John has a long history in HVAC, here are a few of the highlights. He worked at Lennox as a territory manager. At Lennox, he also helped create and grow the quality assurance department. Then he left Lennox and created vVtal Learning Experiences with his wife Vicki Laplant where they provided consulting, training, coaching, and mentoring. John was awarded the very prestigious Service Roundtable “Servant Leader” Award.
Most recently, John and Vicki, joined Service Nation Alliance’s business coaches and are part of that. John teaches the Service Nation Financial section in our boot camp and he also teaches the Advanced Financial Workshop as well. On top of that, I would add that John is just such a great guy, he really cares about contractors. He’s developed a tremendous knowledge of the residential service business and he’s incredibly generous about sharing his knowledge and ideas. So welcome to Profiles In Prosperity, John. Let’s just get started right away. Tell us about these three financial ratios, start us off with the first one.
David Heimer: So this is just taking your installation revenue, divide it by the service sales, and you would want it to be around four. Is that right?
John Laplant: Yes, north or south of four. I’ve seen companies that generate five and above in installation sales compared to service sales. And I’ve also seen companies that that ratio is closer to 1:1 or 1:2 and quite frankly, that slows a company down. You have to be careful if you have that ratio because you’re burning a lot of labor for not much revenue in the company.
David Heimer: So if I’m at two that says that I’m doing a lot more in service sales and I need to figure out a way to get my installation sales higher.
John Laplant: Absolutely, it’s all about allocation. Where you allocate the labor to create the revenue for the company. And of course, the most efficient way to do that is with installation because it generates the greatest volume of gross margin dollar contribution.
David Heimer: Great, I love it. What else have you got for us?
John Laplant: The second ratio is the current ratio and that’s the current assets divided by current liabilities from the balance sheet. In the financial community, again, kind of the sweet spot is around two, twice as many dollars in current assets and current assets is the cash, the accounts receivables, the inventory, and any prepaids versus current liabilities or the obligations the company has to be paid in the next operating cycle. And so, this quick division of current asset dollars by current liability dollars, if it’s around two, that’s considered good for the financial community.
Now, a lot of companies say well what happens if it gets up to three, four, five, they feel comfortable. And what that means is there is an excess of cash or an excess of accounts receivable or an excess of inventory, again, it can slow the company down. So a current ratio of let’s say four or five, the issue is there are dollars there but they’re not being used to create revenue for the company. They’re not being used for a marketing program. They’re used to hire a residential replacement salesperson or to wrap a vehicle. There are dollars there to enhance the performance of the company and also enhance, quite frankly, the value of the company and it’s just not being done.
David Heimer: So sometimes their current ratio could be high because they also have a bunch of money stuck in receivables. Is that right?
John Laplant: Absolutely. Generally, a high ratio means one of those categories of cash, accounts receivable, inventory is way too high, and again, you don’t want your company to get sluggish. And so, if the accounts receivable is getting out of control, we have to be diligent and vigilant on collection policy. Have a defined collection policy and get that receivables number as current as possible. We want to age those accounts receivables and anything over 30 days, we want to try and get that turned into cash as quickly as possible because without the cash the company gets hamstrung to a certain extent.
David Heimer: Yes, so if it is the cash component of current assets that is out of whack. That probably says this is an investment opportunity to turn that cash into more leads or something that’s going to grow the business, invest some of that. If it’s accounts receivable, you have to figure out how to get that turned into cash, then invest it.
John Laplant: Well, correct, numbers has its own communication vehicle and interpretation of those numbers is important for management, but that’s precisely correct. As they say in business, “cash is king.” And if cash is tied up in inventory and receivables, it limits how nimble a company can be to improve the situation of the organization for employees and also the level of customer care.
David Heimer: Perfect. What else have you got?
John Laplant: Another kind of popular metric these days or financial ratio is the ratio of office to field, headcount in the office to headcount in the field. And the reason people are looking at this is, oftentimes, in this industry; companies want to strip down the office and sometimes over-manpower the field and we need to be mindful of what it takes to support the field efficiently. And so, because of the costs associated with headcount both in the field and in the office, we want to be careful that we don’t create the situation where we’re kind of overburdening one area or another. It depends on the business mix, the ratio of residential replacement, for example to residential new construction, to light commercial, or commercial business. It generally takes more office support for residential replacement but we see companies function quite healthily in the two and a half, three, three and a half to one ratio, given the mix of business and that keeps the field very efficient and it keeps the office efficient and being able to support the field. But also gives the office time to help look for leads and opportunities that result in sales for the company.
David Heimer: So, just take all the technicians that you have, the people that are working in the field and including supervisors.
John Laplant: Yes.
David Heimer: And then, you divide it by the number of people that are in the office, right? And that ratio should be in the 2:3 range?
John Laplant: Yes, that is pretty much the sweet spot for business unless 90% of the revenue comes from light commercial or residential new construction. And then, because of the transactions, there aren’t as many contractions, they are usually larger numbers in terms of equipment ordered; things of that nature. We see companies perform with ratios 4:1 and higher. When you have the bulk of the revenue and I say a high percentage of the revenue coming from new construction or light commercial. It just doesn’t take the office manpower to support that activity that it does where you have a high residential replacement component or a high service component.
David Heimer: So we had a really interesting podcast discussion once with Kevin Frump and he said that his advisory board called, they have had a discussion about this very thing and his philosophy was a little bit different than the other people. The other people in his board said that they wanted to have a higher-tech to office ratio and his feeling was that the field techs are such a precious resource, they’re hard to find and they generate revenue for you. So he wanted to pull as much as he could out of the field back into the office. He said he doesn’t have a hard time finding office people, but he has a hard time finding techs. So if he could pull as much away from the techs into the office, he feels like he’s producing more that way. Does that seem like a good strategy to him?
John Laplant: Oh, absolutely. Everybody controls their own world and that is a very legitimate philosophy, especially if you’re virtually a 100% residential replacement installation service. That makes all the sense in the world. Again, the thing you have to be mindful of, every headcount in the field generally causes the bulk of the overhead or operating expense in heating and air conditioning, electrical, plumbing companies. Field people cause overhead and I’ve never seen a company where that’s not the case. And so, the more headcount you have in the field, your overhead yields up, and Kevin’s absolutely right. If you can get the bulk of the support into the office, that burden actually reduces. So, his philosophy is I can make a more efficient machine for his business model by a management decision.
David Heimer: You explain this stuff so well and these are really interesting ratios. We need to get another list from you at some time in the future and do this again.
John Laplant: But there’s a myriad of those ratios and it’s important. One of the real benefits of Service Nation Alliance is the dashboard and it’s one of the things that we cover very periodically, so no one’s left to guess when it comes to any of these operating ratios.
David Heimer: Well, John Laplant, thank you so much for being on Profiles In Prosperity today. The information you’ve provided is great. We’re going to have you back on another time and we’ll go through more ratios again in the future. So thanks everybody, talk to you later.
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