Thinking About Expanding Your Shop?

by Dennis Kiyohara

Almost all shop owners who have been in this business for a considerable length of time have considered expanding or at least remodeling their shops. The desire to expand and/or remodel is usually caused by previous growth and success, but it's important that the decision to expand is carefully made. Expansion at the wrong time can create unnecessary hardship on the business. Following some very simple and basic steps will make the decision and implementation process easier and financially safer.

Are You Currently Making A Profit?
With few exceptions, expansion with the idea of turning losses into profits is a formula for disaster. It is essential that your business consistently generate profits before initiating expansion for three basic reasons:

• Forecasting costs of expansion - accurately forecasting the needed sales and efficiencies to pay for the expansion is much simpler if you are currently making a profit.
• Banking (financing the expansion) - it's easier to receive a bank loan when your business is already generating profits.
• Absorbing unanticipated costs - you can plan for what you can expect, but there are almost always unexpected factors in any project. You need to have the financial stability to absorb costs that you cannot foresee.

Creating Your Plan

There are five basic steps to consider when creating a sound expansion plan:

• Clearly define the reason for the expansion: The main goal of the expansion is typically to increase profits by increasing both sales and production.
• Calculating expansion costs: Be sure the proposed cost of the expansion is as complete as possible, including additional costs such as additional office personnel, equipment and utilities.
• Reasonable calendar of events during the expansion: Make sure the budget can accept delays without generating hardships to the company.
• Benchmarks to measure the success of the expansion: Establish easy-to-measure benchmarks to ensure you are moving toward your expansion goals. Be sure to calculate the needed sales to cover the expansion. If the needed sales cannot be reasonably anticipated, then the costs of the expansion should be reduced until the required sales are reasonable.
• Be ready to adjust your plans because it is impossible to anticipate everything: It is essential that you allow additional time and money to compensate for things that might go wrong.

The easiest way to illustrate these concepts is to use a sample shop, ABC Auto Repair, as an example. ABC is a 7,500-square-foot shop and is considering a 2,500-square-foot addition. The contractor estimates the completed expansion will cost $75,000. The following is ABC's current financial profile for an average month:

	Monthly	Percent of sales
Sales	$50,000	100%
Gross profit	20,000	40
Operating expenses	15,000	30
Net profit	5,000	10

ABC is making a profit! The bank has agreed to a $100,000 loan at 10 percent over five years. The monthly payments are $2,125 per month. To create the business case for the bank, ABC had to establish that it could attract and produce the sales and profits to repay the loan.

Business Capacity
Do you need to expand or just become more efficient? A simple test to determine the business capacity is to use sales per square foot. For ABC, $50,000 in sales divided by 7,500 square feet equals $6.67 per square foot in monthly sales. Multiply $6.67 by 12 months, and it equals $80 in sales per square foot per year. If the industry is producing an average of $78 in sales per square foot per year, then ABC is already producing more per square foot than most shops and expansion is probably the most reasonable method to increase sales. Here are current industry averages for individual shop sales:

Sales per square foot
Mechanical shops Annual sales:	Sales per square foot
Average of all shops:	$78
<$250,000	65
$250,000 to 500,000	70
$500,000 to 750,000	79
$750,000 to 1,000,000	85
>$1,000,000	89
Collision shops Annual sales	Sales per square foot
Average of all shops	$135
<$500,000	81
$500,000 to 1,000,000	127
$1,000,000 to 1,500,000	156
$1,500,000 to 2,000,000	157
>$2,000,000	163

Creating the plan

Step 1: Reason For Expansion
The ultimate objective from any expansion should be to maintain or increase profits. There are several reasons why expansion strategy is used to maintain profits:

• Current profits are good, but margins will fall in the near future creating a need to increase volume to compensate.
• You might want to maintain good profits while executing your exit strategy (retirement).

By definition, expansion in a business sense means to increase sales and production. The expansion plans must be consistent with the sales strategy. For example, the following are some strategies to increase sales:

• Increase customer appeal (more comfortable)
• Faster turn around (faster repairs because of more space)
• Cheaper repairs (faster, more efficient repairs)
• Better repairs (equipment and technicians)

An expansion strategy that calls for more customer appeal might not be consistent with a strategy to reduce operating costs by providing more efficient repairs. Clearly defining the sales objectives also makes it possible to determine the sales requirements needed to pay for the expansion.

Expansion	$75,000
Equipment	$25,000
Total Investment	$100,000
Cost of Capital	10%
Expected pay back	5 years
Monthly Payment	$2,125

Step 2: Calculating Expansion Costs
Calculating the needed sales to cover your expansion plan starts with determining the incremental additional monthly costs for expansion, and for how long. For ABC, we know that their budgeted expansion expense will be $2,125 per month for five years.

