A discriminative study of methods of organizing and operating a plumbing and heating business

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A DISCRIMINATIVE STUDY OP METHODS OP ORGANIZING AND OPERATING A PLUMBING AND HEATING BUSINESS

A Thesis Presented to the Faculty of the College of Commerce and Business Administration The University of Southern California

In Partial Fulfillment of the Requirements for the Degree Master of Business Administration

by Harvey E. Griffin August 1950

UMI Number: EP43299

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This thesis, w ritten by

under the guidance of h%3.... F a c u lty Com m ittee, and approved by a l l its members, has been presented to and accepted by the C o uncil on G raduate Study and Research in p a r tia l f u l f i l l ­ ment of the requirements f o r the degree of

ines s...A.^inis.tratio.n....

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Faculty Committee

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TABLE OP CONTENTS CHAPTER I.

PAGE

THE PROBLEM AND DEFINITIONS OP TERMS USED

...

1

The p r o b l e m ..................... Statement of the p r o b l e m ...................

1

Importance of the s t u d y ...................

2

Definitions of t e r m s .........................

3

Small b u s i n e s s ..............................

3

Plumbing and heating c o n t r a c t o r ...........

3

Plumbing and heating b u s i n e s s .............

ij.

Lack of previous s t u d y ..........

I4.

Sources of m a t e r i a l .........................

ij.

Organization of the remainder of the thesis II.

1

PERSONAL QUALIFICATIONS

.

.......................

Outline of summary and c o n clusions ...........

III.

5 7 7

Technical competence .......................

10

Business ability ...........................

11

Partnerships for diversification of skills .

13

Personality and s u c c e s s ...................

llj.

Reasons for f a i l u r e .......................

l6

Types of b e g i n n e r s .........................

20

THE FORM OF O R G A N I Z A T I O N .......................

23

Outline of summary and c o nclusions...........

23

Individual p r o p r i e t o r s h i p ...................

25

CHAPTER

PAGE A d v a n t a g e s ..................................

25

D i s a d v a n t a g e s ..........

27

P a r t n e r s h i p ..................................

29

A d v a n t a g e s ..................................

29

..............................

31

.*................

33

Disadvantages The c o r p o r a t i o n

A d v a n t a g e s .........................

33

Disadvantages

3^

..............................

Limited p a r t n e r s h i p .........................

36

A d v a n t a g e s ..................................

3&

D i s a d v a n t a g e s ..................... ..

38

Comparison of the forms of organization in the light of federal income t a x e s .............

39

Amount of anticipated e a r n i n g s .............

Ij.3

Income from outside s o u r c e s ..........

lj.5

Amount of salary paid to stockholdere m p l o y e e s ................................ Retention of earnings in the business

. . •

Ij_7 I4.9

Penalty for unreasonable accumulation of e a r n i n g s .......... ..

. .

.............

5>0

Tax on corporate l i q u i d a t i o n ...............

50

Payroll taxes on owners

...................

5l

Capital gains and losses ...................

53

Switching the form of organization...........

53

iv CHAPTER

IV.

PAGE Partnership to corpor a t i o n .................

53

Corporation to p a r t n e r s h i p .................

55

Combination of business f o r m s .............

57

HEATING AND PLUMBING R E T A I L I N G .................

59

Outline of summary and c o n c l u s i o n s ...........

59

The s h o w r o o m ..............

6l

-. . .

Advantages of a s h o w r o o m ...................

62

Disadvantages of a s h o w r o o m ...............

6J4-

Use of the wholesalers display room . . . .

68

Handling additional lines

...................

69

Additional line categories .................

69

Factors to c o n s i d e r ................

J1

Selling goods through window displays

. . . .

77

................................

78

Make windows build s a l e s ...................

78

One idea at a t i m e .........................

80

Store name inside w i n d o w ...................

80

Prices on goods in w i n d o w .................

8l

Kind of window d i s p l a y s ..............

81

Single article displays

82

The sign .

...................

Display of special articles

. . . . . . . .

82

11LineH d i s p l a y s ..........

82

Displays of related articles ...............

83

Displays of service f a c i l i t i e s .............

83

V

CHAPTER V.

PACE

SELECTING A PROFITABLE L O C A T I O N ......................8I4. Outline of summary and conclusions

. . . . . . .

814.

Selecting the t o w n ............................. General economic conditions . . . . .

85

........

86

The size of the community and its tributary p o p u l a t i o n .....................................87 Buying power of the c o m m u n i t y ....................89 C o m p e t i t i o n .......................................90 The town as a place to l i v e ......................91 Selecting the district within a t o w n ............. 92 Nature of business determines location

. . . .

92

External conditions ............................

93

Market conditions ............. ‘...............

93

Outlying shopping centers . . . '................. 94 Selecting the exact s i t e .......................... 95 C o m p e t i t i o n .......................................96 T r a f f i c .......................................... 101 Transportation

................................

102

Location in the b l o c k ........................... 103 L e a s i n g .......................................... lOlj. History of the s i t e ......................... VI.

FINANCIAL CONSIDERATIONS

.........................

. 107 108

Outline of summary and c o n c l u s i o n s .............. 108 Capital requirements

............................ 110

vi CHAPTER

PAGE Fixed vs. working c a p i t a l ................

Ill

Capital requirements v a r y ...................

112

Factors to c o n s i d e r .........................

11$

Operating ratios .............................

Il6

Sources of c a p i t a l .............................

120

Financing by friends and r e l a t i v e s ..........

12lj.

Financing through partnership or in­ corporation

................................

Financing by commercial banks

..............

125

Relations with the banker

...............

130

.

Trade f i n a n c i n g .............................

133

Miscellaneous sources of f u n d s ..............

13li-

Financial m a n a g e m e n t ........... -............. Insurance

135

. . . . .

136

Credit m a n a g e m e n t .........................

138

Cash p l a n n i n g .......................

li^.6

Record keeping VII.

125

.........................

FIXED AND VARIABLE COST C O N T R O L ..........

. .

Outline of summary and conclu s i o n s ............ The variable p r i n c i p l e ..................... .

.

151 154154 157

Stand-by c o s t s ...............................

159

Variable costs ...............................

l6l

The break even c h a r t ...........................

162

Construction of the break-even chart . . . .

163

vii CHAPTER

VIII.

PAGE Value of the break-even c h a r t .............

167

Distribution of overhead toj o b s ..........

168

Contribution to o v e r h e a d .................

169

ESTIMATES, BIDS, AND CONTRACTS. . . . . . . .

17lf

Outline of summary and c o n c l u s i o n s ........

17^

E s t i m a t i n g .............................

175

Methods of p a y m e n t .......................

176

Small repair j o b s .........................

176

Large time-and-material j o b s .............

177

Estimating remodeling j o b s ...............

178

Estimating new j o b s .......................

178

Use of estimate s h e e t s ...................

180

Estimating labor c o s t .....................

181

B i d s ........................................

182

Oral and written b i d s .....................

183

Clauses on specifications .................

I83

C o n t r a c t s ....................................

18ij.

Guiding p r i n c i p l e s .......................

I8I4.

Contract forms

18

. . .

...................

Mechanic* s l i e n ............................

186

IX. ' BUILDING THE B U S I N E S S .........................

189

Outline of summary and c o n c l u s i o n s ........

189

A d v e r t i s i n g ..................................

190

Local newspaper a d v e r t i s i n g ...............

192

viii CHAPTER

PAGE Other advertising m e d i a ......................... 19lj-

Customer prospect file .

......................... 195

S a l e s m a n s h i p ........................................ 199 X.

CONCLUSIONS AND R E C O M M E N D A T I O N S ...............

BI B L I O G R A P H Y .............................................. 203 A P P E N D I C E S ................................................ 209

201

LIST OF TABLES TABLE I.

PAGE Failures in the United States classified by chief c a u s e s .................

II.

Classification of causes of business failures in the third quarter of 1 9 4 9 ...............

III.

.................

ip.

Saving in federal income taxes by operating as corporation ( m a r r i e d ' p e r s o n ) ...............

V.

18

Saving in federal income taxes by operating as corporation (single person)

IV.

17

1±2

Salary payments resulting in lowest total tax c o s t s ............................................... I4.8

VI. VII.

Check list for guidance in selecting a site . . Average amount of rent paid by successful plumbing and heating establishments . . . . .

VIII.

105

Appliance and radio dealers average operating costs and r a t i o s .......................

IX.

97

118

Cash budget showing anticipated cash receipts and disbursements on a weekly basis ........

X.

How number of miles operated affects cost per m i l e ........................................

158

LIST OP FIGURES FIGURE

PAGE

1.

Break-even c h a r t ............................

l6j?

2.

Cost c l a s s i f i c a t i o n ..............................

171

Customer prospect check c a r d ...................... ij.* Customer prospect

check card - reverse side

. . .

196 197

OUTLINE OP SUMMARY AND CONCLUSIONS I.

II.

III.

IV.

The recognition of onefs limitations is extremely important. The personal qualifications of an individual have a direct and important bearing on whether he will succeed in business. Both technical and business ability are essential for the successful operation of a plumbing and heating business. (See page 7«) The particular factors of each individual case must be considered when selecting the form of organi­ zation. The single proprietorship is probably the most effective form for the small operator. For the medium size business the partnership form of organi­ zation may be utilized effectively provided the partners are cooperative# The very large plumbing and heating contractors will probably find it advantageous to use the corporate form of organization. With respect to Federal income taxes the lower income business is usually better off unincorporated, while the middle and upper income companies are usually better off as corporations. (See page 23.) There are both advantages and disadvantages of operating a showroom in connection with a plumbing and heating business. Those contractors who specialize in new construction and rely for the most part on low-bids to get their business are probably just as well off without a showroom. The contractors who specialize in repairs or alterations for the major source of income will find that the added investment and expense required to operate a showroom will be justified because of the increase and stabilization of business that it will create. (See page 59 .) For the plumbing and heating retailer, nearly every phase of operating the business depends to some extent upon its location. The selection of the location should be considered in three separate steps; first, the selection of the city or town; second, the choice of neighborhood; and third, the selection of the exact site. (See page 81J.. )

V.

VI.

VII.

VIII.

Lack of adequate capital, and poor financial manage­ ment are two of the major causes of business failures. When starting a business, the first step is to determine the capital requirements, and the second step is to determine the best source to secure the required capital. It is desirable to establish relations with a banker before it becomes necessary to request for a loan. When credit is extended for small repair jobs the customer should be billed as soon as possible. This should be followed by a systematic follow-up collection when necessary. Before negotiating a contract for large jobs, the contractor should make an investigation of the customer's credit rating and his ability to pay. Proper record keeping, and the use of a weekly cash budget will help the contractor plan the use of his cash for current and future needs with a fair degree of accuracy. Without adequate record keeping it is impossible to maintain positive control of finances. (See page 108.) The post-war contractor is confronted with deathstruggle competition, high costs, high break-even points, and low margins of safety. Therefore, an understanding of break-even points, out-of-pocket recovery points, and the concept of ’’contribution to overhead and profits1* will aid the contractor to achieve success. In some cases it may be profitable to accept a job at a lower price than can be figured with allowing a normal overhead and profit* Any price in excess of fixed costs provides a "contri­ bution to overhead and profits" by helping to absorb a part of fixed charges. (See page l£q-« ) It is risky to take remodeling work on a straight contract basis because of unpredictable factors. Bids should be submitted in writing, clearly out­ lining the extent of work to be performed. The contractor should never sign anything he does not clearly understand. The mechanic's lien is an important safeguard. (See page 17I4.. ) Three suggested methods for building business are: (l) regular week to week advertising; (2) a customer prospect file; and (3 ) salesmanship to sell the con­ venience and comfort that plumbing and heating equipment will provide. (See page 189*)

CHAPTER I THE PROBLEM AND DEFINITIONS OF TERMS USED Since World War II an increasing amount of interest has been developing in the place and problems of small business•

Relatively little, however, has been done toward

providing a well-rounded guide to the fundamental require­ ments, problems, and opportunities of the various fields of small business* I•

THE PROBLEM

Statement of the problem*

It was the purpose of this

study to serve as a practical guide to those who are inter­ ested in starting a plumbing and heating business and prove helpful to those already established*

To accomplish that

purpose the study is necessarily concerned with the problems and basic factors that must b e .considered in establishing and operating a plumbing and heating business. Since the plumbing and heating industry is a good representative of small business, with varied activities from construction to retailing it may serve as a vehicle for ah inquiry into the problems and methods of operating any small business.

Thus, for the purpose of consistency in the

study of small business problems a constant base is provided throughout the entire thesis by limiting the discussion to a

single type of industry# Importance of the study *

The importance of this study

lies in the application of scientific business principles and management techniques to the problems of a small business operation. The small businessman of a generation ago did not pause to carefully analyze and investigate the possibilities of success in a new business venture; seeing a chance, he took risks and plunged#

In the field of small business

today, the risks are greater and the competition much keener than a few years ago*

It has now become necessary to study

methods of organization, costs of operation, and efficient operating procedures#

With the growth of analysis in the

techniques of small business operation, management efficiency will increase, and with it, greater chance of successful operation. If this study helps individual enterprisers to de­ termine if they have the ability and personality to success­ fully operate their own business; and if it helps them to have a better understanding of the sound principles and practices needed for successful business operation, it will perform a useful function#

3 II. Small business.

DEFINITIONS OF TERMS The Department of Commerce has

established arbitrary dividing lines between large and small business In various fields.

In order to be considered as

small business the manufacturing plants must have not more than one hundred employees; the wholesale establishments must have less than $200,000 annual net sales; and the retail stores, service establishments, hotels, places of amusement, and construction enterprises must have an annual net sales or receipts of less than $5 0 ,000.^ To a large extent the term “small business** is a relative one.

For the purpose of this study, however, it

shall be interpreted to mean “any concern which because of size cannot avail itself of the services of the investment banking system in raising capital.” Plumbing; and heating contractor.

A plumbing and

heating contractor is an individual or firm licensed by the appropriate civil authority to enter into contractual arrangements with owners or owners1 agents for the purpose of constructing, remodeling, or repairing the plumbing and heating portion of buildings or other structures. 1 A. D. H. Kaplan, Small Business: Its Place and Problems (New York: McGraw-Hill Book Company, Inc., 1958), p. 10. 2 Carl A. Dauten, Business Finance (New York: PrenticeHall, Inc., 1 9 5 ^ P* 2.

Plumbing; and heating business.

For the purpose of

this study the term plumbing and heating business shall encompass all or part of the following activities:

(1 ) the

merchandising of plumbing and heating equipment, and the installation and maintenance of such equipment;

(2 ) the

handling of additional related lines; and (3 ) the con­ structing, remodeling, or repairing the plumbing and heating portion of buildings or other structures# III.

LACK OF PREVIOUS STUDY

Much has been written about the mechanical and tech­ nical phases of the plumbing and heating industry, but very little has been written concerning the business problems and methods of business management in the industry. The plumbing and heating trade journals contain a limited amount of business information which is of great service to the members of the industry#

However, they are

devoted primarily to the technical phases of the industry# Because of the lack of previous study the methods of business organization and management which have been developed in other industries were evaluated and applied to the. plumbing and heating industry as a part of this study# IV.

SOURCES OF MATERIAL

This study was based on published data listed in the bibliography, and on unpublished data obtained from plumbing

and heating contractors, general contractors, plumbing and heating wholesalers, trade associations, government agencies, and publishers of trade journals*

The latter data were

secured through interviews, supplemented by correspondence. V.

ORGANIZATION OP THE REMAINDER OP THE THESIS

This thesis consists of ten chapters.

It is organized

in business report form, with an outline of summary and con­ clusions at the beginning of each chapter.

This type of

organization gives the reader the opportunity to quickly preview the important contents of each chapter. Chapter II is a study of the personality traits and qualifications necessary for success in the plumbing and heating business.

Chapter III is a discussion of the

advantages and disadvantages of the various legal forms of organization.

Chapter IV introduces and evaluates the

present trend toward merchandising in the plumbing and heating business.

Both the advantages and disadvantages of

having a showroom are discussed, as well as some of the methods of operating a showroom. problem of location.

Chapter V discusses the

The primary considerations with respect

to the selection of the town, the choice of community in the town, and the selection of the exact site— its suitability and whether or not the property should be bought or rented are the factors discussed in this chapter.

Chapter VI is

6 concerned with the financial considerations of establishing a plumbing and heating business*

It contains information

concerning capital requirements, sources of capital, and management of capital*

Chapter VII introduces the break-even

concept and methods of fixed and variable costs control for the plumbing and heating contractor.

Chapter VIII is a

discussion of the problems relative to estimating, submitting bids, and securing satisfactory contracts*

Chapter IX deals

with some of the techniques of advertising and salesmanship that may be used by the plumbing and heating contractor to build business and increase profits*

7 CHAPTER II PERSONAL QUALIFICATIONS OUTLINE OF SUMMARY AND CONCLUSIONS I.

The most important single qualification for success in the plumbing and heating business, or in any small independent business, is an all-around, welldeveloped business ability.

II.

The successful heating and plumbing contractor will possess:

III.

A.

Keen mechanical skill*

B*

Specialized training in heating and plumbing engineering.

C.

General business management ability.

D.

Physical^stamina to make the installations. (one man shop)

E.

Salesmanship to obtain orders.

F.

Considerable tact to collect payments when the work is completed.

Partnerships should augment rather than duplicate the special skills and experience of the partners.

IV.

The personality of an individual has a direct and important bearing on whether or not he will succeed in business.

V.

A large percentage of business failures are because of personal faults or weaknesses of their owners or managers. Less than 20 per cent of failures are due to other causes.

CHAPTER II PERSONAL QUALIFICATIONS Mechanical knowledge and experience, business ability, and certain personality qualifications are essential in the plumbing and heating business.

Since many of the plumbing

and heating contractors are in both the construction and the retailing field all around ability and personal qualifi­ cations are becoming even more important. The purpose of this chapter is to help a person de­ termine if he has those personality traits and personal qualifications necessary to successfully operate a business of his own. Honest self-appraisal is always difficult but must be made.

A check list can sometimes help to make an honest

self-appraisal.

The United States Department of Commerce

in a Monograph, Establishing and Operating Your Own Business, has included a check list of points to consider when planning to start a retail store.

It begins with the following set

of questions: Your Personal Qualifications Have you had previous experience in this line of business? Have you ever bought merchandise before? Do you know the characteristics of the merchandise you will handle?

