Auto Mech Work Shop Question

[rfk]

Does any one have good stats on a small auto mechanic work shop with up to 2 employees - the approximate breakdown of COGS %, GPM% and other relevant expense category. The one I got from bizstats.com does not seem that great and is for 2008. The rent % on the report is really low in comparison.

My client's results show a COGS of 64% and a loss of $56k on $124K of sales. Payroll and rent are a BIG part of the loss. Any thoughts on this? I am just thinking whether the IRS would view this with red flags in mind. The expenses are legitimate but it is just a big loss. Second year in a row. Companies do have losses but...

Thanks.

rfk

[erchess]

Irm

The Internal Revenue Manual (IRM) contains the IRS Instructions to Auditors in every conceivable situation. You just have to look through the huge table of contents to find your situation. I personally do not look at it until such time as a client is actually audited. When I prepare a return I make sure of really just three things. I make sure that what I can see and am told about the client's life is consistent with the return so there's no reason to suspect hidden income. I make sure that deductible expenses are properly documented. And I make sure that if the client is living better than the return would suggest, I get a signed statement that explains things to the satisfaction of my gut. I don't think during preparation about what a return will look like to an auditor because I might be tempted to deny legitimate documented expenses or allow expenses for which the documentation is not there based on a desire to "look right".

[outwest]

I think you are using bizstats the wrong way.

Rather that telling him that it might be a audit risk, I think you should tell him to get his proportions more in line with the Bizstats ratios and quit losing money. Specifically, from the limited info you gave, sounds like they need to fix the gross margin before losing money turns into losing his home.

[JohnH]

Averages don't help much in a situation like this. You need to rely on your common sense and gut feeling to guide your next steps. It does appear fishy on the surface.

I'd want to satisfy myself that the business loss is verifiable through some sort of cash flow analysis or source & application of funds verification. Nothing fancy - just a quick recap of the bank statements. This is a service type business, so losses of that magnitude should be easily verifiable through owner Investment, loans, or depreciation on equipment purchased via financing. Something funded those losses.

This is also a business in which a shady client can omit cash receipts while spending the money on business expenses and trying to take a deduction for them. Dumb move, but it happens.

[dsi]

Is the rent a FMV rent? Is depreciation and/or sec 179 helping to create such a large loss? As it has already been asked, with a larger than normal CGS ratio one would look for unreported income.

[veritas]

Your shop owner

is one of two things or a combination of both:

A total cheat

A knucklehead

[Lion]

What does he charge?

One thing you didn't say you got re his industry, local practice, etc., is rates. Does he charge the going rate for his services and parts? If not, and he doesn't change his business practices, then he's not treating it like a business.

If he does, you can back into his revenue by parts purchased, hours worked, etc., to see if the income he's reporting is consistent with the work his shop is doing. An auditor will.

[taxmandan]

Ask him what his markup % is on parts, how is it calculated: by computer or is he still doing paper work orders? I'm a former co-owner of an auto repair shop with 5 employees. We marked up parts by 80-100%, payroll was ~30% of gross. His numbers indicate that he probably isn't running every repair order through the till and into the bookkeeping records, but the parts get charged to the business in COGS and the cash gets pocketed. How much of the repair payments is by credit card and how much by cash? Our CC payments were usually 38-52% if all payments received. Too few cash deposits may also indicate skimming is going on. It's a common practice for the mechanics to work 'side-jobs' for cash but the parts get billed and paid by the business. That's why I'm a FORMER co-owner, they were using the business' equipment and tools after hours, putting the parts on our account and pocketing the money. He may or may not realize what's going on and/or is doing it too.

[rfk]

Followup to taxmandan

taxmandan,

I am going to ask him some more questions; I have known this individual for a long time and he is honest. But I do not monitor his bookkeeping; I am just concerned about his numbers. He does actual bookkeeping for his little company; not paper to paper.

As mentioned his COG is about 64%; rent is 24% ($2,500 per month); wages were 39% (about $43,229). The rest of course were operating - no depreciation. He admits that he needs to raise the price he charges to his customers. I told him that an equivalent sales for his industry in his situation should be around $164,000 at least.

His payroll hours for wages was 3,078.25 which equals about 1.5 employees for the year. I read a stat that said that industry average annual revenue per worker is $100k; he had $124k. He is short in gross for 1.5 employees by about $24k. I am just following a stat.

So the rest of his problem is the rent and of course one can't help the other operating expenses that part of the operation.

I hope this analysis makes sense.

Thanks.

rfk

[Lion]

Honest

He can be honest but feel he doesn't have to declare cash receipts, only CC, because that was the way he was trained, the way his colleagues do things. And/or, he may allow his mechanics to work on their own, not realizing the amount of parts/supplies used, if he did that himself coming up in the business. Either way, unreported income...

[taxmandan]

Rent is subject to the local market and probably not much can be done about that. Cities like to zone auto shops to industrial sections of town and locating in a reasonable rent location can be difficult.

He very likely is honest, but Lion is right about how he believes that there is nothing wrong with 'side jobs' being off the books and doesn't connect the dots that it is under reporting income and thus lowering taxes. Skimming cash is an epidemic in our country anymore in any business where payments are in cash.

[veritas]

I don't know the prevaling shop labor rate.

taxmandan,

I am going to ask him some more questions; I have known this individual for a long time and he is honest. But I do not monitor his bookkeeping; I am just concerned about his numbers. He does actual bookkeeping for his little company; not paper to paper.

As mentioned his COG is about 64%; rent is 24% ($2,500 per month); wages were 39% (about $43,229). The rest of course were operating - no depreciation. He admits that he needs to raise the price he charges to his customers. I told him that an equivalent sales for his industry in his situation should be around $164,000 at least.

His payroll hours for wages was 3,078.25 which equals about 1.5 employees for the year. I read a stat that said that industry average annual revenue per worker is $100k; he had $124k. He is short in gross for 1.5 employees by about $24k. I am just following a stat.

So the rest of his problem is the rent and of course one can't help the other operating expenses that part of the operation.

I hope this analysis makes sense.

Thanks.

rfk

But using $50 and hour times the available hours (3078) is $153,900.
.
A tool shops use is to compare available hours times flagged hours to see how efficient a technician is. I would say a ratio of 75% is marginal.

[JohnH]

2 years in a row, and losses of over $50k per year? No depreciation, so we can assume this is pretty much cash in / cash out, right? So where did the over $100k of losses come from? after adjusting for a/r, a/p, (if he's on the accrual basis) and verifying inventory accuracy, there should be a drop in cash in the bank of roughly $100k. If that isnt the case, there should be an increase in owner cash into the business or an injection of loans of some sort ( or a combination of all 3 of these)

If none of the above can be established, then the losses are bogus, either by design or as a result of some sort of misunderstanding of accounting principles by the client.

Forget the percentages, ratios, industry standards, if the rent is reasonable, or whether he is charging enough. Your answer doesn't lie in any of that informatuon. He's basically claiming that over $100k flew out the door in 24 months. I'd get the bank statements and make the cash flows prove or disprove what the client says. This is a 30-90 minute task.

[Gary2]

He's basically claiming that over $100k flew out the door in 24 months. I'd get the bank statements and make the cash flows prove or disprove what the client says. This is a 30-90 minute task.

And if there's any pushback, point out that this is exactly what the IRS will do.

[veritas]

I woild ask to see

the repair orders. In numerical order.