Accounting puzzler

[Rich]

I've been thinking lately about the subject of increasing productivity. Doyle has brought this up a few times and in a post on the Uffy tacking tool, sofadoc speculated about how much time could be saved by using one. He suggested that if the time could be dropped from 3 hours hand driving the tacks to a 1/2 hour using the tool, then at $50.00 an hour shop labor rate, there would be a $125.00 profit realized. My thought was something that has not been settled in mind and I thought maybe the great minds on this forum might have some insights. Here's my question; Let's say you actually could reduce your time by 2 1/2 hours with this tool and so, at $50.00 an hour, realize a $125.00 profit. If the tool costs about $600.00 as Gene noted, would you divide that price by $50.00 (shop labor rate) to come up with 12 hours? I say no, because that $50.00 charged for each hour of labor has to pay not only for tools and equipment, but also salaries, shop overhead etc. So what is the correct method for estimating the pay back potential of the purchase of a time saving tool?
Thanks,
Rich

[Mojo]

Rich:

Typically when larger companies look for investments ion tools or machines they consider the payback. If memory serves me correctly they looked for 2 year pay backs. 

There are accounting standards for this and it has been so long since I have been in the consulting game that I have forgotten them. But I believe it is 2 years based on a particular formula.

Of course many industries also consider safety and health issues when purchasing equipment. If a piece of equipment will not save time but provide better ergonomics or better safety then they will purchase it.

Chris

[MinUph]

So what is the correct method for estimating the pay back potential of the purchase of a time saving tool?
Thanks,
Rich

This all goes back to knowing your over all expenses to operate. Building, electric, insurance etc. You could subtract the cost of a truck for this but you would need to figure all in shop expenses and then you can have a true hourly rate. The $50.00 example is not a correct assumption. Unless it takes all things into account.

[sofadoc]

It's kinda like "Obama Care". The Dems say it will save billions.........the Republicans say it will cost trillions.
Whether you're talking about balancing the Federal budget, or buying an air nailer for your shop, you can make the numbers say whatever you want them to say.

About 12 years ago, our local school district decided to go to "block scheduling" (instead of six 1 hr. classes per day.........three 2 hr. classes alternating every other day). They showed the voters how it would save the district $350,000 a year. Naturally, it easily passed. Well 7 years later, they used the same numbers to justify going back to the old scheduling method.

Several years ago, our town voted to "Go wet" and allow alcohol sales. The voters were promised an extra $13 million per year in sales tax revenue. It never occured to anyone that every $ spent on beer might mean a $ LESS spent on milk. There has been no significant increase in tax revenue realized.

Sorry, I didn't mean to take this topic off course. Just sayin' you can use math to validate anything you want.
I don't know if there is a truly accurate formula that takes everything into account.

Bottom line is.....if that air nailer saves time, it'll save money. And once you've saved enough money to pay for the nailer........it's all gravy after that (but I'm still not convinced that nailer is all it's cracked up to be).

[Rich]

Fortunately, in our own businesses, we don't have to resort to spin and smoke and mirrors like the politicians do, we just have to be honest with ourselves and make sure that the numbers we're looking at really do pertain to what we want to know. Now, I will say that many a tool has been bought with the excuse of saving time when the real motive was to have a new toy, but if we really are looking for a return on our investment, we need to know what the numbers mean and I think we should pass on something that while looking like it will bring in more profits, in truth, ends up costing more than it produces.
Mojo mentioned a standard two year pay back period. I'm thinking that was the dividing line between purchase or not? That woud make sense. But, how would you know if a tool would be paid off and making pure profit after that time unless you knew how many dollars it saved each time you used it?
Rich

[Mojo]

Rich:

You would have to calculate your time doing something one way versus with the new tool. I am constantly looking at ways to speed up my production without compromising quality. I think I told this story once but I had my wife sit in the shop one day and watch me make a slide topper. She discovered I was creating more work for myself and that if I changed one procedure around I would save myself 15 - 30 minutes depending on the topper.

Doesn't sound like much but that equates to almost 2 hours on a quad slide order. 2 hours x my hourly rate is a pile of money. That is how I got myself up to $ 135 per hour. Obviously this doesn't work for everyone, especially those who work and charge by the hour. I charge a flat price for each topper so every bit of time savings I can come up with equates to more money in my pocket. There are things we have been doing for years out of habit and do not recognize time savings by changing the way we do things. Thankfully my wife found the savings for me.