9 Do you have the special technical skills which are needed? Have you ever supervised the work of others? boss? Have you ever hired people?

Been

Met a pay roll?

Have you ever dealt with the public? to meet people?

Do you like

Have you ever sold? Can you boss yourself? Drive yourself to do what is necessary? Are you a self-starter? Do you have imagination?

Energy?

Initiative?

Are you willing to work long hours? Can you overcome obstacles? Keep plugging?

Fight down discouragement?

Have you considered working for someone else to get more experience?! These are admittedly stock questions.

However, they

are of fundamental importance in the process of self-appraisal. An affirmative answer is not to be lightly assumed.

Recog­

nition of an individuals limitations is extremely important. Sure success is open only to those who know their personal strengths and weaknesses and who have carefully considered and weighed the factors in their chosen field. The successful plumbing and heating contractor is no miracle man.

However, he must have several kinds of

1 United States Department of Commerce, Establishing and Operating Your Own Business, Industrial (Small business) Series No. ?>o9 (Washington, D. C.: United States Oovernment Printing Office, 19^5)> PP« 19-20.

10 well-developed ability.

He must possess:

1.

Keen mechanical skill.

2.

Specialized training in heating and plumbing engineering..

3.

General business management ability.

i{_.

Physical stamina to make the installations. (One man shop.)

5.

Salesmanship to obtain orders.

6.

Considerable tact to collect payments when work is completed.

Each of these abilities is important if the plumbing and heating contractor is to achieve success.

Entering a

business of any kind is a hazardous undertaking.

All of the

contingencies likely to confront the newcomer cannot possibly be anticipated, however, all-around, well-developed abilities will do much toward increasing the chances for success. Technical competence.

The fact that most sections of

the country require licensing of the plumbing and heating contractors emphasizes the point that mechanical ability is absolutely essential. Most of the plumbing and heating contractors now in business have attained their present positions through pro­ gressive steps.

They started as apprentices when they were

boys or young men. are carrying on.

Their fathers were contractors, and they

11 Under the present system the apprentice contracts to work for an association or group of plumbing and heating contractors for a period of five years.

This gives him

experience in a number of shops doing large-building, smallbuilding, and other types of operations.

When his five

years is completed he will have gained a well-rounded knowledge of all the mechanical phases of heating and plumbing installations. When his apprenticeship is completed he becomes a journeyman.

In many areas it is necessary for the person

who wants to become a journeyman plumber or journeyman steam-fitter to pass an examination which is sponsored by the municipality or state in which he lives. Most journeymen, after receiving their certificates, start out working for a variety of employers in various sections of the country, in order to round out the experience they acquired as apprentices. The best way to get technical training and practical experience is to get a job with a well-managed successful company, and absorb as much know-how as possible. Gaining experience in technical phases, should precede and not be simultaneous with gaining business experience. Business ability.

There is a tendency for many of

the smaller heating and plumbing contractors to unduly

12 emphasize the technical, or manual aspects of the business and let the business-management phases take a secondary position in their thinking* If a person entering the field becomes absorbed solely in the manual and mechanical phases of his work, he might better have remained a journeyman working for someone else, for such a person is headed for trouble.

But the individual

who preserves a balance between the mechanical and business aspects has a reasonable chance for success. The man who has spent years in heating and plumbing work as a mechanic may fail to realize the importance of salesmanship, business promotion, record keeping, and collections.

He is inclined to think that customers call

up his employer without any urging, and the fact that he has been continuously employed may lead him to the wrong conclusion that the heating and plumbing field is one in which even limited ability is an assurance of success. The fact is that customers do not call up contractors without encouragement— at least when the business is first started.

It takes laborious effort over a long period of

years to develop a list of satisfied and repeat customers. Proper records must be kept so that the progress of the business can be measured and a basis for estimating future similar work established. promptly.

Collections must be made

The average contractor in the heating and plumbing

13 business has a limited amount of capital, and cannot afford to carry accounts over a long period of time.

His capital

must be turned over quickly, and that means prompt and effective collections. Partnerships for diversification of skills.

The

majority of partnerships in the heating and plumbing business are formed by two individuals primarily with mechanical skills and inclinations.

In such a combination they dupli­

cate instead of augment their skills and experience. Any person who plans to take a partner,

should seek

to augment rather than duplicate his own skill and experience. For example, a man might have a thorough training in the mechanical aspects of the business.

A friend of his might

have had sufficient experience in business methods, selling, and promotion.

The two should make a good team to establish

and operate a heating and plumbing business. Individuals who are planning to pool their resources should remember that while two heads are often better than one, one should make up for any lack of knowledge or training in the other. If two topnotch mechanics plan to set up a shop but know nothing about the management angle, one of them at least should take time out to learn all about how to manage the business.

34 The members of a partnership should not only have a diversification of skills and experience; they must be good and trusted friends, and they must each have in mind the same objectives for the business.

If one partner has outside

interests he may wish to keep the business small and contribute only a part of his time to the business.

On the

other hand, the other partner may have his whole life wrapped up in the business, and wish to expand and grow into a larger concern. A conflict of objectives may cause an otherwise sound business to go on the rocks.

Such a conflict often arises

because one partner wishes to draw out earnings while another partner wishes to plow back earnings. A conflict of desires is often likely to occur in family or in-law partnerships.

If two brothers are in a

partnership together, there are relationships other than the relationship between the two brothers that must be considered. There are relationships between the two brothers, plus two wives, plus from one to five children that must be considered. A greater number of relationships is likely to cause a greater number of conflicting desires. Personality and success.

A personas entire mental

make-up has a direct and important bearing on whether or not he will succeed in business.

It would pay the prospective

business man to compare his personality traits with those of a typical independent businessman who succeeds: First and foremost he»s the leader type and gets a big kick out of being independent. He has ambition and initiative, energy, and good health. He isnft afraid of hard work. He likes people and he knows how to get along with all kinds and all ages. H e Ts a firm boss but a fair one. He thrives on responsibility. He takes the bad breaks and the good breaks in his stride. He has the knack of sizing up a situation accurately and making quick decisions. If his judgment is wrong he isn!t sunk. • Rather he swallows his medicine and determines not to make the same mistake again. He is honest and pays his bills promptly. word is as good as his bond.

His

He is businesslike--a good manager. He watches details and knows at all times the state of his business and where it is headed. He knows when to borrow money in order to take advantage of cash discounts or quantity buys. He also knows when to expand, when to draw in, when to risk and when not to risk. He gives his customers their money's worth in goods or services. He studies their likes and dislikes; strives to satisfy them without giving away his profit In other words, he keeps his eyes wide open, is smart enough to seize a good bargain and hones enough not to take an unfair advantage of anyone. Lastly, the successful independent businessman feels a definite sense of responsibility to his community. He has civic pride, takes an active part in cooperative efforts to make his town a better place in which to live and work.2

2 Ibid.T pp.

l6 Reasons for failures.

An examination of business

failures leads to the belief that they were due largely to causes which could have been prevented.

The findings in

Table I show that many of the businesses that failed did so because of personal faults or weaknesses of their owners or managers .

Only a small per cent of failures were due to

other causes. 51 per cent of the bankrupt businesses had no adequa-te records or positive control of their finances; nearly ij.0 per cent were incompetent or inexperienced. Dun and Bradstreet> Inc., is a good source of infor­ mation on the causes of business failures.

Table II is a

classification of the causes of business failures in the third quarter of 19^9* as reported by Dun and Bradstreet. The statistics are based on the opinions of informed credi­ tors and information in Dun and Bradstreet*s credit reports. The outstanding fact which this study reveals is that the success or failure of a business enterprise depends almost entirely upon the quality of judgment exercised by the operators in the initial planning stage and during the subsequent managerial activities--particularly until the business is thoroughly established. Broadly classified, most failures— P* 5 «

TABLE II CLASSIFICATION OF CAUSES OF BUSINESS FAILURES IN THE THIRD QUARTER OF X9I4.9 Based on Opinions of Informed Creditors and Information in Dun and Bradstreetfs Credit Reports Per Cent

Broad Classification

105

1**6

Neglect:

Due to

31

l.i*

Fraud:

On the part of the prin­ cipals, re­ flected by

595

26.3

510

22.6

Lack of Experience in the Line 5 Lack of Managerial Experience: Unbalanced Exper­ ience: Incompetence: Disaster:

Evidenced by inability to avoid con­ ditions which resul­ ted in

li)4 790 h5

6.1). 3i(..9 2.0

1.8 2,261

100.0

Reason Unknown: Total

Some of these occur­ rences could have been provided against thru insurance

Underlying Causes

No. Per Cent

Bad Habits 21 Poor Health 50 Marital Difficulties 17 Other 17 -Misleading Name False Financial Statement 1 Premeditated Overbuy 2 Irregular Disposal of Assets 22 Other 6 Inadequate Sales 920 Heavy Operating Expenses 382 Receivables Difficulties 131 Inventory Difficulties 314 Excessive Fixed Assets 322 Poor Location M> Competitive Weakness 153 101 Other Fire Flood Burglary Employees1 Fraud Strike Other Source:

20 k 3 15 3

0.9 2.1 0.8 0.8 -0.0 0.1 1.0 0.3 1*0.7 16.9 5.8 13.9 ll*«2 1.8 6.8 !*.5 0.9 -0.2 0.1 0.7 0.1

Dun's Review. December. lQkQ

19 great majority of the underlying causes are actually the ways in which inefficient management is indicated.^ It is interesting to compare the findings National Gash Register Company with the findings

of the of Dun and

Bradstreet with regard to the causes of "business failures. Dun and Bradstreet attributed 55*3 per cent of all the business failures to inexperience of one kind or another, while the National Cash Register Company found that only £.2 per cent of all the failures were due to inexperience. Herein is the greatest discrepancy of the two charts.

How­

ever, part of the discrepancy can be explained by the fact that lack of capital and unwise credits, which accounted for 36.3 per cent of the failures in the National Cash Register study, could very well be classified as inexperience, since they are

a result of inexperience.

A study of the two charts shows a discrepancy in the various classifications.

However, both studies agree that

most business failures are due to personal faults or weak­ nesses of their owners or managers.

Dun and Bradstreet

reported that 96*2 per cent of the failures were due to faults 3 If further information is desired on the subject of business failures, statistics consisting of a compilation of the numbers of failures and the amounts of liabilities by lines of business and by locations have been kept by Dun and Bradstreet, Inc. since 1857* Summaries of these figures are published weekly through the public press and monthly in Dun* s Review.

20 of those failing, while National Cash Register reported that 81.5 P©** cent of the failures were due to faults of those failing. Types of beginners.

Mr. Jack Reeves, who is the pub­

lisher of the Western Plumbing and Heating Journal and the Reeves Price Guide, personally meets and converses with hundreds of plumbers who are just launching a business for themselves.

He disclosed the fact that he is astonished at

the blissful ignorance of many of these beginners regarding either ethics or fundamentals of business.^* Many of these men would be far better off if they would continue to work as journeymen, drawing $20 or more a day, with no overhead other than "union dues and the inevi­ table taxes that all must pay. In an editorial of the March issue of the Western Plumbing and Heating Journal he reviews a few of the types of beginners who are constantly cropping up: 1st. The skilled mechanic who is a credit to the business and who has well-made plans for getting off on the right foot. This type is always welcome and there is always a place for him in our industry. 2nd. The incompetent workman who, finding that he is unable to hold down a steady job, decides to go into business for himself and, to the detriment of all, men of this caliber can always get plenty of work by the simple process of cutting prices below cost. If Personal interview with Jack Reeves.

21 However, by doing shady work, working long hours, cheating his family, and being a headache to inspec­ tors and everybody else, he manages to muddle along indefinitely. Men of this type, who simply do not know the meaning of business overhead, are parasites on a good industry. 3 r d . We have ever with us the plumber who never figures any job in detail, who never has had, or used ah estimating sheet, but simply counts the number of fixtures on a job and "presto” quotes a price on it. It apparently makes no difference to him if he has to dig in sand, rock or hard-pan adobe, or if one or more fixtures are forty feet from the main stack. We could understand this method of figuring, or "gestimating," a few years ago when five-fixture jobs sold for $900 to $1200. At those prices a plumbing contractor stood little chance to lose but in these days, with competition again "rearing its ugly head,11 it will no longer pay to guess at prices, or to figure jobs haphazardly, and the use of a good estimate form is most essential. Ij^th. We have the beginner who is a "fall guy" for crafty building contractors who, after securing prices from several irresponsible plumbers, show him these bids and persuade him, under the guise of friendship, to do their plumbing at prices still lower. Only too often the poor boob takes the job— without even the semblance of figuring--on the false assumption that, if these other fellows could do the work at the prices shown him, he, too, can get by at an even lower figure and still have a little margin to spare. Surely Barnum was very conservative in his estimate. 5 th. We have the small new-work operator who, although he is not in the "know how" of buying for new work "below the book"--particularly on jobs or projects of any consequence--persists in taking jobs at or below prices submitted by large operators. These large operators, as a matter of fact, can take work at the small fellow*s actual cost and still make a good profit .because of their better buying connections and better organizations. With the small operator it is a matter of live and learn but, unfortunately, he almost invariably goes broke before he learns.

22 6th. There are the young, inexperienced plumbers who haven*t a dime of their own, but are financed and encouraged to start in business by building con­ tractors who use them for the purpose of buying materials at wholesale, and to do their plumbing work at starvation prices. Plumbers of this type are not worth the powder to blow them to Hell but, nevertheless and unfortunately, such men exist. 7th. We have the type that I classify as lfthe boob d.t.u. plumber.” He labors under the impression that he can pay union wages of $2.50 an hour and install d.t.u. fixtures and material, furnishing labor only at $3*75 or $4.00 an hour, and make a profit.5 This may seem like pretty strong language, but these statements have come from a man who is not only a publisher of one of the plumbing and heating trade journals, but a master plumber himself.

He has described these seven types

”in the language of a plumber”— a language the plumber will understand.

5 Jack Reeves, Editorial in the Western Plumbing and Heating Journal, 30:17-18* Mar eh, 194*9*

23 CHAPTER III THE FORM OP ORGANIZATION OUTLINE OP SUMMARY AND CONCLUSIONS I.

II.

No form of business organization has a clear-cut advantage over the other forms. The particular factors of each individual case must be considered when selecting the form of organization. For the very small plumbing and heating business the single proprietorship is probably the most effective form of organization.

III.

For the medium size business the partnership form of organization may be utilized effectively provided that the partners are well known to each other and have mutual trust and respect for the opinions of each other.

IV.

For the larger of the plumbing and heating con­ tractors it will probably be necessary to use the corporate form of organization.

V.

VI.

The limited partnership has the advantages of the simpler forms of organization, plus the added advantage of limited liability for the limited partner. The tax situation is one of the most important factors in selecting the form of organization. The particular factors of each individual case must be carefully considered in the light of federal income taxes before the choice of organi­ zation is made.

VII.

With respect to federal income taxes the lower income business is usually better off unin­ corporated, while the middle and upper income companies are usually better off as corporations.

VIII.

If an individual has considerable outside income, the benefits of operating as a corporation are increased.

IX.

X.

XI.

XII.

XIII.

If the business is expanding rapidly, the corporate form of organization is desirable since it will result in a tax saving if earnings are being plowed back into the business. The switch from partnership to corporation can be made tax free. The cost of switching from corporation to partner­ ship may be considerable because the transfer of assets from a corporation to a partnership results in the recognition of a capital gain or loss. Even if the corporation has been chosen as the best form of doing business, it may be advisable for tax reasons to start as an individual pro­ prietorship or partnership with the idea of changing to a corporation later. In some cases further tax economies may be made by subdividing the business into two corporations, or into one partnership and one corporation.

CHAPTER III THE FORM OF ORGANIZATION When organizing any business familiarity with the legal forms of organization which can be used to an advantage is essential.

The most common form of organization in the

plumbing and heating field is the individual proprietorship. The other three most-used forms are the partnership, the limited partnership, and the corporation.

The discussion

of this chapter will deal with the advantages, the disad­ vantages, and the tax implications of these various forms of organization. I. Advantages.

INDIVIDUAL PROPRIETORSHIP The advantages of the Individual pro­

prietorship may be listed as follows: 1.

Ease of organization.

2.

No corporation laws, corporation charters, or p ar tne r ship agre ement s.

3.

Relative freedom from government control.

Ij..

Singleness of control.

5.

Its credit standing is better than a corporation of equal size.

6.

Certain tax advantages.

The individual proprietorship is the simplest form of

26 business enterprise.

It is owned and operated by one person.

The newcomer in the heating and plumbing field usually starts with this type of organization.

He often operates

what is known as a "one man shop.11 This form of organi­ zation may be started without formality by anyone of legal age who decides to enter the business.

All he must do is

obtain a heating and plumbing contractors license from the state or municipality in which he wishes to engage in business. In addition to being the most common form, and the simplest, it is least expensive to set up.

The operator is

bound by no corporation laws, corporation charters, or partnership agreements.

Although employees may be hired,

the enterprise is usually managed by one person who receives all the profits and bears all the losses. The single proprietorship has a great advantage in the ease-with which the duties and powers may be delegated. The single proprietor directs all phases of the business, and delegates appropriate authority to subordinates who are responsible to him.

"There can be little question about

lines of authority in such an organization. "-** The unlimited liability of the sole proprietorship tends to give this form of organization a better credit 1 Carl A. Dauten, Business Finance (New York: PrenticeHall, Inc., 19^1-8 ), p. 71*

27 rating than that of a corporation if the two forms are being compared size for size. ‘’Relative freedom from government control is an attractive feature of the sole proprietorship.”

Fewer

reports to public agencies are required, and there may be certain advantages with respect to taxes.^ Pisadvantages.

The disadvantages of the single pro­

prietorship may be listed as follows: 1.

Unlimited liability.

2.

The size of the organization is limited.

3.

It lacks permanency.

If.

The amount of capital is limited.

The unlimited liability of the individual proprietor­ ship can be rather a serious disadvantage at times.

If a

person goes into business as an individual proprietor the law makes no distinction,

so far as liability for debts is

concerned, between his business and his personal affairs. If he sets aside $10,000 to go into business and fails so that he has $20,000 in unpaid debts after the business assets have been liquidated, the creditors can attach his 2 Burt W • Roper, Small Business and Government Regu­ lation, Economic (Small Business) Series No. £8, (Washington, D. C^: United States Government Printing Office, 19if7)j P* 2. 3 The tax implications of“ each form of organization are discussed later in the chapter.

