receives payment?
Annualized sales are year to date sales times 12 divided by the month of your fiscal year. Accounts receivable should be only those customers who owe the company money. Do not include employee tool accounts or other employee receivables.
For residential companies, receivable days should be under 30 days. If they are not, then the company is not collecting COD. The higher the receivable days, the longer it takes to get paid.
Taking credit card payments is essential to having receivable days under 30 days.
For commercial companies, bill every day. If invoice terms are net 30, if you haven’t received payment by the 31st day, then someone must call the customer and ask when payment will be received. Staying aware of receivables sends a message that your company is serious about getting paid. This usually results in quicker payments.
Inventory Days
Inventory Days = 365 ÷ Annualized COGS/inventory
Inventory days answers the question, how many days pass between the time the company purchases a part and uses it on a job?
Annualized cost of goods sold (COGS) are year to date cost of goods sold times 12 divided by the month of your fiscal year.
For residential companies, inventory days should be under 30 days. If they are not, then the company has too much inventory. The higher the inventory days, the more inventory the company has.
Inventory is a bet. The company is spending its hard earned money on materials that it hopes it will sell. Many times inventory sits on shelves, is damaged on trucks, or not used on customers’ jobs. Proper inventory procedures mean using a purchase order system, standard truck stock and replacing inventory from service tickets, as well as using material sheets for replacement jobs.
It takes less than 30 minutes to calculate these five ratios every month. Then, graph the numbers. You will see trends:
- If your net profit per hour and current ratio are trending upward, then your company is becoming more profitable.
- If the productivity ratio is trending downward or stable, then your employees are productive.
- If the receivable days and inventory days are 30 days or less, then you are generating cash through collections on a timely basis and not building up inventory.