Some other items to examine in determining the total cost per month for the expansion include:

• Increases in utility costs, such as plumbing, electrical, telephone and safety
• Licenses and permits
• Employees to handle the increase in sales

To anticipate all the costs would be impossible, but it is essential to allow for contingencies.

Step 3: Reasonable Calendar Of Events During The Expansion
Remodeling and expansion is disruptive. It is important that a calendar of events be documented. Performance clauses should always be written in both contractor agreements and equipment purchase agreements. The most common complaints in most expansion projects are delays in the build-out or receiving all the equipment. Even if the expansion does not have a negative effect on business operations, delays will increase the total cost of the project. Be sure the calendar compensates for delays and attempts to anticipate the cost of potential delays.

Step 4: Benchmarks To Measure Expansion Success
The main benchmark is total sales. As mentioned before, increasing profit via expansion almost always means increasing sales. Following is a basic formula to determine the needed sales to create the required gross profit to pay for the investment (assuming you are already making a profit): Needed monthly burden divided by gross profit percent equals the required sales (monthly requirements Ö GP % = required sales). For ABC, the burden (monthly cost) is $2,125 and the gross profit is 40 percent. Therefore, $2,125 Ö 40% = $5,313 in monthly sales x 12 months = $63,750 in annual sales.

ABC, currently operating at a 40 percent gross profit and with expansion costs of $100,000 over five years at 10 percent, has to sell an additional $5,313 per month ($63,750 annually) to cover the $2,215 monthly expansion costs. However, selling less than an additional $5,313 per month would reduce ABC's cash flow, with a worst-case scenario of ABC losing $2,125 per month (if sales did not decrease below the normal $50,000 per year expected).

Note, the higher the gross profit (more profit per job), the fewer sales that will be required to pay for the investment. The following is an incremental chart for ABC:

Gross profit	Additional sales required to offset the monthly expansion cost
Percent	Monthly	Annually
35 %	$6,071	$72,857
36	5,903	70,833
37	5,743	68,919
38	5,592	67,105
39	5,449	65,385
40	5,313	63,750
41	5,183	62,195
42	5,060	60,714
43	4,942	59,302
44	4,830	57,955
45	4,722	56,667

Anticipating the actual monthly costs can be difficult. The task is not only to know what the additional monthly payments might be, but the additional costs that expansion might cause, including additional personnel, equipment, operating costs, etc. These additional expenses should be added to the sales and production burdens.

With a gross profit of 40 percent, each additional $1,000 monthly payment or cost would require $2,500 in additional monthly sales. The following chart illustrates this formula for a $1,000 investment:

Gross profit	Additional sales required to offset each additional $1,000 cost
Percent	Monthly	Annually
35%	$2,857	$34,286
36	2,778	33,333
37	2,703	32,432
38	2,632	31,579
39	2,564	30,769
40	2,500	30,000
41	2,439	29,268
42	2,381	28,571
43	2,326	27,907
44	2,273	27,273
45	2,222	26,667

If you decide you need to include a $1,000 advertising campaign to increase your sales, you must add $2,500 to your sales requirement. If your utility bills go up by $1,000 per month, add $2,500 to your sales requirement. If you need additional equipment and the lease payments are $1,000, add $2,500 to your sales requirement.

It is often assumed that the expansion will increase efficiency, and this can only be measured by an increase in gross profit. If the expansion increases efficiencies and the gross profit increases to 45 percent, the sales requirements will be much less.

Note that without increasing sales, if the expansion could increase the efficiencies and the gross profits, then the increase in the profits could cover the additional expansion debt of $2,125. (For the sake of simplicity in this illustration, additional interest from the loan and depreciation from the equipment were not added to the operating expense).

Sales $50,000 100%
Gross profit 22,500 45 (after increased efficiencies through expansion)
Operating expenses 15,000 30 (w/o additional interest/depreciation)
Net Profit 7,500 15

Step 5: Be Flexible
Be ready to adjust your plans because it is impossible to anticipate everything. This is an understood business principle.

In summary, making a profit before expansion gives the shop the flexibility to cover the additional expenses until enough sales and production are created to meet the financial requirements of expansion.

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Dennis Kiyohara, president of AutocheX, Inc., is well-known for his expert analysis of mechanical shop data and business management techniques. He has served as an AMI instructor and chairman of the Inter-Industry Conference on Auto Collision Repair (I-CAR) financial committee.

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AutoInc. Magazine ®, Vol. XLV No. 4, April 1997