28 personal assets and colleet as mueh as they can of the $20,000 due them.^"

This unlimited liability provision

would be a serious handicap to any business which is of considerable size, but it is not too great a handicap when a person is going into business and has his whole life and fortune tied up in the business.^ Another disadvantage is that it is very difficult for one person to properly organize and supervise a business of very great size.

This tends to restrict the single pro­

prietorship form to the small and medium-sized business. The death or disability of the operator of a sole L proprietorship will create a serious problem. Such an event usually leads to dissolution, or at least to a drastic change in the business.

Since the existence of this form

of organization is dependent upon the willingness and ability of the proprietor to keep running the business, it lacks the permanency which is necessary to get others to supply funds to the business.

Thus, !fthe amount of capital available to

a single proprietorship is limited to that which the owner I4. The owner can declare himself bankrupt and be allowed a certain property exemption provided for by the law of the state in which he resides. Such laws usually provide for a certain sum in cash or personal property. 5> Dauten, 0£. cit., p. 73* 6 It should be pointed out that the death or disa­ bility of the key man of any form of organization will create a serious* problem.

can supply plus some loans he may be able to make on real estate or other tangible assets•f!^ II. Advantages.

PARTNERSHIP

The advantages of the partnership form

of organization may be listed as follows: 1*

Ease of organization-.

2.

The amount of capital is not as limited as in the single proprietorship.

3.

It brings a diversification of skills, aptitudes, i.

and experience together with incentive. Ij..

It widens the number of prospective customers.

5.

Certain tax advantages.

A partnership is an association of two or more indi­ viduals to carry on as co-owners a business for profit.

The

rights and duties of the.partners are regulated by the partnership agreement and by the state partnership law. Although a written contract is not required in some cases, it is advisable to reduce all the terms of the partnership agreement to writing.

This will serve to minimize later

difficulties or disagreements that tend to arise.

Legal

advice should be obtained in the preparation of the written contract.® 7 Dauten, ojd. cit., p. 73* 8 Roper, o£. cit., p. 2.

30 Lawrence Mutter and Kenneth Davis made the following statement regarding the use of the partnership form of organization in the plumbing and heating business: Many heating and plumbing contracting businesses now in existence are organized on a partnership basis. By far the majority of such partnerships are consti­ tuted of two individuals primarily with mechanical skill and inclinations. They formed the partnership to cut down overhead through increased business volume, to widen the number of prospective customers, or combine special skills and aptitudes. A lesser number of partnerships are those wherein one individual specializes in the mechanical aspects of the business while the other takes care of the business phases. Wuch a partnership is ideal if both the partners are properly qualified.9 The partnership brings the assets of two or more men into the business.

Therefore more capital can be raised

through this form than by an individual proprietorship. The unlimited liability of each of the partners usually gives the partnership a better credit standing than a corporation of equal size.

It may, therefore, be possible

to secure short-term loans more easily and on a more favor­ able basis. Partnerships, like single proprietorships, have the advantage of relative freedom from government regulations. They also have certain tax advantages 9 Lawrence P. Mutter and Kenneth R. Davis, Establishing and Operating a Heating and Plumbing Contracting Business, (Washington, D. C.: United States Government Printing Office, 19I4.6), p . 8. 10 The tax advantages of the partnership are discussed at length in the latter part of the chapter.

Disadvantages.

The disadvantages of the partnership

may be listed as follows: 1.

Unlimited liability of each partner.

2.

It lacks permanency. Scientific organization is difficult.

1^..

The

transfer of ownership is cumbersome.

5*

The

size of the organization is limited.

6.

The amount of capital is limited.

Perhaps the greatest disadvantage of the general partnership is the unlimited liability and personal responsi­ bility of each partner for all debts of the business. partner is a general agent for the firm.

Each

The acts of one

partner, within the ordinary operation of the business, are binding upon the organization. The following quotation was taken from the book entitled Business Finance by Carl Dauten: The total property of a general partner is subject to unlimited liability for partnership debts. A creditor may levy against the assets of any individual partner even though all the partners have sufficient assets to meet their debts or even if the partnership itself has sufficient assets upon liquidation to take care of all liabilities. The only exception to this rule is that personal creditors have the first elaim against personal assets and business creditors have the first claim against business a s s e t s . H The life of a partnership is indefinite since the death, incapacity, withdrawal, or bankruptcy of any of the 11 Dauten, o p . cit*, p* 82.

32 partners dissolves the partnership as such.

It is then

necessary for the remaining partners to pay off their share in the business.

For this reason, it is often -desirable

for the partnership agreement to provide for insurance on the lives of the partners. It is difficult to organize the partnership .for effective management.

The fact that each partner is a general

agent«for the firm, makes it difficult to tie the partners down to definite tasks. The partnership can last only as long as the partners are able and willing to work together.

If one of the partners

feels that he is not being treated squarely he can always withdraw the partnership and thus bring the business to an end.

This makes it more difficult to obtain long-term l o a n s . ^ The transfer of shares of ownership of the partnership

is often more difficult than that of the corporation.

Such

a transfer can be made with a minimum of disturbance, however, if the partner is able to find a person who is willing to buy his share in the business and also be acceptable to the other partners. tfThe partnership is limited in growth and development because there is a limit to the number of men who can work together effectively as co-equals•11^ 12 Ibid., p. 80. 13 Ibid., p . 8 1 .

Thus, the amount of

33 capital is limited since the only way to get additional funds is" to bring in additional partners. III. Advantages.

THE CORPORATION

The major advantages of the corporate

form of organization may be listed as follows: 1.

Limited liability.

2.

The ease of transfer of shares of ownership.

3.

Continuity of existence.

If.*

Susceptibility to scientific organization.

5.The size is not limited. 6.

It is somewhat easier to

raise capital thanin

the other forms. 7*

Certain tax advantages.

The outstanding advantage of the corporate form is its limited liability.

The assets of the individual are not

impaired through liability for corporation obligations. This is of benefit primarily to stockholders in the larger corporations.

In the small corporation which would be used

in organizing a heating and plumbing business the advantage of the limited liability is more apparent than real.

When

a banker makes a loan to a small corporation he requires that the owners of the business countersign all notes of the business, poration,

not in their capacity as officers of the cor­

but as individuals.

In many cases the large trade

creditors make this same requirement.

Consequently, if at

any time the business assets are not sufficient to meet the business debts of the corporation the personal assets of the individuals may be levied on under the endorsement of the note. The corporate form of organization makes it easy to transfer,shares of ownership.

All the individual stockholder

must do is find a buyer for one or more of his shares of stock. The corporation has more stability than the sole pro­ prietorship or the partnership.

It is not disrupted by the

death, inability, or bankruptcy of any of its members.

This

fact, plus the ease of transfer of ownership make it easier to raise new capital for the business. A scientific functional organization can be applied to the corporation as easily and as effectively as in the case of the single proprietorship.

When the president is

elected b y 'the board of directors, he has final authority for his stay in office.

He may appoint subordinates and

delegate authority to handle various phases of the business. The tax advantages and disadvantages of the corporate form of organization are discussed in the last part of this chapter. Disadvantages.

The disadvantages of the corporate

form of organization are as follows:

1,

Incorporation expense,

2.

Cost of original financing,

3-

It is subject to many state and Federal regu­ lations •

I}.,

It is subject to an annual franchise tax.

Several disadvantages should be considered before choosing the corporate form of organization. Incorporation involves considerable Mred tape11 and expense.

It is necessary to apply for a certificate of

incorporation.

This requires various forms to be filled in

with the aid of legal counsel.

Also an incorporation tax

must be paid. It is necessary to print stock certificates and set up facilities to handle transfers of securities.

This makes

the cost of original financing higher than the other forms of organization. There are many state and Federal laws which regulate corporations.

If an incorporated business wants to operate

in a state other than the one from which it has received its charter it must obtain another license to operate in that state and abide by all the corporation laws of that state. The corporation is the only form of business that is subject to an annual franchise, tax. Since the corporation business activity is limited by the powers which are granted to it in its charter, the

36 charter is often drawn up with such a broad scope of powers that the corporation may engage in almost any business activity. IV.

LIMITED PARTNERSHIP

A limited partnership is formed by an agreement be­ tween one or more general partners and one or more limited partners.

The general partners operate under, and are subject

to, the same laws that relate to the partners of a general partnership.

A limited partner is really half-way between an

owner and a creditor.

Specific state statutes provide for his

limitation of liability.

It is therefore necessary to file

a certificate of information with the state and provide such information as the name, type, and location of the business, the names and addresses of the partners, the contribution of the limited partners, etc. The limited partner must act in such a way that no one can possibly mistake him for a general partner.

He has

no voice in the management of the business, nor can he enter into any contracts for the business.

The limited partner

may sell his interest in the business to another person with­ out the consent of the remaining partners. Advantages.

The advantages of the limited partnership

may be listed as follows:

37 1.

The same advantages of a general partnership.

2.

The business obtains funds from the limited partner on terms more favorable than those of a loan.

3.

The limited partner has clear-cut limitations of liability.

if.

The general partners do not have to give any voice in the operation of the business to the man who supplies the capital.

The limited partnership has the advantages of a general partnership.

It also has certain other advantages over the

other forms of organization.

It provides a means for the

general partners to secure funds for the business on terms more favorable than those of a loan.

This is true since the

business has no fixed loan charge to meet. partner bears more risk than a creditor.

The limited He receives his

income out of the profits and, therefore, cannot throw the business into the hands of receivers if the enterprise is not immediately profitable. The limited partner has no voice in the policies or management of the business.

Therefore, the general partners

have complete control of the business operations. If a man has money to put into a small business, and does not want to take an active part in its management, he can achieve limited liability better in a limited partnership

38 than in a corporation.

In a corporation h© may be forced

to guarantee notes if the business is to receive any credit. Disadvantages.

The disadvantages of the limited

partnership may be listed as follows: 1.

The same disadvantages, of the general partnership.

2.

The area of operations is restricted to the state in which the partnership was legally formed. Other states may not recognize the limitation of liability.

3.

Individuals are often reluctant to invest a substantial amount of money in the business as a limited partner.

All of the disadvantages of the general partnership, except the unlimited liability, also apply to the limited partnership. The greatest disadvantage of the limited partnership is the fact that it can operate only in a restricted area since states other than that in which it was created usually treat it as a general partnership.

This would prove to be

a very real disadvantage to even the small contractors in the heating and plumbing business if they were located near the state line, where part of their contracts would be in the adjoining state.

39 V.

COMPARISON OP THE FORMS OF ORGANIZATION IN THE LIGHT OF FEDERAL INCOME TAXES

One of the most important factors in choosing a .business form is the comparative tax load which the profits must carry. A wise decision on the tax issue of partnership vs. corporation requires a correct answer to the four following fundamental questions: 1.

Which form results in the most business profits reaching the individual owners?

2.

If the present business form is not the best, what is the cost of changing?

3.

Can further tax economies be obtained by sub­ dividing the business into two corporations, into one partnership and one corporation, etc.?

ij..

If a change is desirable, how can it be ac. complished to gain the greatest tax benefits?^* ■____ ’ __ ' 298.80 718.80 1,061.76 1 .459.52 1.879.52 2,333.60 2,773.60 3,233.60 3,803.8k 4 ,263.84 5 ,183.84 6,744-48 8,426.08 10,505-12 13,665.12 18,784.00

Tax Saving as Corporation $ ......... 77.04 22.24 34.08 184.32 370.88 652.48 991.52 1 ,280.16 1,731.84 2,793.60 4,432.64 6,109.12 7,574-72 8,122.40 9,549.60

TABLE IV SAVING IN FEDERAL INCOME TAXES BY OPERATING AS CORPORATION (Married Person) (Under 194^ rates, assuming (a) no dividend payments, (b) salary from the corporation as listed below, (c) no other source of income, (d) the individual is a married man with one child, and (e) the optional standard deduction is used.)

Net Business Income $ 2,000.00 k,000#00 6,000.00 3,000*00 10,000*00 12,000*00 111, 000.00 10,000*00 18,000.00 20,000*00 22,000.00 26,000.00 32,000*00 28,000.00 Ij4 , o o o *o o

50,000.00 60,000.00 Source:

Tax as Individual Proprietorship #

....... 298.80 597*60 935*01). 1,283.52 1,712.96 2,170.56 2,670.5.0 3,198.110 3,768.6k 7.953-92 10,520.00 13,328,96 16,310.24 21,699.52

Operating as Corporation Total Tax on Indi­ Assumed Salary vidual and Corporation $ 2,000.00 1*.,000*00 4,000*00 6,ooo«oo 8,000*00 8,000*00 10,000*00 10,000.00 10,000.00 12,000.00 12,000.00 12,000*00 lk, 000.00 16,000*00 18,000.00 18,000*00 20,000.00

Research Institute of America.

# ....... 289.60 718.80 1,017.60 1,355.0k 1,775.0k 2 ,123.52 2,563.52 3,023.52 3,k52.96 3,91.2.96 k,832.96 6,210.56 7,670.5.0 9 ,5.78.5.0 12,658.5.0 17,568.65

Tax Saving as Corporation # ...... 121.20 82.56 71.52 62.08 57. 0k 106.85 175-*88 315.68 5-55-.08 85.3.52 1,75.3.36 2,85. 9.60 3,850.56 3,711.8k 5 ,230.88

1*3 6.

Corporate liquidation.

7*

Payroll taxes on owners.

8.

Capital gains and losses.

Amount of anticipated earnings.

tfAs a broad general­

ization the lower income business is better off unincorporated, while the middle and upper income companies operate more ■ 1 /I

profitably as corporations.11 This broad generalization holds true in most cases, but there are quite a few exceptions.

A partnership with

fairly substantial earnings may at times create a definite saving in income taxes.

The following cases show the possi­

bilities under various conditions. CASE I A and B are operating a partnership which has a #50,000 net income distributable on a 70-30 basis. Each partner has a wife and two children.17 Partnership Income

Tax Payable

A

...................... #35,000

# 8 ,914.6.56

B

15,000

2,262.08

Total tax on partners

16

"

#11,208.61j.

Loc. eit.

17 Under the current tax law each is allowed an exemption of #2,lj.00 for dependents. An allowance of 10 per cent of income or #1 ,000, whichever is less, is also deductible in each case for contributions, taxes and interest.

kk !r CASE II The business is incorporated, A is allowed a salary of #5,000 and B is allowed a salary of #1|.,000. The. remainder of the income of the corporation is paid to the partners as dividends on a 70-30 basis. Corporation Salaries

Share of profits after Corporate T a x ______

Tax Payable

A . • #5,000

#18,739.00

# 1^,719.76

li-,000

8,031.00

1 ,582.78

B

. .

6 , 302.514ll^.,230.00

Total Tax on Individuals Corporate Income Taxl8

#20,532.51^

Total Tax

C A S E III

The business is incorporated. The owners take the same salaries as in Case II. No dividends are paid. The balance of corporate income after paying salaries is all retained in the business. Corporation Salaries A

.................

B

........................ i|.,000 Total tax on Individuals Corporate Income Tax Total Tax

#5,000

Tax Payable #

3I4.8.60 199-20 5^-7-60 lif,230.00 777 •B0

If A and B operate as a corporation as in Case II, the combined tax, including the corporation income tax, will 18 The Corporation will report as income the #14*1,000 of profits left after paying the salaries amounting to #9,000

ks be $9,323.90 more than the total tax paid by A and B if they operate as a partnership as in Case I. If A and B operate as a corporation, withdrawing only their salaries, and plow back all earnings after paying the corporation income tax,

(Case III) the total tax will still

be over $ 3 >5>00 higher than the tax paid as a partnership (Case I).

There may be a tax saving, however, if one of the

partners has a considerable amount of income other than that derived from the business. Income from outside sources.

If an individual has

considerable outside income, the benefits of operating as a corporation are increased.

If the outside income is large

enough even the lowest income business can show a lighter tax load as a corporation than an unincorporated business.

Any

business income left in the corporation is subject to com­ paratively low corporate tax rates.

However,

if the business

is unincorporated the individuals* outside income is piled on top of his share of the company*s income and is, therefore, subject to peak surtax rates. Cases IV and V illustrate the possible tax advantage of operating as a corporation rather than as a partnership if one of the individuals has considerable outside income.

CASE IV A and B are operating as a partnership. The case is the same as Case I except that A has $50,000 income from o ther sour ce s • Partnership Partnership Income A . . . $35,060 B . . .

Other Private Income |5o,000

Tax Payable • $35,67.3.92

15,000

2 ,262.08

Total Tax on Partners

$37,936.00

CASE V The business is incorporated. The case is the same as Case III except that A has $50*000 income from other sources. Corporation Salaries A . . . . $5,000 B . . . .

Other Private Income

Tax Payable

$50,000

$18,651)..72

4,000

Total Tax on Individuals Corporate Income Tax Total Tax

199.20 18,853.92 l4,230.00 $33,003.92

These last two cases show that if the earnings are being plowed back into the business, and one of the owners (A) has $50*000 income from other sources, the use of the corporate form will reduce taxes by over $ij., 800.

k-7 Amount of salary paid to stockholder-employees.

The

choice of the form of the organization depends not only on the income level of the business, and the amount of outside income, but also on the amount of corporate earnings paid to the owners in the form of salaries and other expenses. In order to obtain the best tax arrangement the earnings must be split between the stockholder (in the form of salaries) and the corporation (in the form of retained earnings) in such a way that the minimum amount of tax is paid.

This can be done by increasing or decreasing the

salaries of the stockholders until the tax rate paid by the stockholders equals the tax rate paid by the corporation. Table V shows the salaries that will result in the least over-all tax burden at various levels of business in­ come.

The table considers none of the factors except salary

and income, but it indicates the marks at which to shoot. The best salary is not always possible for two reasons: 1.

The owners may need a larger salary to live on.

2.

The tax law may not allow the salary that is desired.

All salary payments to the stockholders are examined by the treasury to see that they are not a disguise for a dividend.