I have reached the peak and can no longer find any more time saving procedures unless I sacrifice a little quality. My reputation and sales are based on the highest quality topper or awning an RV'er can buy and I refuse to sacrifice even a little quality. In other words I have milked it for all I can.

Chris

[baileyuph]

Rich,

I sure like your mind, cut through the chaff and tell me what I need to know type of guy. ;)

So I will cut through the mess and offer the best way is to look at the shops net.  How much will anything take away or enhance the shops net is where the answer really is.  If you do a project one way and then another way, how did it change the shops net?  It could have gone down or up both ways.  

How specifically this tool benefits a shop will vary from shop to shop.  The equation isn't the same.  If a shop isn't paying any significant earnings tax before or after obtaining the tool, there has not been a significant benefit has there?  No. Because the net didn't reflect any.

Shop net will give an accurate number when all other variables are held the same.

Back to the tool, if early estimates are not giving clear judgement regarding purchase, then we have to rely on experience and judgement and possibly speculation about our business performance going forward.  This applies to any business big or small, only the magnitude of things varies.  Use your gut in other words.  It wouldn't hurt to review your past "gut" performance, if it is usually wrong.........well maybe we have gone far enough.   :)

Going forward, if there is significant work for the tool, the tool works like it is supposed to, and will there be a positive from it all on your tax return, it leaves little to argue about.  If a shop is paying big taxes, that issue has to be reviewed.  All those things are rolled up in your net.

All said, the net performance, not shop rate, etc., is the parameter that is statistically most important to me.  Other considerations can provide some guidance (for the gut) when harder numbers are not available.

Doyle

[Rich]

I have reached the peak and can no longer find any more time saving procedures unless I sacrifice a little quality. My reputation and sales are based on the highest quality topper or awning an RV'er can buy and I refuse to sacrifice even a little quality. In other words I have milked it for all I can.

Chris

Sometimes, even when I think I've maxed out my productivity, I find one more thing to improve the situation. But even so, it sounds like you're doing well.


Doyle, Are you saying that taxes would prevent you from increasing your profit? Sometimes, I've wondered about that since it seems the gov't takes away incentive from the small guy, but I usually just try harder anyway.

Yes, the net is the most important thing, but my question is do we take (as in Sofa's example) all of the increase ($125.00) as pure profit, or a portion of it. The more I think about it, I'm inclined to choose the former since, if the tool didn't exist, the job would take three hours (assuming, of course that the example is correct) and that's 2-1/2 more hours than if it did exist. To take the opposite approach, suppose you had a tool that enabled you to do an operation in a half hour and it broke down. Until you could repair or replace it, you'd be forced to spend three hours doing it the old way and 2-1/2 of those are hours that you could be earning your shop rate (at least your shop rate) doing another job.
Rich

[gene]

When I sold industrial packaging materials, big companies would look at the pennies. If they buy 1 million boxes a year and can reduce the cost by 1 penny per box, that's a $10,000 per year savings.

I think it's a different world for a one person small business.


(I use Quickbooks so the following is very easy to do on a monthly, quarterly, and annual basis.)

I take my monthly gross sales.

I subtract the same month expenses. This gives me my net income for the month.

I subtract a percentage that I use to indicate the taxes that will be paid on this net income. I got this from looking at past years' tax returns. I also subtract any sales tax that I collected that will be paid to the state.

The remainder is my after tax net income. This is what I can stick in my pocket.

I can now divide my after tax net income by the number of hours I worked that month and find my hourly rate - how much I am making per hour.

For most one person businesses, I don't know why one would need any more information than this. This can be an excellent benchmark.

The goal becomes to find ways to get this hourly rate up and up and up.

Comparing annual rates is important because some months will be down and others will be up, and the months are not always the same year after year.

Also, buying a $600 tool to increase productivity should average out the year if it does indeed increase productivity. A lower rate for the month you bought the tool but a bit higher rate for the months where the tool helps you be more productive.

Does anyone have a different, or easier way, to bench mark their income?

gene

PS: The owner of Subway Restaurants said in an interview last week that if he had to start his company today he would not be able to. Just in the last 15 years the taxes, rules and regulations have become extremely detrimental to small businesses.

[sofadoc]

Just a thought. I don't necessarily try to put a price on increased productivity. In the hypothetical example with the Uffy nailer, I would be equally interested in the tool reducing my physical exertion.

I use a vacuum cushion stuffer because it's less physically taxing, not because it's quicker (because it really isn't). Same with my electric rotary cutter. It only saves a few seconds per 100 inches of cutting, but it saves a ton of wear and tear on the joints in my hand.

