By Don E. Ray, Portfolio
When I’m working with auto dealers to evaluate a potential dealership acquisition, I always evaluate the performance of each dealership department. While evaluating each department’s opportunities, I look at not just the historical but also consider ways to increase future profitability. Here are a couple of service department evaluations I recommend that I learned from Jeff Sacks, my buddy and fellow automotive consultant.
First, when reviewing the gross profit earned on labor an exercise should be undertaken that will compare what should have been earned with what is actually earned. The reason for this exercise is to establish if the dealership target is experiencing any labor gross profit “slippage.” If so, it can usually be rectified thus increasing profitability.
There are two steps to this exercise.
- Calculate what the labor gross profit should be. This is done by taking the retail labor rate per hour and deducting the average cost of labor (the average amount paid to the technicians per hour) in order to obtain the gross profit earned per hour. Take this gross per hour and divide this by the retail labor rate and convert it to percentage terms. This will now be the gross profit percentage that should be earned on labor.
PLEASE NOTE: The calculation of the average amount paid to the technicians should be a weighted average amount. Merely take the pay of each technician and convert it into the hours it represents. Add up all the hours. Add up all the pay. Divide the pay by the hours to obtain the weighted average amount paid to the technicians. This exercise should be undertaken for the past two months to obtain a valid cost of labor figure.
- Calculate the actual gross profit earned. This is done by simply taking the year-to-date figures off the operating statement. Add up all the labor sales relating to customer pay and warranty. Add up all the gross profit earned from these sale accounts and deduct (or if applicable add) the adjustment to cost of labor sales.
The resultant gross profit should be expressed as a percentage to the labor sales. This gross profit percentage should then be compared with the gross profit that should be earned in step one. This difference or slippage can be converted to dollar terms. Merely multiply the difference percentage by the amount of labor sales.
There are a number of reasons why the financial statement gross profit percentage could be less than the gross profit analysis.
- Technicians are charging out – and being paid for -work that is not being reported into accounting.
- Work is being done and the documentation is lost.
- Fictitious flags are being produced for payment.
- Clerical errors are taking place in the charging out of the repair orders.
- Non-flagged technicians are being charged to the cost of labor sales accounts.
- Technicians are being paid guarantees.
- The labor rate is being discounted instead of the discount being expensed.
- Inconsistent and incorrect accounting allocation of expenses.
- The calculation of the weighted cost of mechanical labor was incorrect and understated.
In the event the financial statement reflects a higher gross profit analysis than the technician’s analysis the following could have occurred.
- The calculation of the weighted cost of the mechanical labor was incorrect and overstated.
- Certain productive work is being done by people who are being expensed into the salaries portion of the expenses.
Another area of concern could be Adjustment to Cost of Labor, otherwise referred to as Unapplied Time. One excellent reason for Unapplied Time would be if the technicians are being paid a guarantee.
Should the amount guaranteed to the technician exceed what has been earned in the commission schedule, the excess should be expensed into this adjustment account by using the technician number. This will lead to a history being established in the accounting records.
These are a couple of tried and true ways to evaluate opportunity in the service department. Described here is a new way of maximizing parts and service opportunity.
Now, dealers have an opportunity to provide a limited warranty in the service department on all eligible customer pay repair orders which extends the manufacturer’s coverage on the applicable part. The warranty covers the part and the applicable labor adding up to 4 years of additional coverage, not to exceed 5 years total.
- This is a part specific, re-insurable extended warranty program.
- Offers service department customer peace of mind.
- Builds customer retention/loyalty in the service department.
- Dealership sells more parts by extending coverage.
- Dealership is differentiated from competitors.
- Generates a new source of income.
- Increases reinsurance premiums in your company.
- Full integration with major DMS providers.
- Available on wholesales as well as customer pay
In summary, when evaluating dealership acquisition opportunities consider both the old and new. You will find they both work quite well.