Such salaries must be "reasonable” in the light

of services rendered.

ij.8

TABLE V SALARY PAYMENTS RESULTING IN LOWEST TOTAL TAX COSTS*’

Corporate Income Before Salary

Under 1947 Law Married Man, No Dependents; or Single Man, One Dependent

Under 1948 Acts Married Man, Single Man, No Dependents One Dependent

$ 10,000

$ 5»ooo

$ 9 .2 0 0

$ 5 ,2 0 0

15,000

5 ,ooo

1 0,000

7 ,200

20,000

5 ,o o o

13,200

7 ,200

25,000

5 ,o o o

1 3 ,2 0 0

7,200

30,000

7,000

13,200

7 ,2 0 0

4 0 ,0 0 0

1 5 ,0 00

15,000

1 5 ,000

5 0 ,0 0 0

2 1 ,0 00

25,000

2 5 ,000

6 0 ,0 00

21,000

3 5 ,0 0 0

27,200

*’ Assuming stockholders outside income equals deductions. Source:

Research Institute of America.

k-9 The courts are well aware of the difficulties faced by the small businessmen who try to comply with the many government regulations.

This, plus the fact that it is very

difficult to determine just how much a man is worth, allows the small business considerable flexibility in which to determine the amount of salaries to be paid. In the small business where profits are so small that they must be paid as salaries to the stockholders, the corpo­ rate form gives the operators the legal advantages of a corporation without the federal tax disadvantages.

The stock­

holders will pay tax on their individual salaries, but there will be no corporate tax since all the profits are used to pay the stockholders. Retention of earnings in the business.

In many cases

the profits left in a corporation will bear a lower tax than if the business is run as an unincorporated business.

The

previous diseussion has shown that if the owners wish to plow back most of the earnings of a business, form of organization is often desirable.

the corporate

But the money left

in a corporation cannot be used to put children through school, buy a new ear, house, etc. The question of how much should be withdrawn as divi­ dends can be determined by deciding how much profit can be left in the corporation and yet give the owners their desired standard of living.

50 In calculating the relative tax advantages of the corporate forms of doing business, it is necessary to make a careful estimate of probable future dividend payments. This is important because of the double tax on dividend payments. Penalty for unreasonable accumulation of earnings. There is no penalty tax if earnings are kept in a partnership, however, in a corporation there may be a tax on illegal accumulation of surplus if the income tax authorities feel that money has been left in the business primarily as a means of evading taxation .^ There is no rule of the thumb for measuring permissible earnings accumulations, however, here is one general guide. ”No dividends need be declared so long as funds are retained 20 for the reasonable current and future needs of the business.11

It is not easy for anyone to determine the ^reasonable needs” of a particular business.

The danger of penalty will

not arise unless ”the business begins to use its funds in a

21

manner inconsistent with the normal business practice.” Tax on corporate liquidation. was taken from the Tax Coordinator: Dauten, o p . cit., p. 79* 20 Tax Coordinator, p. 21, 821. 21 Loc. cit.

The following quotation

Even though no dividends are paid, double taxation is still possible, though not as drastically as in the ease of dividends- If the corporation is dissolved or the stock sold, the accumulated corporate profits will be reflected in the increased value of the assets distributed to the stockholder or in the price obtained for the stock. This increased value will almost always be taxed as a long-term capital g a i n . lf22 Therefore, if the owners plan to dispose of the corpo­ ration in the future, part or all of their tax savings for the past years may be lost. Payroll taxes on owners.

In respect to unemployment

insurance taxes the single proprietorship and partnership may have certain tax advantages over the corporation. State Unemployment Tax.

In most states the u n ­

employment insurance tax is levied upon employers of eight or more persons.

In determining whether the employer is

subject to this tax, officers of the corporations are counted; whereas' individual proprietors and partners are not counted. The effect of this is very important.

For example, if a

business has two stockholder-employees and six other employees it is subject to the state unemployment insurance tax.

If

the same business were operated as a partnership the business would be considered as having only six employees and would not be subject to the unemployment tax.

Since the state rates

are usually 2*7 per cent of the total payments to employees,

22 Loc.cit.

52 it is obvious that ,fthe state unemployment insurance tax constitutes an appreciable cost of doing business.rf^ (k) Federal Unemployment Insurance T a x .

The Federal

unemployment insurance tax is relatively unimportant from the standpoint of effect upon the form of organization, because ffthe taxpayer is given credit for the amount of unemployment insurance tax paid to the states prior to the due date of the federal return, up to 90 per cent of the Federal t a x . " ^ In most states the unemployment insurance tax rate is 2.7 per cent of the total wages payable. ployment insurance is 3 P©r cent.

Federal unem­

(Beginning with 19I4-O, the

Federal tax is based on only the first $>3>000 of wages paid to each employee.) The tie-up between the Federal and state laws is as follows:

When making the Federal return the taxpayer is

given credit up to 90 P©r cent of the Federal tax for the amount of state unemployment insurance taxes he has paid prior to the due date of the Federal return.

Since the

state rates are usually 90 P er cent of the Federal rates, credit is usually taken for the full state tax.

Thus,

23 Charles W. Gerstenberg, Financial Organization and Management of Business, (New York: Prentice-Hall, Inc., I9I4-6 ), P. 173. 2lj- Loc. cit.

53 in effect, the Federal tax is one tenth of the above rate. Capital gains and losses.

If a business has con­

siderable long-term capital gains and losses there are three reasons for not operating as a corporation. 1.

The maximum tax rate on long-term capital gains for both corporation and individuals is 25 pei* cent. But the minimum tax rate is quite a! different story. A corporation cannot pay less than 21 per cent while an individual may pay as little as 8.30 per cent.

2.

The corporations * capital losses cannot be used to affect any capital gains that the stockholders might have, nor can they be used to affect other income of the corporation. However, the capital losses of a partnership may be used by the partner to offset any personal capital gains. In addition, $1,000 of capital loss may be offset against the ordinary income of the partner. He may also carry over any business losses for 5 years and use $1,000 of the loss to reduce his in­ come tax each year.

3.

Any long-term capital gains realized by a corporation will be fully taxable to the stock­ holders as ordinary income when disbursed as dividends. VI.

SWITCHING THE FORM OF ORGANIZATION

Partnership to corporation.

The change from partner­

ship to corporation can be made tax free.

The property of a

partnership or a single proprietorship may be transferred to a corporation^ in exchange for stock without realizing any 23 For further study of capital gains and losses see the Tax Coordinator, p. 21, 822.

capital gain or loss, if: 1.

The partners have at least 80 per cent of the out­ standing voting stock and 80 per cent of all other classes of stock,

2*

The partners receive securities and stock in the same proportion to the amount of interest they • had in the partnership..

In most cases these requirements will automatically be met, therefore, the transfer will usually involve no tax. Even if the corporation has been chosen as the best form of business it may be advisable for several reasons to start as an individual proprietorship or partnership with the idea of changing to a corporation later. The first few months of any new business will often show a loss.

Under the corporate form of organization, only

a restricted amount of the loss (a maximum of 38 P@r cent) could be used to reduce future profits of the corporation. If the business is a partnership or single proprietorship, the taxpayer can use the loss to reduce his personal income. 26 By carrying a loss over to reduce future profits, the corporation can save a maximum of only 38 per cent because 38 per cent is the maximum that a corporation is taxed. For example, if in 19lj-8 a corporation incurred a net loss of $100,000 and in 19-^8 the same corporation showed a net profit of $100,000, the total of the 19J4-8 loss could be carried over to reduce the 19^-9 profit. The 19^-9 profit would be reduced to zero. But only 38 per cent of the $100,000 would be saved because that is all that would have been taxed of the $100,000 if the 19^8 loss had not been carried over to reduce it to zero.

55 If the taxpayer is in the upper income brackets, his immediate tax saving will be substantially more than 38 per cent. One possible way of "having your cake and eating it too" would be to operate the business as an individual pro­ prietorship or partnership until the loss period ends, then shift to a corporation.

The benefits of the loss would thus

be available to the individual or partners, while the profits would be reported by the corporation. ^7 Even though no losses are expected it may be advisable to operate for a limited time as a partnership in order to compare the estimated income with the actual income. The corporate form of organization is usually adopted on a basis of estimated future earnings.

If the actual

earnings do not come up to the estimated earnings the in­ corporation may be postponed until the actual earnings do meet the estimates. Corporation to partnership.

The transfer of assets

from a corporation to a partnership results in the recognition of a gain or .loss.

When the corporation is liquidated, the

market value of the property distributed is considered full payment to the stockholder for the stock surrendered to the corporation.

The assets of the corporation will be valued at

the fair market value as of the date of liquidation. 27 Tax Coordinator, p. 21, 825*

In

most cases, the market value of the asset is different than the book value--on the balance sheet of the corporation.

The

difference constitutes a capital gain or loss. It may seem advisable to change from a corporation to a partnership because of expected annual tax savings, but the immediate cost of dissolving the corporation may make the change prohibitive. It should be pointed out that it is possible to secure a long range tax benefit by stepping up the basis of the assets of the new unincorporated business.

Where the market

value of the corporate assets is greater than the book value, the gain is taxable to the stockholders as a long-term capital gain.

On the other hand, the increased basis may be used by

the new business to reduce ordinary income which is usually subject to a higher tax rate. For example:

If a corporation’sclosing inventory

which cost $10,000 has a market value of $20,000, corporate liquidation would result in a maxiumu tax to the stockholders (due to the increase) of $2,500.

However, when the inventory

is sold by the new partnership in the following year, the income is reduced by the full $10,000 of increase.

If the

owner is in the 5 4 *5& Per cent bracket, the saving would be $5 ,14.5 6 .

Therefore, the net tax savingamounts to

28 IbidT, p. 21, 875.

$2,956*^®

51 Combinations of business forms.

There is no law that

requires all of the business to be transacted under one form of organization.

If a corporation proves to be more advan­

tageous taxwise than a partnership, two or more corporations may be still more advantageous.

Or a combination of partner­

ship and corporation may be preferred.

Organizations may be

split or combined if there are valid business reasons for doing so. The larger contractors in the plumbing and heating field may find that the formation of more than one corpo­ ration will yield at least two advantages: 1.

Liability is further limited.

2.

The income of each may be subject to lower normal tax rates.

For illustration:

If one heating and plumbing business .

as a corporation shows a net income of $50,000, corporate income taxes amount to $19#000.

On the other hand, if the

income were split equally between two corporations, the total tax payable of both would only amount to $>11,500--a saving of $7 ,5 0 0 . The medium size and larger plumbing and heating firms could effectively be subdivided into two corporations, or one partnership and one corporation in this manner.

The new

construction, remodeling, and repair business could be carried on under one form of organization; while the merchandising

58 of equipment and appliances could be carried on under another organization. There are several possibilities.

One corporation

could be formed to carry on new construction, and another corporation (or partnership) could be formed to carry on the remodeling and repair; and if so desired, a third or­ ganization could be formed to transact the merchandising business.

59 CHAPTER IV HEATING AND PLUMBING RETAILING OUTLINE OP SUMMARY AND CONCLUSIONS I.

II.

III.

There are both advantages and disadvantages of operating a showroom in connection with a heating and plumbing business. The particular factors of each individual case must be considered when deciding upon whether or not to enter the retailing field. The major advantages of having a showroom are: A.

It gives the contractor the opportunity to show the fixtures he proposes to sell.

B.

It is an advertisement of the business.

C.

It gives the impression of stability, and builds public confidence.

D.

It provides a means to increase profit possibilities by taking on additional lines.

The major disadvantages of a showroom are: A.

The high cost of equiping the showroom properly.

B.

The additional expense of operating the showroom.

C.

The short discount rates offered contractors on heating and plumbing equipment.

D.

Price-cutting, and the present trend on the part of the consumer to buy direct from the wholesalers and manufacturers.

6o IV.

v.

VI.

Contractors who specialize in new construction and rely for the most part on low-bids to get their business are probably just as well of without a showroom. The contractors who specialize in repairs or alterations for the major source of income will find that the added investment and expense required to operate a showroom will be more than justified because of the increase and stabilization of business and profits that it will create. Some contractors find it to their advantage to make use of the wholesalers display room. This gives them some of the advantages of a showroom without any added investment or ex­ pense.

VII.

It is often possible to both increase and stabilize profits by taking on additional lines, not directly related to the heating and plumbing business•

VIII.

It is usually better to have a vertical special­ ization of families of fixtures and appliances, rather than a variety of appliances from a variety of lines, to merchandise in a limited store space.

IX.

A good store front is the contractors silent salesman. If the window displays are properly arranged they will attract business and sell not only their products, but the establishment itself.

CHAPTER IV HEATING AND PLUMBING RETAILING The present trend is toward more merchandising in the heating and plumbing field.

The trade associations and

trade journals all agree that a completely equipped showroom is an ideal toward which heating and plumbing contractors should aspire.

However, a store is not essential for the

beginner, and many of the old established contractors operate very successfully without one. This chapter is a discussion of plumbing and heating merchandising.

Both the advantages and the disadvantages of

having a showroom are discussed, as well as some of the methods of operating a showroom. I.

THE SHOWROOM

There are two lines of thought regarding the desira­ bility of operating a showroom in connection with the con­ tracting business. Some contractors feel that by operating from their home or a small office they can make more profits.

Their

overhead is less and this gives them an advantage in com­ petitive bidding.

These contractors usually specialize in

the new construction field, and they rely, for the most part, on low-bids to get their business.

62 Other contractors feel that the extra investment and expense required to operate a showroom is more than justified by the increase in business and profits it creates. In any case, both the advantages and the disadvantages should be understood before such facilities are started. Advantages of a showroom.

The major advantages of

having a showroom are listed as follows; 1.

It gives the contractor the opportunity to show the fixtures he proposes to sell.

2.

It is an advertisement of the business.

3.

It gives the impression of stability, and builds public confidence.

ij-.

It provides a means to increase profit possibilities by taking on additional lines.

The principle advantage of a showroom is that is gives the contractor the opportunity to display the actual fixtures or other materials he proposes to install. see what they intend to buy.

Customers want to

If the master plumber cannot

show the goods he wants to sell he is at a disadvantage. A variety of products, well displayed, often serves to arouse the desire to possess.

Furthermore,

such a display

gives the consumers the opportunity of making a choice between several types of sinks, lavatories, hot water heaters, and such products.

63 It is very difficult to explain a mechanical device by mere words; or even to describe it through pictures.

The

fact that the average customer has little or no mechanical knowledge, and is often not interested in mechanical details, makes it even more important for the contractor to show the goods he proposes to sell.

By showing the product the con­

tractor has a better chance to observe the customers interest, and explain those points on which there may be any doubt in the customer1s mind. Another advantage of a store is that the showroom itself is a good advertisement of the business. definitely on the map,

so to speak*

It puts the business

If the contractor is

located on a good street, townspeople remember him when they need something. The contractor without a store often must depend upon a limited number of general contractors for a large part of his work.

But the contractor with a store does not have to

depend upon a half dozen, or ten or twenty general contractors for the majority of his work.

He appeals direct to the same

people who support the general contractors— consumers, who need plumbing and heating service of all kinds, whether for new jobs or alterations and repairs, A showroom places the contractor on the same level with the rest of the merchants in the community.

It gives an im­

pression of stability to the business, and is a builder of good will and public confidence.

% Another advantage of a store is that it gives the contractor the opportunity to increase profits by expanding his line and getting into the appliance business.

Certain

additional lines, not directly related to the heating and plumbing business, are being handled more and more by the plumbing and heating contractors in an effort to increase profits. Disadvantages of a showroom.

The principle disadvantages

of a showroom are listed as follows: 1.

The high cost of equipping the showroom properly.

2.

The additional expense of operating the showroom.

3.

The short discount rates offered contractors on heating and plumbing equipment.

i|..

Price-cutting, and the present trend on the part of the consumer to buy direct from the wholesalers and manufacturers.

It is true that a plumbing fixture can be a thing of beauty, but plumbing fixtures are not bought merely to look at.

They are bought because they afford comfort and con­

venience.

Therefore, in order to effectively display a

plumbing fixture, it must be installed in its natural en­ vironment— and that takes additional investment. is true with regard to heating equipment.

The same

A boiler is not

1 For further information see the latter part of the chapter.

65 likely to attract attention on the score or its attractiveness alone. use.

The

boiler, like a plumbing fixture, is purchased for

Customers can better

be convinced

of aboiler’s ef­

ficiency if

it is actually installed in

a contractor’s show­

room.

contractors go so far as to

hook up a boiler with

Some

polished copper pipe or tubing as a means of attracting at­ tention, and as a method of showing their craftsmanship. It is necessary to tie up a considerable amount of money in fixtures and equipment in order to make a showroom into an effective merchandising medium. Each contractor must determine whether the expense of opening a store would be justified in his particular case. He must be reasonably certain that enough extra heating and plumbing goods can be sold through the showroom to offset the expense of establishing and operating it. Some contractors found that the expense of operating a showroom was so great that it was a drag on the whole business.

It should be pointed out that it is quite possible

that a poor location and poor management were factors mainly responsible for this.

In any event, a showroom will con­

siderably increase a contractor’s fixed expense, as well as his investment. The increased fixed expense and investment must be considered in the light of the prevalent discount rates afforded contractors selling heating and plumbing equipment.

66 In most cases, discounts average about 20 per cent of the p selling price. With such short discount rates it is quite obvious that the contractor who invests a considerable amount of money in showroom facilities must have a large volume of business to carry the load of added investment and expense. For example, if a contractor were to invest $2,000 in a showroom, it would mean that the amount of money he had tied up would be equal to the customary gross discount on $10,000 worth of .pierchandise, or the average net profit on $20,000 worth of business.

If the expense of operating

the showroom were $250 a month, it would take the gross dis­ count of $1,250 worth of sales to cover it. Competitive factors should be taken into consideration when deciding whether or not to invest in a showroom. Department stores, mail order stores, and furniture stores have all come into the plumbing and heating retail field. The big question is exactly how can master plumbers, or any small businessman, buy from wholesalers and then sell at retail in competition with elements who buy direct from manufacturers. 2. Lawrence P. Mutter and Kenneth R. Davis, Establishing and Operating a* Plumbing and Heating Contracting Business, Industrial (Small Business) "Series number 36 , (Washington D. C.: United States Government Printing Office, 19M>), p. 25*

67 This question is not easily answered.

However, the

master plumber has one distinct advantage over these firms, if he cares to exercise it.

If the master plumber knows his

market and knows his materials he can give these ”pricecutters” a run for their money. The greatest competitive advantage the plumbing and heating contractor has over the larger retailing concerns is the fact that he is in a position to know the needs of the consumer far in advance of the larger concerns.

He has

opportunities to get into the consumer's homes and anticipate their needs, sometimes before the consumers themselves are aware of them.

