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Business Health Checkup: Pre-tax Net Income

Dec 5, 2019 | Business, Business Health, Tax

Authors: David Wagstaff and Calvin Longer 

Periodically we will highlight a ratio or benchmark and talk about how you can use these to better understand your business.

The disclaimer: Benchmarks and ratios, blindly applied, can be dangerous. Benchmarks can be useful in understanding areas to investigate, but it’s important to understand what’s being compared and why variances might exist.

Benchmarking Run Amok

Alarmed, a client called me. He had been running some benchmarks and saw his company had over 10 times the number of people in its collections department as other loan collection companies its size. The client was in the process of engaging consultants to help “right” size the department and wanted strategies for how to reduce staff. We conducted a day-long preliminary assessment and found the problem wasn’t with the number of staff but rather the choice of “comparable” companies. The subject company was collecting on $5,000 used auto loans and the comparables were banks that were collecting on $250,000 mortgages (a 50 to 1 ratio). It naturally takes many more staff to collect on $250,000 worth of used auto loans than to collect on a single $250,000 home loan.

The Benchmark: Pre-Tax Net Income

In benchmarking we like to start with the basics and the big picture. For this first exploration, we will look at Pre-Tax Net Income. Is the business profitable and how does it compare to similar companies in the same industry?

One measure of profitability is total sales to Pre-Tax Net Income. In this analysis it’s important to consider whether compensation needs to be normalized . That could be necessary if the owner’s and family members’ compensation is included in the profit calculation. If it is included, does some of that compensation reflect distributed profits (family paid in excess of normal market rates) or uncompensated labor received from family members (i.e. family member(s) working for free or for less than market rate).

Below are some sample Pre-Tax Net Income Ratios for some common industries.

Industry Sales $1 mm to $2.5 mm Sales $2.5 mm to $5 mm
General Contractors & Builders  

9.90%

 

8.56%

Restaurants 6.43% 5.60%
Health Care 14.37% 10.80%
Legal Services 5.59% 2.21%
Engineering Services 7.33% 8.08%
Store Retailers 3.44% 2.61%

 

Benchmarking reports were retrieved from the Bizminer Database. Industries Examined [NAICS]: General Contractors & Builders [236115.02]; Restaurants [7225],; Health Care [62]; Legal Services [5411]; Engineering Services [541330]; Store Retailers [453].

If you are in a different industry or size business and would like additional information on how you compare to your industry, give us a call.

 

 

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