Do you only use a furniture dolly because it makes moving heavy items quicker? Or because it also reduces strain on your back?

I think that when trying to justify the cost of a tool, physical reduction should be factored in (which would make it even easier to justify buying "toys" that we may not really need ;)).

[Rich]

Gene,
That's a good method for knowing where you stand especially if you'd like to know whether you'd be better off financially closing up shop and working for someone else! But it won't help you to decide if a tool or method has any benefits over the way you currently do things. I'd like to know how to do that.
As an aside, in the past year, I've been keeping track of my income and expenses and comparing them to a standard for break-even. I know when I reach that point in the month where all my expenses are paid and I begin to work for myself. That was an eye opener! Like right now, starting a new month, I go to my shop and everything I do is for someone else. Tomorrow, same thing. But I can see the expense numbers going down and the income coming up and at some point, the numbers change from red to black (spreadsheet) and I am officially making a profit. I find it's  a mental boost to keep score this way.
Sofa, I agree that time savings is not the only factor to be considered. Like you said, reducucing fatigue as well as other facors important to you can also be good reasons to pay for a new tool. You do need to know the numbers however, to judge profit, whereas with comfort or ease of use, your body will tell you that!
Rich

[baileyuph]

Paul's comment and the rest pretty well say the same thing, these analysis can provide a summary or a play by play analysis of business performance. 

There is subjective and objective reasoning in most decisions in business.

Doyle

[gene]

But it won't help you to decide if a tool or method has any benefits over the way you currently do things.

I agree and that's one of my points, Rich. If I have 35 people each putting in decorative nails 40 hours a week, then finding out that info can save a lot of money for the company.

As a one person band, I could measure the time savings by doing a job by hand and then a similar job by pneumatic gun and comparing the difference. This info would be interesting but I don't think of any major benefit to my company's performance. I would probably use the gun if it made my work easier.

As the owner of a business, I can buy tools because they save me time, because they make my work easier, or because they look great hanging on the wall. I think sofaD's comments say this same thing.

My point is that for a small business, I have a bench mark and I can buy anything I want to and at least see how it affects my monthly hourly rate for the month, quarter, and year.

For a small business, I don't know if there is any additional info that could be more beneficial to my company.

Another example is doing a full blown market research project for my geographical area. This could be very valuable for a larger company, but I think it would be a waist of time and money for a one person band. I need to have an idea of what my competition is doing, but this can be an informal and ongoing gathering of market info.

gene

[gene]

Doyle posted 3 seconds before I did. And I agree. I can gather summary info or take more time and money and gather play by play info.

What I'm looking at is answering the question of what analysis or gathered of info will help me in my business.

Every minute spent on market analysis or work studies or compliance documentation or efficiencies of new tools is a minute taken away from actual work that results in making money.

Most of the stuff I read in books and on the net is for larger businesses, not for a poor soul toiling away all by their lonesome is some dark and dingy upholstery shop.  :(

I spent several hours yesterday doing my taxes. I will include those hours in my monthly total.

Thanks for this topic and the posts.

gene

[crammage]

In my regular job we use a CBA (Cost Benefit Anaylsis) form that helps us to evaluate whether a project (including equipment purchases) would be worth the effort.  Two of the key factors are effect on revenue and cost.  We project the net effect for 5 years.

How does this apply to the one man or woman shop?

Again, we are looking at two main items, revenue and cost.  For example, if we can increase our revenue by 10% a year by creating and maintaining a web site for $1,000 bucks initial cost.  If you have $100,000 in revenue per year then you can pay for the cost within one year, plus have the increase in revenue hopefully for a number of years to come.
With costs you look at the savings of time or resources, if you save 3 hours of work a month, billable at $50.00/hr, by buying a product for $500.00 it would take 10 hours to recover the cost.

It is as simple as that, however, the issue now becomes what happens to the 3 hours of time per month that is saved.  If you don't have sufficient work to fill that time then nothing is really gained from a financial sense unless it's used to increase revenue. 

The hardest thing in any business is to value the things that you can't quantify, as a sole proprietor you may have a goal of saving time simply to be able to spend more time with family.  Or to catch up on bookwork or clean up or other non-billable functions that need to be done.

Most all the decisions made in mmy corporation are based on if it will increase revenue or reduce costs (there is another set that involves compliance with state and federal laws but I won't get into that!) and most of them are pretty simple in their calculations of this.

I work under the keep it simple principle and it's worked well both in corporate and my small business.  Part of that is that I am pretty simple and not capable of thinking really complex thoughts, just ask my wife!

Clay