If the master plumber is won his toes11 he

will take advantage of this close contact with the market and give the larger firms a lfrun for their money.” Wholesalers have "muscled in” on the retail job. Most of the wholesalers will sell direct.

Those few who

will not sell direct are those who see an actual profit from not doing so— those few who have been able to capi­ talize on their virtue of not competing with their customers; The trend on the part of consumers to buy at a dis­ count direct from the wholesaler or through a wholesale purchasing service-^ is of growing concern, not only to the 3 These ”We-can-get-it-for-you-wholesale-services” establish connections with both wholesalers and manufacturers. In many cases they take the customer right to the wholesale showroom or to the factory. The customer picks out the mer­ chandise he wants and the purchasing service arrangea the purchase for 10 per cent, or sometimes as little as 5 cent of the wholesale or factory price.

heating and plumbing retailers, but to nearly every retailer, both large and small, in any of the durable or semi-durable goods industries. The post-war consumers are bargain hunters.

Many of

them are learning that they can purchase almost anything from an automobile to a kitchen sink at a substantial dis­ count, right in the teeth of the Pair Trade laws. No one can say how far this trend will continue, or how far-reaching its results will be; but the prospective heating and plumbing retailer should note its existence, and give careful consideration as to how it will affect his particular case. Use of the wholesaler* s display room.

Some contractors

prefer to use wholesalers* showrooms rather than their own. Some consider it an advantage to follow the practice of taking customers to these showrooms.

Others consider it a disadvantage.

The principal advantage of using a wholesaler’s show­ room is that it does not cost the.contractor any money. Most wholesalers have a relatively complete line of heating and plumbing equipment attractively displayed. A further advantage is that wholesalers often furnish assistance in closing sales.

It ean sometimes be very

advantageous to have the assistance of a wholesaler’s sales­ man, particularly when the salesman is in a position to say

69 something about the reliability of the master plumber*s work, his financial responsibility, etc. The main disadvantage of using the who l e s a l e r s showroom is that it places the contractor in the position of a broker.

The customers are quick to discern the fact

that the contractor does not himself own the fixtures he proposes to sell.

Consequently, some of the customers may

be reluctant to pay the contractor a profit on them. Further, by taking the customer to the wholesalers show­ room, it may encourage him ti dismiss the heating and plumbing contractor and attempt to buy the materials direct from the wholesaler. II.

HANDLING ADDITIONAL LINES

Many heating and plumbing contractors have tried to increase their profit possibilities by taking on additional lines, not directly related to the heating and plumbing business• On items such as oil and gas burners, stokers, stoves, refrigerators, and washing machines, profit margins are higher than on the regular plumbing and heating items.

More

and more master plumbers are handling these lines in view of their greater profit potential. Additional line categories.

Additional lines, suita­

ble for heating and plumbing contractors, fall in three

general categories: 1*

Equipment requiring installation such as oil burners, gas burners, and stokers.

2.

Equipment requiring only a minor amount of instal­ lation such as gas ranges, water softeners, re­ frigerators, and garbage grinders.

3.

Smaller items in the appliance line such as electric clocks, toasters, etc.

It is logical that those items in the first two cate­ gories should be sold by contractors because they require a certain amount of skilled workmanship for installation.

But

there is no reason why a contractor cannot handle such additional lines as electric clocks, toasters, and even radio and home freezers, because they are all part of the home appliance business, which is logically one business. The home appliance business is logically one businessnot only because the consumer expects, and likes, to find a complete line— but because if the business is set up to handle several appliances properly it costs little more to set up for a complete line. The master plumber should be certain, before obli­ gating himself to carry lines in the first category, that he is prepared to furnish installation and maintenance. For example, the contractor who goes into the oilburner or stoker business must establish stand-by facilities,

71 either his own or arranged through someone else. The initial profit on this type of equipment is relatively large, but consideration-should be given to the cost to the master plumber of the stand-by service.

With

oil-burners this element of service cost is not so high; but in the case of coal-burning stokers, it sometimes runs into a considerable amount. Before taking on such lines the contractor should be sure he has the proper set-up to take care of both the instal­ lation and the servicing. The element of installation is relatively small with regard to stoves, refrigerators, and water softeners, and usually they require very little maintenance. In regard to the smaller appliance items neither the delivery nor the servicing problem is involved; but it should be pointed out that competition is more keen on these items than oil the larger items requiring installation. Factors to consider.

The following six factors should

be considered before the contractor makes a decision to expand his line of products: (a)

Customer acceptance and competition.

Before the

contractor decides to take on additional lines he should familiarize himself with the competitive conditions in his community.

72 For example, in certain areas, it is impossible to sell gas-conversion burners in any great volume owing to the high gas rates. In other areas, stokers do not sell well because of the relatively high cost of coal.

And in a section of the

country where natural gas is available in large quantities at a low rate, oil burners obviously would be a second choice and would offer limited sales possibilities. (b)

Source of supply.

After the contractor decides

to take on one or more additional lines, the next point to consider is the channel through which he will purchase the products. There are several systems for the distribution of these additional lines: (1) One is from the manufacturer through his local distributor to a local retailer. (2) Another is from the manufacturer direct to a local retailer. (3) The third, is from the manufacturer to a wholesaler, who may handle many other lines, such as heating and plumbing equipment and hardware.. Obviously,

the discounts accorded a direct factory

representative would be higher than those which could be gotten either through a local distributor or a local whole­ saler.

But operating as a direct factory representative

73 would probably make it necessary for the contractor to carry more stock and be better financed than if he were working through a local distributor or a wholesaler, since they frequently handle the financing of installations. Therefore, the question confronting the master plumber is whether he is strong enough financially to earn the extra discount, or whether he should forego the extra discount in the interest of having financial facilities made available to him by others. Agency contracts.

The contractor should exercise

extreme caution when signing any instrument having ambiguous clauses or containing obligations he is not in a position to fulfill. Unfortunately, unscrupulous persons sometimes victimize the heating and plumbing contractor by getting him to sign what he thinks is an agency contract, but what is a legally binding purchase order obligating him to take a certain number of pieces of equipment over a certain period of time. ' (cO Sufficient capital.

As has already been mentioned,

in order to effectively display equipment such as oil-burners, gas-burners, and stokers, the contractor should make an actual installation so the customer can see the equipment in use. Even if the wholesaler were financing the equipment it would mean an additional investment for the contractor to include the cost of installation.

7h (e) Old products have appeal, too.

The master plumber

should give early attention to the question of whether old and proven products of his industry, which have long been neglected but which have all the elements that are required to provide turnover, might not be stocked, displayed, and stressed— rather than the new appliances on which there will be more intensive competition. There is less competition for the plumber in the goods that have always been identified with him.

People do not

usually go to department stores for grease traps, water-hammer preventing devices, and the like; yet the master plumber has numerous likely occasions when a sale might be made, and at a reasonable price— that is, a price that does not require a family conference before being approved. These may seem like little things, but many businesses have been built on smaller things.

When the master plumber

is considering an expanded line he will do well to think first of his own industry. (f) Rounded store service.

Careful thought should be

given to the question of vertical specialization of families of fixtures and appliances, rather than picking a variety of appliances from a variety of lines, to merchandise in limited store space. The following excerpt was taken from the Merchandising Guide for Plumbing-Heating Contractors:

75 Modern merchandising experts agree that full-line selling gives consumers most in service. Buyers dislike such excursions as visiting one store to get a bathtub, another for a shower curtain, another for a medicine cabinet, etc.. A contractor who determined to specialize in bathroom equipment to the neglect of, say, kitchen equipment, could afford to fill out his line even to window-shower curtain sets, floor-mats and towels.4For example, the master plumber sells sinks.

But

customers today do not want to buy sinks; they want at least sinks plus cabinets.

Many of them want dishwasher sinks,

with cabinets, and with a garbage grinder. A rounded dealer will stock logical combinations of products.

The following list of products are grouped in

logical combinations: FAMILIES OF INDUSTRY PRODUCTS Kitchen Group Sinks Cabinet sinks Kitchen cabinets Electric sinks Dishwashers Disposal units Refrigerators Frozen food cabinets Ranges Range oil-burners and pumps Electric mixers, irons, clocks, etc. Grease traps Drain pipe cleaner Enamel polish k- Merchandising Guide for Plumbing-Heating Contractors, (A reprint of articles which originally appeared in Plumbing and Heating Business, Grand Central Terminal Bldg., New York, New York), p. 23•

76 Heating Group Boilers and furnaces House insulation Water heaters, electric and gas Tempering valves Relief valves Automatic heating controls Indirect water heaters Oil-burners Stokers Gas-burners Pipe insulation Boiler chemicals Laundry Group Automatic home laundries Washing machines Dryers Ironers Laundry trays Water softeners Spot Heating Group Space heaters Floor furnaces Radiant heaters Wall heaters Portable electric steam heaters Unit air conditioners Radiator covers Bathroom Accessory Group Bathroom accessories, paper, toothbrush, tumbler holders, stools, etc. Toilet seats Medicine cabinets Shower Curtains Rods Towels Plumbing Group Plumbing fixtures Fixture trim Shower cabinets

77 Water coolers Thermostatic shower mixing valves Water hammer arrestors Miscellaneous Group Sewer service: bituminous fibre pipe Water systems Fire sprinkler systems Lawn sprinklers Industrial apparatus in plumbing and heating III.

SELLING GOODS THROUGH WINDOW DISPLAYS

Good window displays attract business and sell not only their products, but the establishment itself* The store front of the plumbing and heating contractors establishment performs three functions: 1.

It is a frame for displaying merchandise and creating "eye-appeal” and the desire to buy.

2.

It is a billboard that serves to identify the store. It is an entrance to the store, which provides easy access to the interior.

A good store front is the contractors silent sales­ man.

It will go on selling goods for him long after he has

gone home.

Therefore, the matter of choice of the window

display is of great importance.^ 5 For further study see Walter S. Hayward, The Retail Handbook, (New York: McGraw-Hill Book Company, Inc., l9'2l]_", first edition), pp. 2I4.3-88 .

78 Windows are the face of any store. Customers are evidently impressed by them, for it is claimed that 50 per cent of the sales of a store are made through window displays. Probably this is true, because people learn more through sight than through all the other senses combined. G-ood window displays produce high/returns because they make people stop, look and buy.k The sign.

Before going ahead with the subject of

window displays it should be noted that the sign is a very important part of the store front.

The sign should be

arranged with the window display in such a way that when the customer sees one he will see the other. The sign gives the identity of the place of business, therefore, the phrase, "P-lumbing and Heating” is usually an integral part of it. An illuminated sign costs more, but it is quite possible that it will pay for itself by working longer hours as well as contributing to the life and action of the entire establishment. Make windows build sales.

”A recent investigation of

1,000 store customers disclosed window displays to be the •7 greatest outside influence for bringing people into the store.” 1 6 Selling G-oods Through Window Displays and Proper Lighting, (Merchants Service: The National Cash Register Company, Dayton Ohio), 1 9 P* 7 Ibid., p. 153•

79 A window display which simply makes people stop and remark about its cleverness or artistic arrangement, and pass on without any recollection of what is for sale, does very little good.

Plumbing and heating stores— or any of

the smaller stores are not justified in using their window space in this way. The master plumber should ask himself two questions before preparing a window display: 1.

What attracts people to a store window?

2«

What brings them into a store to buy?

A window display must have certain attention-getting features if it is to attract people.

Some of the things

that attract customers are: Bright illumination Vivid coloring Strong contrasts Motion * Timely Merchandise Novelty Interest Pleasing Features Large readable signs The things that bring people into the store to buy are very hard to write about.

However the principal features

which should be stressed in a window display in order to

80 bring people in to buy are: Quality Price Desirability Seasonableness One idea at a time.

The master plumber can test the

window display with the question.

"Does it show clearly

the main idea I wish people to get?*1

People will not stop

to take the time to try to figure out the point of a display; thus, the display should be constructed so that it will show the main point at a glance. Every part of the display should be worked out to emphasize the main point to be made. permitted to detract from it.

Nothing should be

Background,

colors, lighting,

and all related items should combine to make one dominant idea clear and convincing. Store name inside window.

The name of the store in

big letters over the window or on the store sign cannot be seen by a person who is looking closely at the merchandise in the window. window.

Therefore, the store name should be in every

It will then be seen by those who pause to examine

the display.

The good store manager aims to make the goods

and the store name inseparable in the mind of the one who examines the window.

81

Prices on goods in window. before most people decide to buy.

Price is weighed carefully When no price is shown,

many people assume that the price is so high that the merchant prefers not to show it.

Plainly marked prices on displays

*

*

may help them to decide to buy.

If the prices are right,

there is no danger in marking them plainly on the goods in the window.

However, the price should not be over-emphasized.

Kind of window displays.

Window displays may features

1.

A single article.

2.

A line of goods.

3.

A group of related articles.

I}..

A process of production or manufacture.

5>.

A general interest in the goods.

6.

General services offered by the store.

7.

Seasonal or special even goods.®

Displays of production processes and displays based on a general interest in the goods are not too well suited to the small plumbing and heating store.

This is true both

because the nature of the merchandise to be sold is not easily adopted to this type of display, and because such a display usually requires considerable time and expense to install.

The other types of display are worthy of some

discussion, however. 8 Ibid., p. 155-56.

82 Single article displays. -Single article displays can be used effectively in the case of the larger items such as refrigerators,

stoves, washing machines, etc.

A small article, offered at a low price, is more im­ pressive when shown in large quantities.

It seems that well-

arranged masses (of the same article) make stronger impressions and draw more trade on a price basis than a window full of various articles. Display of special articles.

A special-article display

is often built around the first item of much-publicized merchandise to reach the city, such as a new electrical ap­ pliance, or bathroom accessory, being featured in a national advertising campaign. For this type of display, the manufacturer or dis­ tributor will oftentimes furnish supplementary helps, such as posters,

signs, folder coverings, background material,

or even whole display outfits. rfLineft displays. a number of types.

A line display will usually include

For example, a line display might show

one or more of each article in the spot heating group:

such

as space heaters, floor furnaces, radiant heaters, and wall heaters.

It is good to supplement such a display with de­

scriptive matter telling about each of the articles shown.

83 Displays of related articles,

The associated or

related-article display is composed of goods which are used together.

If the window is large enough a small completely

equipped kitchen or bathroom could be featured. A display of this nature may involve considerable expense.

It is true that elaborate sets attract attention,

but the master plumber must think in terms of sales, not of crowds.

He should be sure that the returns from such

displays justify the time and expense involved in making them. However, there are certain types of displays which do not bring large sales but may occasionally be useful as general store publicity. Displays of service facilities.

Window displays can

be used very effectively to advertise the service that the master plumber has to offer*

Telephone order and, delivery

service, and installation service can be emphasized by miniature or full sized equipment and cards* explaining the steps followed, the time saved, and other features the con­ tractor wants people to appreciate. The master plumber will do well to emphasize any special service that he may have to offer, such as rapid service or 2l|. hour service— night, Sundays and holidays, etc.

CHAPTER V SELECTING A PROFITABLE LOCATION OUTLINE OF SUMMARY AND CONCLUSIONS I.

II.

III.

Location is so intimately, and continuouslyrelated to all other aspects of a plumbing and heating business that over-emphasis would be difficult. For the plumbing and heating retailer, nearly every phase of operating the business depends to some degree upon its location. The contractors who deal principally with the general public and sell various lines of home appliances in addition to plumbing and heating equipment should be concerned with all the factors affecting retail stores selling consumer durable goods. With respect to the selection of a city or town, careful consideration of the factor of geographic location, stability of incomes, and the merchandising situation of the area under consideration will amply repay the con tractor’s efforts.

IV.

With respect to the choice of neighborhood, consideration should be given to external conditions, market conditions, and the present trend toward decentralization.

V.

With respect to the selection of the exact site, careful study should be given to traffic, convenience of transportation, nature and extent of competition, leasing arrangements, and the history of the site.

CHAPTER V SELECTING A PROFITABLE LOCATION A good location is one of the most important factors in determining the degree of success or failure in the plumbing and heating business* The primary considerations with respect to location are, the selection of the town, the choice of community in the town, and the selection of the exact site— its suitability and whether or not the property should be bought or rented. These factors are discussed in this chapter* The purpose of this chapter is not to describe the one ideal procedure which should be used by all contractors when selecting a location, but rather to set forth a general, practical, and easy-to-follow procedure which may be used as a pattern, to be changed here and there as the individual sees fit. I.

SELECTING THE TOWN

In selecting the region or town for the location of a small business, personal factors are of much greater im­ portance than they are for the large concern. The master plumber may wish to locate among friends and acquaintances.

The climate and health factors often play

an important role in his choice of a town.

86 The average small operator is rarely in a position to choose the town on a completely scientific basis.

Neverthe­

less, he should evaluate a town to the best of his ability and limited resources before deciding to locate there. Five major factors should be studied in selecting the city or town in which to locate: 1«

The general economic conditions. wealth, and trends of

2.

The sources of

the community.

The size of the community and its tributary population.

3.

The buying power of the local population and the stability of incomes.

i]_. The nature and extent

of competition.

5.

as a place to live.

The town or community

General economic conditions.

Communities are usually

centered around certain industrial, commercial, or agricultural activities.

The local inhabitants draw their livelihood from

one of these sources.

It is necessary to judge whether the

source of wealth and income will continue to grow in the town, and whether the town is progressive enough to attract new inhabitants and increase building construction.

A growing

town may hold great promise for a new business venture. One of the simplest ways of determining the economic trend of a town is to spend a day or two looking it over.

87 The factory managers and local merchants can provide con­ siderable information from personal knowledge as to whether population and industrial activity are growing or shifting to other towns. The average postmaster knows a lot more about a town, the class of

people, the industries, and large business

ests than he

gets creditfor.

inter­

The information gathered from

the postmaster is often more valuable than any obtained from other, perhaps more biased,

sources*

An officer of the local bank is a good source of information.

Bankers, as a rule, are more guarded in what

they say, but if one can

gain their confidence and ask

questions inthe right sort of way they can be

very helpful.

The prospective businessman will want to know if the industrial activity of the town is seasonal or regular.

If

people work only a few months of the year during rush seasons and must spread their earnings over the entire year for maintenance, they cannot produce a very high buying power.

