Are You Killing Profits With Your Salaries Expense?

The most common profit killer I see when analyzing dealer financial statements is salaries. I wrote an article some time ago giving you the “secret formula” for calculating salaries expense. This article has since become the most visited article on my website and the subject is so important to your bottom line I thought I’d share this “secret formula” with you again. Here it is.

Profit is like baking a cake.  There are a number of ingredients that go into baking a great cake but if you mess up on the main ingredient, your cake is sure to fail.  If you don’t use enough flour your cake won’t rise, but if you use too much it will be heavy and not taste good. 

Your business works the same way.  Not enough staff and you will miss sales opportunities and provide poor service.  On the other hand, too many staff for your sales volume and you can kiss your profit out the window.

So what is the right formula?  Before we apply the formula you have to make sure you are using the right number for salaries in your calculation.  Salaries should include all of your staff with the exception of your Service Technicians.  Your Tech salaries or wages should be accounted for as a cost of goods sold in your Service Department. 

Another mistake often made is including sales staff commissions as a cost of goods sold for your unit sales.  Salaries should include sales staff whether they are commissioned or waged, administration staff, and management including the Service Manager and Service Writer.

Now that you have the right salaries expense number, divide it by your gross sales, not including other income.  To use an example, let’s assume that your gross sales, which includes units, parts, accessories and service is $7,500,000 and your salaries are $850,000 for the year.  If you divide $850,000 by $7,500,000 you get 11.3% as your salaries percentage of gross sales.

The ideal target for salaries is 9.0% of gross sales.  How do I know this target to be true?  After years of analyzing dealer financial statements and accumulating the data, it became apparent that the top performing dealers in profitability were all hitting the 9.0% target or slightly less.  You can see from our example that our dealer has over spent by 2.3% or $175,000.  In my book that is a significant loss in bottom line income.

This percentage remains the same whether you are a $2,000,000 or a $10,000,000 business.  Obviously your flexibility becomes much less the smaller your volume is, but ultimately the number you want to hit for salaries is 9.0% of gross sales.

The other benefit to this calculation is it helps you find those key break points in sales volume.  You might find that you just cannot properly service your dealership at the 9.0% level when the sales are at $2M per year, so you may need to increase to $2.5M. 

On the other hand you may find your optimum level is at $3.5M, because if you increase to $4M you have to increase your staff and throw out your balance with salaries.

Take a few minutes of your time and run this calculation on your last few years financial statements.  It’s a real eye opener and may shock you to find how much income you lost because you were not hitting the salaries target. 

We are conditioned to think sales first, but we all know how many units you have to sell to make a little more net income.  Maintaining the right staff levels can make a huge difference in your bottom line profit.

If you need a little help with this important target or just want to confirm you are using the right calculation, contact me for a free consultation.

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