The area that almost all body shop owners struggle with (and quite honestly cringe at the mere thought of) is all about bookkeeping. Many traders are former coachbuilders and painters who have become owners; therefore, they never learned the art of accounting.
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Together, we’re going to run through a series of articles that will connect all the dots and cover all things bookkeeping in a body repair shop. At the end of this course, you will be an accounting pro!
Understanding financial performance
One of the most valuable things for any collision repair business is for ownership and management to have an accurate understanding of their financial performance. This often starts with organizing all the accounting to map or feed into a financial statement. There are many ways to approach this; however, for the purposes of this series, we will discuss the benefits to business profitability. Additionally, we will discuss accrual/GAAP methodologies versus cash accounting methods while guiding business owners and operators through the best and most simplistic approach to transitioning to these methodologies.
Incorrect mapping is the biggest problem we see in 90% of all body shops. I can almost guarantee if you’re reading this you have a problem with mapping.
What is cartography? Let’s think about a repair. For ease of explanation, let’s say that for each repair order, we have a sale and a cost for body labor, paint labor, parts, paint materials, and taxes. . Think of each of these categories as a bucket or file for each sale and expense. In your management system (CCC, Mitchell, etc.), each of these buckets or files must be aligned (also called “mapped”) to the corresponding account in your accounting system. Typically, at the end of the month, sales and costs are exported to the accounting system (Quickbooks, Xero, etc.), where sales and costs are posted. It is crucial that costs and expenses are correctly configured in your management system and exported to the correct accounts. If this mapping is not configured correctly, your data is unreliable and you have no idea what is going on financially in your store. Reliable data creates multiple benefits for the owner/management:
Understand the individual gross margin categories. The fact that selling and repair expenses are mapped in the same way on the income statement (P&L) allows management to understand each category of gross profit (parts, labor, paint and materials, sub- rental) based solely on repairs. This is important for owners, so they can measure themselves against past results, expectations, industry or budgets.
Easily identify trends in financial statements. When this happens, management can review historical gross margin trends or percentages, allowing them to easily identify gross margin trend declines in each category. When everything is bundled into one sales bucket, it’s impossible to spot mistakes and limits your ability to track down errors. When you see a P&L status and everything is correctly assigned, errors are easily identified, allowing you to correct the problem(s).
Identify financial opportunities. Properly mapping sales and cost of goods sold (COGS) also makes it much easier for management to recognize financial opportunities. When you find that your parts margin fluctuates from month to month, you can do some research to determine what determines the parts gross profit margin. Accessing the operating system and running reports will help identify repair orders that are driving the parts margin down. You may notice that you are not receiving the correct discounts from suppliers (which can be fixed), that you are using more LKQ parts than expected (which reduces the margin) or that you are using more spare parts (which which increases the margin). Maybe your estimator isn’t using your preferred vendors or checking for discounts when ordering parts. In another example, if they notice that the margin on the job has gone down, it would be obvious and point the direction towards research. They may have hired a technician at a higher flat rate or the retailer is working extra overtime, which would reduce the work margin. Either way, having the information is good for management.
Link sales and COGS. Matching sales to costs creates an atmosphere where management has more detailed information. This helps him make better and more informed repair order decisions based on data rather than gut feelings. Owners have so much pressure throughout the month, and their focus needs to be spread throughout the store. This allows them to spend less time working on financial statements or looking everywhere for information. It would be very obvious and easy to assess where the profit opportunities are.
Improved profitability. Mapping properly helps management in their decision making within each category to improve profitability. In the parts example mentioned earlier, management might recognize that a supplier is giving discounts below expectations, prompting them to meet with the supplier to negotiate a better deal. Or, management could talk to the estimator to educate them on the importance of using their preferred suppliers to increase profits or selecting the most profitable part selection. In the labor example above, having this information could lead management to assess overtime and/or distribute working hours more evenly or ensure that it affects working hours based on skill level.
In addition to having correctly mapped the sales and cost of goods sold from the estimation system, it is also important to correctly code your overhead costs. Creating specific general ledger accounts for expenses allows expenses to be categorized into “groups”. Here are some examples :
- Overhead – includes admin or front office payroll
- Repairs and maintenance
- Meals and entertainment
- Store supplies
- Vehicle fuel/maintenance
- Bank charges
There are many different accounts that can be created to suit each store’s needs, but having them is important for management. Generally, overhead costs are fairly constant (depending on the accounting methodology used), so it should be easy to recognize a spike or drop in an account.
Choose an accounting methodology
We’ve heard this from our accountant before, but did you really understand what your accountant meant when he or she referred to cash or accrual accounting? I know many of us probably look at accountants like a deer in the headlights as they talk over our heads – and we don’t talk for fear of looking stupid. Well, fear no more.
There are two accounting routes an owner can use: cash accounting and accrual accounting. Most auto body repair owners use a more complex version of cash accounting. Cash accounting involves recording transactions only on the actual flow of cash entering or leaving the business. Revenue is recognized when cash is received from the customer, while expenses are recognized when cash is paid. In this industry and according to the estimation system used by the operator, only sales and repair expenses are transferred to the accounting system. All other expenses are entered as they are paid directly into the accounting software. This method makes it easy for the business owner to realize their free cash flow and liquidity – something important for a business owner to know. However, this method of accounting limits an owner’s ability to understand long-term profitability. Moreover, it becomes difficult to create financial reports for potential lenders or investors.
This brings us to accrual accounting. Income and expenses are recorded as they are earned, even if payments have not reached an account. For example, when a repair order is “closed”, sales and expenses (parts, labor, paint and materials, sublease) are recorded at the same time. This allows the owner the opportunity to study the gross profit on each vehicle. This accounting method also allows owners to properly account for costs such as insurance, subscriptions, etc., over a period of time rather than a lump sum. In the case of insurance, the expense is usually an annual expense. In accrual accounting, expenses are divided by 12 months and counted as such rather than one large amount in a month.
Although both accounting methods are used, the one that will show management the overall health of the business would be the accrual method. The benefits of making gross profit percentages as they are earned without muddying it up with expenses that don’t belong to the sales produced are extremely valuable. Having cleaner financial statements is imperative if an owner is looking for an investor or needs to present their financial statements to a bank. It also exposes abnormal company spending and can easily amplify errors. The clearer the information you have as an owner, the better prepared you are to make business decisions such as budgeting and managing gross profit through to recognizing the true value of your business if you plan to sell your business.
In future articles, we’ll learn how to identify leaks (and, subsequently, the root cause of the leak), profit margins, and what a monthly review of your finances should look like.