2

The size of the community and its tributary population. The prospective contractor will want to know whether the 1 Fred Rost, going Into Business For Yourself (New York: McGraw-Hill Book Company, Inc., 1953T7, p. 93* 2 Lawrence P. Mutter and Kenneth R. Davis, Establishing And Operating a Heating and Plumbing Contracting Business" (Washington, D. C.: United States Government Printing Office, 191^.6 ), p. 3 0 .

88 population is stable, growing, or declining.

If the popu­

lation is small or definitely on the decline, the number of potential customers is, of course, limited. In small towns a plumbing and heating contractor may expect to draw customers from rural areas, a fact which must be considered in estimating the buying power of potential customers.

General information regarding the trading area of

a town is usually available through the local chamber of commerce or the regional office of the United States Department of Commerce. The size of the population tributary to any given town is affected by many variables, the most important of which is the availability of other shopping districts in the general area, the size and completeness of the neighboring shopping districts, and the convenience of transportation. Helen G. Canoyer of the Marketing Division of the Office of Domestic Commerce has made some interesting studies of retail store locations.

She made the following statement

concerning the boundaries-of retail trading areas: To locate the boundaries of retail trading areas and thereby estimate the amount of retail trade which a town will draw from the surrounding area, one of several methods can be used. For example, figures on newspaper circulation are often used to define a town’s market area. Or license numbers of automobiles driven by shoppers may be checked at the state highway depart­ ment for ownership of the car and residence of the owner. The method which requires the least work, however, is Reilly’s Law of Retail Gravitation. This law was

89 developed by D r * ,William J. Reilly of the University of Texas in 1929 and is stated as follows: ,ftwo cities attract retail trade from an intermediate city or town in the vicinity of the breaking point approximately in the direct proportion to the populations of the two cities and in inverse proportion to the square of the distances from these two cities to the intermediate town.11 Although this law applies only to shopping goods such as wearing apparel, furniture, household furnishings, it can be used to some advantage for specialty goods as w e l l , 3 Buying power of the community.

The income and buying

power of the community is an important factor to consider when selecting a location.

A townfs spendable income is

revealed by the number of telephone subscribers, analysis of income tax returns, number of bank depositors, car loadings, bank clearings, and the number of utility company customers. A quick approximation of the level of income in any given community may be obtained by a study of the rent being paid in the community.

Such information may be obtained

through census studies, through realtors, or by checking advertisements for places to rent.

After finding the amount

of rent being paid by families in the community a rough estimate of individual incomes may be obtained by multi­ plying rental amounts by five, since about twenty per cent of family income is spent on housing (including electricity and fuel).

For example, a rental average of ft.0 per month

normally indicates a family income of $200 per month. 3 Helen 0. Canoyer, Selecting a Store Location (Washing­ ton, D. C.: United States Government Printing Office, !9lji>), P. 9.

90 A community largely made up of people working for wages in low-income industries offers fewer opportunities in the plumbing and heating business than are afforded in a community having a higher income level.

The size of the

community has little to do with the per capita income, and appearances in a large community can often be deceptive. A town may seem to be booming and the sales of merchandise may be high but these facts will always mean that a market exists for the more expensive lifetime goods. if the town is a highly industrialized,

Therefore,

thickly populated

one, it is particularly important to check on per capita income Competition.

The extent and quality of competition

is, of course, one of the most important factors to consider in selecting a town.

Any community, no matter what its other

merits, may be a poor one in which to locate if there are already too many good plumbing and heating establishments located there.

Of course, the presence of a number of

plumbing and heating contractors is not necessarily unfavor­ able if they are all doing a good business or if they are not fully meeting the needs of the community. Information on the number of stores in a community may be obtained from the decennial reports of the census 4- Mutter, loc. clt.

91 published by the Department of Commerce.

These are available

at the chamber of commerce, newspapers, banks, and public libraries. In a study for the Department of Commerce, Lawrence Mutter and Kenneth Davis wrote: The heating and plumbing industry estimates that it takes approximately 1,500 residents to furnish the business for one heating and plumbing contractor in the medium and larger cities. Take the population figure for the town and divide that number by 1,500 and you will have a pretty good idea of how many heating and plumbing contractors the town can support. If the field already is well covered, your probability of success is small unless you can offer some specialized services or a higher grade of workmanship than the community has had available or has been accustomed to buying.5 The town as a place ,to live.

The character of the

city is a factor that the prospective businessman will want to consider before he makes a final decision to locate there. The extent of transportation facilities, professional services, schools, churches, medical services, and amusements all play an important role in the selection of a town. The type of people and whether they are congenial is a factor to consider.

It may be well to check on the number

and denomination of churches, since these may reflect the racial composition of the population.

5 Loc. cit.

92 Home town.

It is often considered risky to go into

business in a particular town solely known

because one is well

there. However, sound business reasons often

such a decision.

favor

Credit is easier to obtain where the

operator has established a good reputation.

His intimate

knowledge of the community^ people, their buying habits, their likes and dislikes, and other characteristics such as trends and developments to be expected in the near future, and of other useful facts may be an asset that a total stranger would acquire with difficulty. Friends and acquaintances will give helpful word-ofmouth publicity.

However, the beginner should not count

too heavily on receiving their patronage merely because of friendship.

Also, friends do not always pay as promptly as

do strangers. II.

SELECTING- THE DISTRICT

Nature of business determines

WITHIN A TOWN location.

The factors

pertaining to location which would be most emphasized by a plumbing and heating contractor are determined by the type of business in which he specializes. A contractor whose principal source of business is obtained- from large general contractors would probably require little more than an office space in the downtown area.

If the contractor specializes in servicing and

93 remodeling, a small attractive store and office to advertise the business would be needed in or near the center of his neighborhood shopping area. On the other hand those plumbing and heating con­ tractors who deal principally with the general public and sell various lines of home appliances in addition to plumbing and heating equipment, naturally would be concerned with all the factors affecting retail stores selling consumer durable goods.^ External conditions.

Real estate developments and

property values are good barometers of a district’s prosperity. A new subdivision or a large apartment house development will often be an indication of a new and promising location.

The

presence of several suburban developments with housing and shopping centers is a good sign that the district is expanding and the population is increasing. External conditions such as the rerouting of a major highway or the possible change in location of an army camp or other government installation must be considered. Market conditions. out a low-rental district.

It is not always wise to seek If there are too many business

vacancies in a location the chances are that the neighborhood k Merchandising Guide for Plumbing-Heating Contractors, (New York: Plumbing and Heating Business), p. 18.

9^ will not support either a specialized service or sales organization in the heating and plumbing field.

Without

customer volume a low rental may be more difficult to meet than is anticipated.

The rental must be in a favorable

proportion to the business volume. A careful survey of the proposed neighborhood should be made to make sure that it is not already covered by others in the same business. The market should be studied.

If it appears that the

owners take pride in their possessions and keep up with modern improvements it is a point in favor of the house­ holders that live in the neighborhood.

If the local people

depend on small income from payday to payday, it means that the market may be inadequate and the prospects few. The relative number of premises occupied by owners compared with the number occupied by tenants is an important consideration.

Owners make better customers than do renters.

People are more likely to keep up their property and make the necessary repairs and improvements when they live in their own buildings than when they rent them from others. The normal pride in the ownership of a modern home will 7 influence home owners to keep up with developments.1 Outlying shopping centers.

With the present trend

away from congested shopping areas, plumbing and heating 7 Mutter, 0£. cit., p. 32.

95 contractors will do well to give some thought to the possi­ bilities of locating on highways leading away from such congested areas.

More and more the trend is for certain

city people to drive out to a highway store which they have found satisfactory.

Many persons would rather travel some

extra miles than be confronted by city parking' difficulties-o and perhaps parking fees too. In describing the growing importance of the outlying or suburban shopping centers Pearce Kelly and Kenneth Lawyer wrote: A substantial portion of the total retail sales in the large city is completed outside the central shopping area, and the proportion of the number of stores in the outlying districts is even greater. This is part of a general American decentralization tendency. The import of such tendencies already has been noted. On the average, in retail stores total expenses may be 7 per cent lower outside the central shopping districts.' III.

SELECTING THE EXACT SITE

Chain stores and some large independents often spent months in preliminary studies of volume and character of traffic before they select a site.

However, since the master

8 Ernest A. Dench, "Highway Site Considerations of ' New Store Location," Western Plumbing and Heating Journal, 30:20, December, 1959* 9 Pearce Kelly and Kenneth Lawyer, How to Organize and Operate a Small Business (New York: Prentice-Hall, Inc., 1959), P. 18S.

96 plumber has neither the time nor the training for such a scientific study he will have to depend to a large extent upon observation. As a guide to the selection of the best site for a plumbing and heating retail store the check list presented on the three following pages is recommended.

The list is

merely a guide to use in choosing the one site among several that has the best over-all combination of desirable location factors and the fewest undesirable ones. Of course, as has already been stated in this chapter, if the contractor plans to specialize in repair and mainte­ nance, accessibility of the shop to traffic is relatively unimportant; the main consideration should be nearness to the actual work operations. Competition.

Some master plumbers feel that the best

policy is to locate as far from competition as possible, and to particularly avoid proximity to a department store or chain store.

However,

the contractor does not have to run

away from such competitors when he has the kind of sales and and service set-up which they cannot provide. The chain- and department stores are usually found in very favorable locations.

There are many of potential

customers moving about the area every day.

In locating near

such an establishment, a contractor can be assured of the

97 TABLE VI CHECK LIST FOR GUIDANCE IN SELECTING A SITE* (For each of the points below make a check mark In the column showing how it reflects your appraisal of the answer in the first column*)

A.

COMPETITION Number of independent stores of same kind ................. Same block ................. Same side of street • . . . Across the street ......... Number of chain stores • • • • ............. In same block Same side of street . . . • Across the street ......... Kind of stores next door . . ♦ Number of vacancies . . . . . Same side of street . . . . Across the street * . . . . ................. Next door Dollar sales of nearest competitors .................

B.

TRAFFIC FLOW Sex of pedestrians . . . . . . Age of p e d e s t r i a n s ........... Destination of pedestrians • • Number of passers-by . . . . . Automobile traffic count . • • Peak hours of traffic flow . . Per cent location of site: 100 per c e n t ............. .. 90 per cent ............... 80 per cent ............... 60 per cent ............... O t h e r ......................

Poor

Pair

Rating Good

Points Upon Which Site is Chosen

Answer Yes or No Numerical or Qualitative

** Helen G* Canoyer, Selecting a Store Location (Washington, D. C.: United States Government Printing Office, 19l4-o)>

pp. 21, 22*

98 TABLE VI (continued) CHECK LIST FOR GUIDANCE IN SELECTING A SITE

Points Upon Which. Site Is Chosen C.

TRANSPORTATION Transfer point ............. • Highway ...................... Kind (streetcar, bus, subway, a u t o m o b i l e ) ............... ..

D.

PARKING FACILITIES Large enough and convenient ♦ Large enough but not con­ venient ...................... Convenient but too small • • • Inadequate in all respects • .

E.

SIDE OF STREET ...............

F.

PLANT Frontage (iii f e e t ) ........... Depth (in f e e t ) ............. Shape of building (must permit efficient operation) ......... Condition .................. .. Heat ( t y p e ) ............. * . Light ........................ Display space ............... Back e n t r a n c e ............. .. Front e n t r a n c e ............... Display windows .............

G.

RENT OR LEASE

H.

CORNER LOCATION ............. If not, what is it? .........

I.

UNFAVORABLE SITE CHARACTERISTICS Fire h a z a r d s ............... .. Cemetery ..................... Hospital .....................

...............

Rating Answer -t Yes or No 1Toi •uH f O Numerical or o 03 o Pm Qualitative

*

99 TABLE VI (continued) CHECK LIST FOR GUIDANCE IN SELECTING A SITE

Points Upon Which Site Is Chosen I.

UNFAVORABLE SITE CHARACTER­ ISTICS (continued) Industry . . . . ............. Relief office ♦ . . . . . • Undertaking establishment . . Vacant lot--unless it can be used for p a r k i n g ........... G a r a g e s .......... . . . . . • Playground . ................. Smoke, dust, disagreeable odors, etc. . . . . . . . . . Poor sidewalks and pavement • Old and worn-out neighboring s t r u c t u r e s ............. .. . *

J.

NUMBER OF PROFESSIONAL MEN IN BLOCK . . . . . . ........ . ........... • Medical doctors Dentists ...................... Lawyers Veterinarians ............... O t h e r s .......................

K.

HISTORY OF SITE

. . .........

Answer Yes or No Numerical or Qualitative

Rating u h ts. S o •H o o o a.

xoo necessary store traffic.

The real problem is to make the

sales which the chain store is competing for. When people are buying products which represent a considerable investment and are intended to be used for a long time they like to shop around a bit.

They like to

compare products, prices, and the kind of offer each retailer makes.

The location of a candy or cigar store, where the

customer dashes in to make a ten cent purchase, may be advantageous even if it saves the customer twenty steps in going to the competitor.

On the other hand, in the case

of the plumbing and heating contractors store, the proximity of competition actually brings in business. The following is an excerpt from the Merchandising Guide for Plumbing-Heating Contractors: The chain and the d-t-u have as their principal selling point an allegedly low initial price for their goods. However, the mongrel, little-known makes of goods usually offered and the handyman type of service available from these competitors gives the regular contractor an excellent opportunity to break down the strength of such competition by locating nearby. Through actually showing the public recognized leading makes, offering the skill of trained m e ­ chanics, and setting up a direct comparison with such competitors, you can greatly enhance your chances of success. Certainly this kind of operation will prove more profitable than slipping down into a quiet back street where your establishments identity is known almost solely through your telephone listing.*1-0 10 Merchandising Guide for Plumbing-Heating Contractors (New York: Plumbing and Heating Business), p* 19.

101 Other types of competitors are also good traffic builders.

Large stores selling other types of merchandise

attract a large volume of customers,

some of whom will

naturally go into a nearby contractors store. Traffic.

The quality and composition of both auto

and pedestrian traffic have a lot to do with the success of any retail establishment.

Most of the plumbing and heating

contractors feel that pedestrian traffic is of more value than auto traffic. The nature of the traffic is an important factor. The prospective operator should know where the traffic comes from, where it is going, and why it is there.

There is a

vital difference, for example, between a traffic stream largely made up of office workers on their way to and from work and a stream made up of persons on their way to. shop.

11

Chain stores use pedestrian traffic as a direct guide in the evaluation of any site.

The master plumber can use

chain methods in comparing and appraising various possible locations.

Two factors are important:

total pedestrian

traffic during business hours, and the percentage of it that is likely to enter the store. In making traffic counts, the checker should select a few half-hour periods during the normally busy hours of 11 Canoyer, 0£. cit., p* 23*

102 the day*

Only possible customers for the plumbing and

heating business should be counted, with men and women recorded separately*

12

To estimate the probable number of pedestrians who would enter a plumbing and heating store, samples may be made of the percentage of them that enter plumbing and heating stores in various districts. The mode of transportation used by cutomers is im­ portant*

If most of the customers come to the store in

their own cars, a location several blocks from the shopping center that has sufficient parking space is more accessible than a so-called !I100 per cent” location.

Corner locations

with entrances on each street have similar advantages for pedestrian traffic. ^ Transportation *

When selecting a site the plumbing

and heating retailer should consider the type, amount, speed and quality of transportation. A good location may be fixed to some extent by the streetcar .lines.

For example, good locations for plumbing

and heating showrooms are often on the side of the street on which passengers alight from cars coming from the middle class and better residential districts• 12 Kelly, o p . cit*, p* 19&. L o c * cit* lif. Canoyer, op. cit*, p* 29*

103 Transfer points provide good locations for plumbing and heating stores.

In outlying districts it has'been found

many people will not cross a main motor highway.

They

usually go to the nearest good store inside certain traffic . lines.^

Therefore,

the plumbing and heating showroom that

is placed near the center of such a shopping area is best suited to draw trade. If the showroom is located on a highway where it intends to draw from highway traffic,

such factors as accessi­

bility and visibility are very important.

The showroom

should be seen for at least a half block and if there is a traffic signal at the corner the best site is on the far side, which will permit consideration of whether or not to stop. Location in the block.

If it is possible to locate

at a corner and the extra rent is not out of line, most contractors feel that it would be wise to do so.

The extra

window space which is usually available almost doubles the opportunity for pedestrians to see the displayed products. There are also certain disadvantages of a corner location.

Stores catering to customers who require time to

make decisions usually prefer a quieter spot and seek the inside locations.

The fact that inside locations often have

15 IbidT, pp. 29-3 0 .

lolf more space for curb parking is another factor in their favor. By observing the traffic flow it is possible to determine to what extent the pedestrians prefer one side of the street to the other,

11If they do exhibit such a prefer­

ence it is wise not to locate contrary to it, unless the rent differential compensates for the lower sales potential. Leasing.

On the whole, it is much safer for a new

business to rent a building rather than purchase or build one.

It gives the operator an opportunity to get the business

started without having to make a large outlay of capital for the premises, and the responsibilities and cares of ownership are avoided. An investigation of the rental situation in the com­ munity will help the contractor determine what is a fair amount of rent to p^y.

The problem is to keep the rental

costs in favorable relationship to the estimated business volume. The exact amount of rent that should be paid depends, of course, upon individual circumstances.

The figures in

the table on the following page, which were obtained from successful plumbing and heating establishments by the National 15 Walter Shaw and Edith Kay, How to Start Your Own Business (Chicago: Ziff-Davis Publishing Company, 1945), p. 57. 17 Canoyer, o£. cit., p. 31*

105

TABLE VII AVERAGE AMOUNT OF REND PAID BY SUCCESSFUL PLUMBING AND HEATING ESTABLISHMENTS'*

Annual Volume of Business #

Source:

7,500

Average Annual Rental $

180

10,000

2^0

15,000

300

20,000

1^80

25,000

600

35,000

780

50,000

1,000

75,000

1,500

100,000

1,500

150,000

1,800

200,000

2,000

250,000

2,500

Lawrence P. Mutter and Kenneth R. Davis, Establishing and Operating a Heating and Plumbing Contracting Business, Industrial (Small Business) Series No* 3 6 . (Washington, D*C*: United States Government Printing Office, 1946),

106 Association of Master Plumbers, may be helpful. The next problem to consider is the length of the lease.

No contractor will want to be placed in a position

where, after he has built up a good business in a certain section, he may be forced to move because of whims of the landlord or because the rent is unexpectedly raised. Mutter and Davis in their study for the Department of Commerce gave some good advice for prospective contractors: A 5-jear lease should be to your advantage. Be sure that all the terms of the lease are clear and that the owner’s obligations to you as tenant, as well as the rights and privileges that you will exercise in the course of your business, are defined* Have it fully understood in writing which of the ex­ penses of the building are yours and which are the owner’s. Before signing the lease, read it carefully and, if possible, have it examined by a lawyer.18 Recently the graduated percentage lease has become popular.

,fIt provides for a determination of the rent

payable on the basis of a graduated percentage of the gross volume of sales by the tenant.11^-9 Some contractors feel that it is to the advantage of the small operator to arrange for a short-term lease for the first year of operation.

They say that the owner of the

building usually appreciates the fact that to him the value of the lease is dependent upon the ability of the contractor to realize a profit under it.

Therefore, the landlords are

lB—Mutter, 0£. cit., p. 3I4-. 19 Canoyer, o£• cit*, p* 32.

107 willing to agree to an arrangement which will be a workable one over a period of years. The particular factors of each individual case will have to be considered in order to make the proper lease arrangement. History of the site.

Valuable information may be

obtained from studying the occupancy history of the site under consideration.

In some cities an inventory of the

business property is made and kept up-to-date.

In other

towns it may be necessary to get such information from the records at the city clerk's office. In speaking of site history, Kelley and Lawyer wrote the following: At least the recent history of each site under consideration should be known by the prospective retailer before he makes a final selection. Although most Americans no longer believe in haunted houses, experienced merchants know that hoodoo locations do exist. These are sites that have been occupied by a succession of retail failures. Naturally there are logical reasons having nothing to do with the location why the site has not been a successful one at certain times in the past, but there are also the dangers that prospective customers have formed a habit of avoiding the location, or that the next prospective renter will overestimate his ability to succeed where his prede­ cessors have failed.^0 "HoodooM locations, on which many businesses have failed, should be avoided, both for occupancy and as neighbors. 20 Kelley, 0£. cit., p. 200.

108 CHAPTER VI FINANCIAL CONSIDERATIONS OUTLINE OF SUMMARY AND CONCLUSIONS Lack of sufficient capital with, which to start is one of the most important factors leading to failure in small business. Therefore, the amount of capital requirements is the first financial consideration. II.

The amount of money necessary to start a plumbing and heating business will vary considerably, depending upon the various factors of each individual case. Therefore, the question of how the business is to be financed cannot be effectively approached until the following factors have been determined* A.

Amount of rent.

B.

Approximate cost of equipment, furniture, fixtures, tools, etc., and the terms of purchase.

C.

The cost to stock the necessary equipment and materials•

D.

The approximate monthly pay roll.

E.

The salary to be taken by the proprietor or partners•

a

III.

The various sources of capital for financing a small business may be divided into five groups: A.

Friends and relatives.

B.

Partners or shareholders of a corporation.

C.

Banks or other lending institutions.

D.

Suppliers of materials, or customers who prepay their contracts.

109 E.

Miscellaneous sources, such as local capitalists, other businesses, and various governmental agencies.

IV.

It is desirable to establish relations with a banker before it becomes necessary to request for a loan. It is wise to discuss probable needs in advance of bidding on a large job, and give the banker a chance to participate in the decision of taking the work. The banker that has committed himself in advance is more or less morally bound to see the job through.

v.

An understanding of the fundamental principles governing the protection and management of capital is equally as important as the knowledge of where and how to obtain capital. The management of finance includes insurance, credit management, cash planning, and record keeping.

VI.

When credit is extended for small emergency repair jobs the customers should be billed as soon as possible. This should be followed by a systematic follow-up collection routine when necessary. Before negotiating with customers or general con­ tractors for jobs which will incur heavy cash outlays, it is well to make a thorough examination of their financial status and credit standing.

VII.

With the aid of a weekly cash budget the master plumber can plan the use of his cash for current needs with a fair degree of accuracy. A carefully prepared cash budget will reveal possible cash deficiencies as well as the week in which such deficiencies will probably occur, thus allowing ample time to negotiate a loan.

VIII.

Lack of adequate record keeping is one of the major causes of business failures, because without proper records it is impossible to maintain positive control of finances.

CHAPTER VI FINANCIAL CONSIDERATIONS When considering the establishment of any kind of. business enterprise, a person should have reliable information concerning:,

(l) the types and amounts of capital needed;

(2 ) the sources of capital available; and (3 ) the methods of planning the use of capital. Each of these points will be considered briefly from the point of view of a small plumbing and heating contractor with limited capital and experience, who needs broad and basic information that will help him to better understand and handle his financial problems. I.

CAPITAL REQUIREMENTS

The term capital is used here to mean command.over purchasing power, the total of owned and borrowed funds, plus credit accepted.

In their book on How to Organize and

Operate a Small Business, Kelley and Lawyer wrote the following with regard to capital: Capital must be regarded as a business tool re­ quiring skill in its use. Those who have no capital of their own must borrow it and pay a fee in the form of interest. When a businessman considers the use of capital, he bears in mind: first, that its use should yield, with his efforts, an income or profit; seconds that if it is not actually borrowed but is granted in credit instead, he must expect to pay a fee accordingly; third, that the interest rate will increase as decreasing

Ill collateral or assurance of success increases the lender’s risk; fourth, that whether or not his venture is profitable, the use of funds, even his own, is a business expense; and fifth, that if the capital is his own, someone else would have paid him for its use if he had not used it himself.1 Lack of sufficient capital with which to start is one of the most important factors leading to failure in small business*

Some of the beginners lack cash reserves to meet

unexpected expenses during the first few months*

Others

fail to plan all of their expenses carefully and find their funds gone before they have adequately set up their business. Still others go out of business partly because their lack of funds does not allow them to take advantage of cash and 2 quantity discounts* Fixed v s * working capital*

One basic distinction in

the types of business capital relates to the "fixed” versus the "working" character of the capital.

"Fixed capital

consists of assets or properties to be used for several years before the investment is recovered in cash."^

Working capital,

on the other hand, is that portion of investment which is 1 Pearce Kelly and Kenneth Lawyer, How to Organize and Operate a Small Business (Hew York: Prentice-Hall, Inc., 1959)7 -p* 131 • 2 Lo c* cit* 3 James G. Dockeray, Financial Considerations in the Establishment of a New Small Business (Washington, D .C .: United States Government Printing Office, 1959)> P* 3*

112 being constantly .turned from cash to merchandise to receiva­ bles, and back to cash.

For the purpose of this study

working capital will be considered equal to the current assets of the business.^ With regard to the plumbing and heating business, working capital is relatively more important than fixed capital.

As a general rule the beginner should invest the

minimum amount necessary in fixed assets.

By limiting the

investment in fixed as much as possible, the businessman maintains a flexible position which will permit building up c his fund of working capital. Capital requirements vary.

The amount of money neces­

sary to start a plumbing and heating business will vary con­ siderably, depending upon the various factors of each indi­ vidual case.

Kelley and Lawyer made the following statement:

Determining the amount of funds required for starting any business is difficult because many contingent factors usually surround the beginner. The m a n ’s specific business experience, his market contacts, the community’s needs, and the amount of pioneering necessary all affect financial require­ ments. Whereas one man who goes into an undeveloped area with little experience and limited contacts may k-•Bankers, credit men and credit rating agencies usually define working capital as being equal to current assets minus current liabilities. This reflects their interest in a con­ cern’s assets which are not already offset by current obliga­ tions. From an enterpriser’s point of view, however, the entire current assets represent a better measure of his working capital situation. 5 Dockeray, o|). cit., p. 6.

113 require a certain amount of capital, the experienced operator may !fknow the ropes11 well enough to start profitably on half as much.° If a person desiring to enter the heating and plumbing contracting business intends to operate out of his home, he can start on a relatively small amount of capital*

He can

use his home telephone, use his own car, and use the tools that he had before he went into business for himself.

Even

with all of these advantages, he must have a certain amount of cash.

,fThe minimum amount should be equivalent to a two-

months* volume of business.”

Most contractors in the

industry feel that such a beginner can make a good start on as little as $500 in cash.

Although this amount is not

equivalent to the average two-month volume of business, it is probably enough if the operator makes his collections promptly.

The industry average is probably $1,000 a month.

However, even this sum is inadequate if extensive operations are contemplated. The beginning contractor should not assume that he has no business expense just because he does not have to lay out additional cash for such things as rent, automobile, and telephone.

A common cause of difficulty is due to the fact

0 Kelley and Lawyer, o£. cit., p. 132. 7 Gustav Larson, Robert Johnson, and Walter Teller, Selecting and Operating a Business of Your Own (New York: Prentice-Hall, Inc., I9I4-S), P* 233*

114 that many persons who enter the plumbing and heating con­ tracting business are unaware that they have a so-called overhead expense arising from the use of capital on which a o return should be received. Since they own their home and already have an automobile, they charge nothing against the business for the use of the home or automobile. If the contractor does not choose to operate from his own home, and does not have his own tools, an automobile, or a telephone, the situation is somewhat more complicated and' requires some more thought.

It is the opinion within the

industry that, “before entering into the business, 6 months’ rent should be on hand, plus the cost of an automobile or truck, plus the cost of a complete equipment of tools, plus at least $5>0 0 *,,3-So.

126 and Lawyer, in their book entitled, How to Organize and Operate a Small Business, wrote the following with regard to general types of loans that may be secured from commercial banks: Although short-term loans for less than a year predominate, many banks make long-term loans ranging from one to ten years with an average maturity of about five years. These term loans, four-fifths of which are secured by collateral, constitute one of the best ways for the small businessman to supplement his equity capital if he is not among the fortunate few who have interested relatives or friends willing to contribute with r,no strings attached. Bank loans are of two major types, character (or unsecured^ and collateral— that is, secured by certain assets having a value well in excess of the amount of the loan. Although character loans tend to be for shorter periods and smaller amounts than collateral loans, so much depends upon the individual borrower that exceptions to this generalization are easy to find. A person with proved managerial ability, an excellent reputation, and a good business proposition may receive a character loan for several thousand dollars on a long­ term favorable interest basis in the same bank where another, less well-known individual is obliged at the same time to put up collateral worth f>500 to secure a short-term loan of $200 at the bankfs maximum rate of interest.29 The following are various special types of loans which may be obtained from commercial banking institutions: A.

Equipment loan.

An equipment loan may often be

obtained on more favorable terms from a commercial bank than from the equipment manufacturer or supplier* loan may be defined as:

An equipment

an arrangement in which the purpose

of financing is to make possible the acquisition by a business 29 Kelley and Lawyer,

ojd. c i t ., p. 157*

12? enterprise of income producing equipment and in which the financing agency retains title to or holds the lien on the equipment, and the purchaser contracts to pay off the obligation.^ The size of equipment loans depends upon the type and amount of equipment being purchased.

There is no strict rule

regarding the amount of down-payment for equipment financing; however, the down-payment is often at least twice the amount that would have to be deducted from the original value of the equipment to find its resale value after it is installed. Since in this type of loan the title is turned over to the financing agency, a lien instrument must be used to com­ plete the transaction.

This may take the form of a con­

ditional sales contract, under which the sale is not complete and the title does not pass until the last payment has been made; or it may take the form of a chattel mortgage in which the title passes but the financing agency has a right to repossess the equipment in the event of default under the mortgage.

*31

The chattel mortgage is considered to be the

cheaper of the two methods. B.

Accounts receivable financing.

The plumbing and

heating retailer may sometimes have an occasion to make use of his accounts receivable as a basis for a bank loan. 30 Dauten, oja. cit., p. 2l±7 . 31 Ibid., p. 259*

Under

128 such an arrangement the bank makes funds available to him in return for one or a series of assignments of his accounts receivable as collateral for the loan.

His customers may

never know that their accounts were assigned unless they fail to make payments as agreed.

In such a case the bank may

notify the delinquent debtor and assist in making collection. When the bank is considering such a loan it will be interested in the amount and cause of merchandise returns, the average size of individual invoices, and the average age of the accounts. The maximum advance on accounts receivables is usually not over 80 per cent of the gross receivables, and the amount is reduced by any trade discounts given to customers and by the normal percentage of merchandise returns. Field warehouse financing.

It is possible for the

plumbing and heating contractor to obtain a loan secured by a field warehouse receipt.

This method can be used when small

appliance items or plumbing materials are used as collateral. Instead of having the goods transported to a warehouse for such a loan, a field warehouse is established by a bona fide public warehouseman on the premises of the business- establish­ ment.

The purpose of such a field warehouse is to make it

possible for the warehouse company to issue a warehouse receipt which may be sued as collateral for the loan without

129 having to move the goods to a w a r e h o u s e . ^ The advantages of field warehouse loans to the plumbing and heating contractor, and retailer, may be listed as follows: 1#

To repay his loan in an orderly manner through funds made available by the sale of the goods pledged.

2.

To take advantage of cash and quantity discounts and purchase appliances and plumbing materials at the most advantageous times.

3.

To provide adequate capital to handle large contracts when operating costs are expanded and working capital is not sufficient.

If.

To maintain adequate inventories and avoid forced liquidation. Mortgage loans.

Mortgage loans are sometimes made

on the basis of either chattel mortgages or personal or business property or real estate.

Such mortgages may be on

property owned by the business unit or by the individual enterpriser apart from his business.

The mortgage loan is

often used when a business is expanding.

It is recommended

that the business earnings be large enough to cover the mortgage interest at least three times over a complete cycle. 32 For a complete discussion of field warehouse receipt financing see Carl A. Dauten, Business Finance (New York: Prentice-Hall, Inc., 19lfS)> pp. 331 ”^-2.

130 The plumbing and heating contractor who owns real estate and needs increased working capital to expand his operations may obtain the funds by placing a mortgage on the property.

Such a step is desirable when it is definitely

certain that the loan can be repaid out of increased earnings. E.

Other types of loans.

In addition to the above

mentioned loans there are several other types of loans that may be of value to the plumbing and heating contractor. They are: 1*

Unsecured loan, based upon the financial condition of the contractor.

2.

Loans with discounted customers* commercial paper as collateral.

3*

Loans with the contractor’s own paper as collateral, plus the accommodation indorsement of a customer.

lj_.

Loans secured by assignments of contracts, agree­ ments •

5*

Comaker paper, i.e., supported by others.

Relations with the banker.

Some businessmen feel that

it is advisable to borrow from a bank solely for the reason of establishing credit.

This is usually not necessary;

however, it is desirable to establish relations with a banker before any request for a loan is made. It is to the contractor*s advantage if he can impress the bank executives with his knowledge of business conditions

131 in general and the grasp of his business in particular.

If

he keeps them advised of his condition and operations, con­ sults with them freely about various types of commercial credit, and seeks their frank opinion about his business and personal activities, he will be in a favorable position to request a loan when such a request becomes necessary.

The

prospective contractor should talk to a bank official and discuss his new business.

It is up to him to build up his

credit reputation by establishing a checking account and handling his deposits and withdrawals carefully. The following factors should be considered in deter­ mining the choice of a bank: 1.

Is the bank well managed?

2*

Is the banker interested in the plumbing

and

heating business and its problems? 3*

Does the banker stress an attitude offriendli­ ness to small business in general?

Ij..

Is the banker willing to assume a risk, providing there is a reasonable assurance of repayment?

Jj.

Are the barik^s interest rates reasonable?

In order to have an application for a bank loan handled in the quickest possible manner, the contractor should be ready to give the banker the following information: 1.

A history of the business and personal data on the principal owners*

The banker will be interested

in the nature of the business, how and when it was organized, and the personal and financial status of the owners. A description of the property of the business and its effectiveness for the uses to which it is being put. Amount and purpose of the loan.

The banker will

be interested to know how the contractor arrived at the amount of funds needed, and the exact use that is to be made of the funds. A list of the principal merchandise suppliers. This will provide the banker with a check on the payment record of the concern. A detailed set of financial statements, showing clearly the accounting methods that have been followed and how the figures have been prepared. A schedule of uncompleted contracts showing the nature of the work, the size of the contracts, the amount completed to date and the amount remaining to be done. Taxes will be of interest to the banker.

The

amount of accrued earnings, and full provision for income taxes that must be paid should be honestly shown.

133 It is wise to discuss probable needs in advance of bidding on a large job, and give the banker a chance to par­ ticipate in the decision on taking the work.

If the banker

has committed himself in advance, he is morally bound to see the job done • Many banks hesitate to extend loans to a field as full of inherent risks as is the construction industry.

Therefore,

since interest rates are not a large item of cost, and probably the only item that has not shown a substantial increase in recent years, they should be one of the least items to be considered when seeking a loan. Trade financing.

Trade credit is essentially a method

of purchasing materials, equipment or merchandise on credit. Credit from resources for the purchase of materials, equip­ ment, merchandise, and supplies is a widely used type of financing among plumbing and heating businessmen.

It often

provides a major part of the retail plumber’s working capital needs.

The beginner should exercise judgment in selecting

his sources of supply and not become unduly influenced by liberal credit terms. Carl Dauten, in the book entitled, Business Finance, made the following statement concerning the cost of trade credit: The indirect cost o*f trade credit to the businessman may be quite high. He may not always be cognizant of the fact because his bill is usually presented as a net

1314amount and a discount is given if it is paid early. For example, selling terms of 2^/lO-net 30 are quite general. The seller is paying 2 per cent to get his money twenty days before it is due at the net amount. Paying 2 per cent for the use of money for twenty days is the same as paying an annual interest rate of 36 per cent. Another common form of credit term is l$/l0net 30 , which amounts to an annual interest rate of 18 per cent. • . . The small businessman should constantly keep these Interest rates in mind and realize that it is often possible to increase profits by making use of discounts when offered, even if a loan is necessary to do so.33 Miscellaneous sources of funds.

Finance companies are

often used by plumbing and heating retailers.

They are a

good method of financing for home appliance dealers. types of time-sales plans may be arranged.

Various

This may be

coupled with the taking over of the contractor^ collections and the passing upon his credits if he desires to be relieved of all his credit and collection operations. Three agencies of the Federal government have, to some extent, aided in the financing of plumbing and heating businesses:

The Veterans Administration, the Reconstruction

Finance Corporation, and the Federal Housing Administration. In most cases the loans are made by established lending institutions and repayment is insured or guaranteed by the government agency concerned.

Loans guaranteed by the Veterans

Administration have been much overpublicized. called lfGrIu loans.

Such loans are

Loans through the R.F.C. appear to have

33 Dauten, o£. •cit., p. 355*

135 been of greater relative importance and probably have enabledseveral plumbing and heating contractors to secure financial assistance that would not otherwise have been obtained at reasonable rates.

Although in theory this type of financing

should be a boon to all small businessmen, experience so far shows it to be relatively unimportant. III.

FINANCIAL MANAGEMENT

An understanding of the fundamental principles gover­ ning the protection and management of capital is equally as important as the knowledge of how and where to obtain capital. Before the plumbing and heating contractor can take steps to adequately protect his capital he must understand the nature and extent of inherent risks in the plumbing and heating business.

The risks or hazards common to the plumbing

and heating contracting business may be listed as follows: 1 . Non-payment for work. 2.

Technical errors and omissions.

3*

Violations of codes, laws, and regulations.

1}.. Failures in performance. 5*

Extraordinary physical conditions.

6 . Weather. 7 . Public liability. 8 . Unknown underground conditions.

9 * Changes in material prices and labor.

136 Insurance.

It is impossible to eliminate all of the

above risks; however, some of them may be taken care of through insurance coverage*

The subject of proper insurance

coverage for the plumbing and heating contractor is so involved that no attempt will be made here to even enumerate all the available types of coverage or even most of them* The wise plumber will take advantage of the advice, knowledge, and experience of a reliable insurance broker or agent. In the cities where plumbing contractors make street excavations and sewer connections, it is essential that the contractor take out public liability and property damage insurance protecting him against damage suits for accidents which might result from hazardous street openings.

In many

municipalities such insurance is mandatory, and the con­ tractors must also carry such insurance with companies satis­ factory to the municipal authorities. The proper types of liability and property damage insurance also protects the contractor against suits insti­ tuted by people of the public and arising as a result of accidents caused by him or his workmen in transporting materials on trucks or through the use of automobiles*

Such

insurance will further protect him against accidents caused as a result of hazards created within a building through plumbing installation operations there, as well as many other accidents- to the public that might occur, naturally or

137 ■unnaturally, through the conduct of the business. Most of the states have a workmen*s compensation law. The prospective contractor should look carefully into the state laws and local ordinances covering the various phases of employer-employee responsibilities and relationships. Workmen*s compensation insurance provides the contractor protection against damage suits which might arise as a result of accidents to his workmen while in performance of their work. The plumbing and heating retailer will, of course, want insurance against fire on furniture, fixtures, and the merchandise stock. Any small businessman should consider the advisability of taking out life insurance on his partners or key employees for the following reasons: 1*

To prevent liquidation upon the death of the partner owing to the necessity of paying out his interest.

2.

To compensate for the loss of the partner*s services.

3.

To compensate for disruption of the business due to the intervention of the partner*s family or executor. «

If..

To compensate for the necessity of finding someone of comparable ability to replace him.

138 To prevent the shrinkage in value of the business arising from withdrawal of capital. 6.

To compensate for the loss of confidence on the part of creditors, investors, and employees.

Credit management.

lfCredit can be a very profitable

customer service, or it can be the cause of business failure. . . . The user's success or failure will depend on how skill­ fully he uses this instrument• Extension of a certain amount of credit is almost necessary in the plumbing and heating business.

It is not

profitable to ask a reliable customer who orders work done almost weekly to write a check every time a small job is performed.

Nor can the contractor expect immediate payment

for a large-scale job. Prime contractors for whom the plumbing and heating contractor will probably do much of his work are often unable to settle their accounts in full until mortgages have been placed. Any work for the municipal, State, or Federal govern­ ment will often not' be settled until five or six months after the work has been completed. To refuse to handle these types of business is to limit the scope of the contractor's activity and, of course,

35 Kenneth Lawyer, Manual of Small Business Operation (New York: Prentice-Hall, Inc., 1956 ), p. 127 *

139 curtail his income. The beginner will do well to decide on a credit policy before he becomes actively engaged in business.

His ability

to handle credit will be limited by the amount of working capital which he has at hand.

However, by carefully esti­

mating in advance his ability to handle credit, he will know whether he must refuse to accept any terms except cash, and thus risk turning away what might be profitable business,

or

whether he can afford to be fairly liberal in the extension of credit. When determining his credit policy the plumber should weigh both the advantages and disadvantages of extending credit.

Some of the major advantages are 2 1.

Credit tends to make regular customers.

2.

Credit helps to maintain a more personal relation­ ship with the customers, who feel they are a part of the business.

3*

Credit is a factor in building up good will for the business.

i|_.

Credit customers are usually more interested in quality and service than in price.

5*

Credit facilitates adjustments when goods are returned by the customer.

6.

A list of credit customers provides the -business with a permanent mailing list for special promotions.

lij.0 Some of the major disadvantages are: 1.

Credit involves more risk.

2.

Credit requires more capital.

3.

Credit increases operating and overhead expense by adding to the bookkeeping costs and collection costs•

i|_.

Credit customers feel more at liberty to abuse the privileges of returned goods.

Two distinct classes of credit are extended by the plumbing and heating contractor:

one for the smaller jobs,

calling for such emergency repair as cleaning a sewer line or stopping a leak; the other for larger jobs where pre­ arranged terms of payment and a contract have been negotiated. In the case of a small emergency job for a new customer the contractor will usually render the service and trust that the customer will pay him.

It would not be advisable to

spend the time and money which would be required for a pre­ liminary credit investigation in connection with such a small job.

However, by a knowledge of the community, the contractor

will be able to determine roughly from the street address whether there is a great credit risk, since there are certain sections in every town in which people of questionable credit risk seem to concentrate. It is suggested that these small credit customers be billed as soon as possible after the job is completed.

If

the statement is mailed the evening of the day the work is finished, while the matter is still fresh in the customer’s mind, he ,is likely to feel appreciative and under obligation to the contractor for the service rendered.

If the statement

is not mailed until the end of the month the chances increase that the customer will overlook the bill.

Even with prompt

billing on these routine small accounts their average turn­ over usually runs from ij.5 to 60 days. One way to encourage prompt payments is to allow a discount if the account is settled within 10 days.

If such

a discount hastens the settlement of small accounts, the cost to the contractor is certainly warranted. A systematic routine of follow-up for the collection of small accounts is very important.

The following statement

concerning the follow-up routine for overdue accounts was taken from the small business manual on Establishing and Operating a Heating and Plumbing Contracting Business prepared under the direction of the United States Department of Commerce The secret of handling overdue small accounts successfully requires the development of a systematic follow-up routine. Small businessmen, especially if they do their own bookkeeping and clerical work, are prone to allow their accounts to slide for some time and then attempt to rectify the matter by means of a whirlwind collection spree. The results are never satisfactory; often a considerable number of accounts have to be written off the books and the loss of good will is heavy. Furthermore, any such rush to collect

35 Mutter, op. cit., pp. 118-19*

lij.2 money may create the impression that the p l u m b e r ^ funds are short. In a small neighborhood, especially, such gossip can be extremely detrimental. A constant, regular method, or routine, for collecting is allimportant. 36 A discourteous or threatening tone in collection corre­ spondence should be avoided.

Such phrases as, "Unless your

payment is received at once, we will have to take legal action," is both crude and hackneyed, and it puts the contractor on the defensive if the customer calls his bluff. On the slow accounts three polite billing notiees should be sufficient.

Additional collection notiees are

merely a waste of time and postage.

If after three collection

efforts the customer shows no signs of responding, it is time to contact him by telephone.

It is usually better for the

contractor himself to do the telephoning himself,

since if

this task is left to the clerk or bookkeeper, who may not be thoroughly acquainted with the facts, more harm than good may result. 37' When large amounts of credit are extended to individuals for major plumbing or heating installations and improvements or to general contractors constructing new buildings or homes each account should be considered carefully, and time should be taken to investigate their credit'standings. In the case of the individual who is making major repairs or improvements on his property, the personal contact 3b Ibid., p. 119.

37 Ibid., p. 120.

343 with him, general indications with respect to his standing in the community, and an investigation through the local credit bureau should provide sufficient information for judging the advisability of extending credit to him.-^ Before negotiating with prime contractors for jobs which will incur heavy cash outlays, it is well to make a thorough examination of their financial status and credit standing.

The following is a list of sources of credit

information: 1.

The applicant himself.

2.

The local banker.

3*

The local credit bureau.

i|_.

Other businessmen of the community.

5*

The a p p l i c a n t s sources of supply.

After all of the available information on the pros­ pective customer has been collected, the next step is to use that information properly in determining whether to extend eredit. The Retail Handbook gives four tests of universal application to all credit risks. 1.

They are:

Character. The character of the applicant determines the moral risk. Character is judged from the general history of the applicant, his standing in the community, the position which he holds, etc. Character measures the intention or willingness of the applicant to settle his bills.

38 IbidT, p • 121.

1 Capacity# Capacity is measured by the earning power of the applicant. It is a measure of his ability.

3 * Capital.

If the applicant has character and capacity, the chances are that he will have acquired capital. Capital measures the extent of the appli­ c a n t s ability to pay.

ij.. Cooperation. Cooperation is denoted by buying regularly, paying promptly, and concentrating purchases at the place where credit has been ex­ tended. 39 Many times when a prime contractor fails, the sub­ contractors who are his creditors are dragged down financially with him.

Therefore,

the sub-contractor should not only be

careful when agreeing to a contract which will tie up considerable capital, he must also be alert to the operations and dealings of the contractors with whom he is doing business. Some general contractors lack sufficient capital to carry out their ambitions, and as they engage in larger and larger jobs they depend more and more on the sub-contractors to carry the financial burden.^*® Before negotiating the contract find out if reliable money interests are concerned with the project.

Information

concerning the project’s backers will give an indication of the probable success of the undertaking.'

39 Walter S. Hayward, The Retail Handbook (New York: McGraw-Hill Book Company, Inc., 9 p. i^Oi|.. ij-0 if the prime contractor defaults on his payment to the sub-contractor the sub-contractor may be able to salvage a certain amount, depending upon what protection is given in the community by the mechanic’s lien. (See Chapter VIII.)

AS After the contract has been negotiated the contractor should watch the development of the job carefully.

The

Department of Commerce Manual on Establishing and Operating i* Heating and Plumbing Contracting Business contains the following advice in this respect: Keep a watchful eye on the development of the job. Note whether other sub-contractors are being paid on schedule. It will help to be on friendly terms with the carpenters, masons, electricians, and others. If you have a payment due on the 30th and you learn that the mason was -unable to obtain money due him on the 15th, it is time to find out what the trouble is. What protection do you have? Be prepared to take advantage of your mechanic*s lien, if necessary. Re check the contractors or home owner* s assets, as the case may be. Be ready to force collection or withdrawal from the job if you have to . . . If you notice that supply houses are delivering material for the building contractor*s account c.o.d., it would be well for you to look into the matter. Perhaps the contractor prefers to pay in this manner, but it may be the wish of the supply house credit manager. These things, combined with other information,, are signs that you should, be especially diligent in watching your investment.*P It is advocated that the plumbing and heating con­ tractors have access to competent legal counsel in order that matters requiring legal action for settlement can be handled adequately and properly.

Before undertaking legal action the

plumber should determine whether the customer has assets which can be attached if necessary, or whether pressure could be exerted to effect payment without legal action.

Mutter, op. clt., p. 126-27

An understanding of the sound principles governing the extension of credit and collection procedure is necessary if the contractor is to manage his capital in a manner that will secure best results. Cash planning.

The plumbing and heating contractor

must see that pay rolls and bills are met promptly regardless of the reasons or situations which may slow up his collections. This requires cash planning. Some of the plumber* s major problems that require cash planning are pointed out by Lawrence Mutter and Kenneth Davis in the following statement: The heating and plumbing contractor, in his normal business operation is particularly prone to extend and request credit. Jobs in progress represent rela­ tively large amounts of capital. Pay rolls must be met and bills for materials paid. In the case of new construction, a considerable outlay is made for roughing-in materials and labor shortly after the building is started. The installation of the fixtures is one of the last steps to be taken before the building is completed. Therefore, between the first roughingin and the finishing installation, several weeks elapse during which the contractor has no work to perform on the job• If arrangements are not made to provide for a partial payment after the initial work is completed, the contractor must carry the burden of financing the project. To keep men employed it will be necessary to carry on several jobs of this sort at one time. Naturally, good journeymen are not going to wait around without pay for the carpenters, bricklayers, and plasterers to finish their part of the workrl-^ Ij-2 IbidT, p . 86.

347 — ^t-=the time a contract is accepted the terms of pay­ ment must be carefully arranged.

Often a certain percentage

of the total price is paid when the roughing-in work is ■ finished, and the remainder is paid when the job is completed. On a large job it is well to request that payments be made on a monthly basis,

covering the amount expended on the job

each month. With the aid of a weekly cash budget

the businessman

can plan the use of his cash for current needs with a fair degree of accuracy.

The cash budget will help the master

plumber determine whether or not his cash fund is sufficient to finance operating expenses, as well as capital needs. The weekly cash budget is a projection by weeks of anticipated cash receipts and disbursements, showing as of the end of each week the net amount of cash available to finance current operations, payments on indebtedness, and capital expenditures. The cash budget is used to determine the following: 1.

Whether there

is sufficient cash on hand at all

times to take care of anticipated expenditures. 2.

The amount of

cash available to meet bank debt

or other indebtedness. 3.

The amount of

surplus cash available for with­

drawals or further investment. lj_. The necessity

of obtaining bank loans to meet

financial obligations.

iif.8 The first step in the preparation of the cash budget is to estimate cash receipts.

By considering the trend of

cash sales and carefully checking the accounts and notes receivable, the cash receipts may be estimated for some time in a d v a n c e . ^ The next step is to estimate cash disbursements.

They

will arise primarily because of the pay roll, the purchase of materials, repaying loans, interest, and other operating ex­ penses.

Each item of operating expense must be considered

individually.

Depreciation, for example, should be excluded

(unless funded).

For other items such as rent, light, heat,

etc., payment will usually not be made in the week in which the services are actually consumed, but will be paid in a later week. By taking the beginning cash balance, adding the esti­ mated cash receipts, and subtracting the estimated cash disbursements, the cash balance at the end of each week can be projected.

Table IX is an example of a cash budget

prepared on a weekly basis. A carefully prepared cash budget will reveal possible cash deficiencies as well as the week in which such deficien­ cies will probably occur, thus allowing ample time to negotiate a loan. If the business is just starting some consideration must be given to lftime lag” required to build the volume of business, which will occur before the volume of business has reached a break-even point.

TABLE IX CASH BUDGET Showing Anticipated Cash Receipts and Disbursements on a Weekly Basis

1st Week Anticipated Gash Receipts: Cash Sales Collection on Accounts Receivable Notes Receivable Total Cash Receipts Anticipated Cash Disbursements: Pay roll Materials Supplies and Expenses Rent Payments on Loans New Equipment Total Disbursements Summary of Cash Requirements: Cash Balance at Beginning of Period Increase or Decrease from Operations Cash Balance or Deficit

#200 300 150 #850 $250 •300 I4O 70

-

2nd Week Week #200 300

Cumulative $500 800 130

$500

$1350

#230 •600 60

$ 300 ■ 900 100 70

$ 350 800 130 100 200

I 850 ■1700 250 70 100 200

$660

$980

$1370 .

$1600

$ 170

#500 190

I69O 480

$

$ 210

|

#690

#210

Add: Bank Loans Capital Financing Total Cash Bal. at End of Period

3rd Week Week Cumulative I230 $ 630 1400 600 130 $2200 $830

-220

-750 $- 5^0 $1000

$690

$210

$ 14.6-0

-970

150 Assume, for example, that the cash budget indicates a heavy demand for cash during the third week of the month. The demand for cash may be caused by a number of reasons, but whatever the reason, the contractor will know about it in advance and can decide what must be done. Possibly a bank loan is in order.

If the position

of the business is basically sound, there is little likeli­ hood that such a loan will be refused.

By knowing his needs

and taking action sufficiently in advance, the contractor may be able to avoid what might have otherwise proven to be a serious blow to his credit standing. It is difficult to estimate how much cash should be laid aside from profits to make possible the replacement of equipment as it wears out or becomes obsolete.

However,

reserves should be established and kept in the form of cash or other readily marketable securities.

The cash reserves

should be kept in a separate savings account.

This will

avoid its being absorbed by the current business operations.^* Some plumbing and heating contractors put a certain percentage of profits into a reserve account for contingencies. As this fund is allowed to grow over a period of years, it serves as a cushion against the off-periods that come to any business.

It provides a certain amount of insurance against

future difficulties.

44 Mutter, o£. cit., p. 88.

151 Record keepingany business*

Adequate records are essential for

Without adequate records it is impossible for

the businessman to maintain positive control of his finances. Pew small businessmen make the most effective use of records. First of all, many of them fail to keep adequate records; second, they fail to make effective use of the few basic • records they do keep. "Records as a tool of management affect almost every activity.”^

Without' proper records it is impossible for the

modern plumbing and heating contractor to handle "buying, inventory control, credits, and collections, expense control, personnel, and most other aspects of management efficiently. The bookkeeping system need not be complicated, but it must be sufficiently detailed to give the master plumber the essential information that he needs.

The record system

should at least provide the master plumber with the following information: 1.

His volume of business.

2.

His sales of materials and labor.

3.

The amount of money owed him by his customers.

1}.. The amount the business owes to wholesalers others who furnish supplies and services of kinds. ^

Kelley, o p . cit., p. 663.

W * Loc* cit.

and various

152 5.

His bank balance.

6.

The value of his inventory.

7.

The amount of his expense for operating

the

bus ine s s . 8.

The net worth of his business.

9*

The amount of profit he makes from

itsoperation.^

Certain information provided by the accounting records is used for the expense control that is discussed in Chapter VII., and use has been made of various data secured from accounting records in other places throughout this study. Almost every activity of a business is dependent to some extent upon record keeping. Appendix A contains a complete, double-entry book­ keeping system, especially designed for heating and plumbing contractors, together with examples of forms and instructions on how to use them.^"® With the increasing government control of business it has become necessary to keep records for other reasons than management control. W

Basic tax records are mandatory for any

Mutter, 0£. cit., p. 105*

4*® Accounting systems, bookkeeping sheets, and forms particularly suitable for use by plumbing and heating con­ tractors are available through the National Association of Master Plumbers of the United States (Inc.), 917 Fifteenth Street, N. W., Washington, D. C. The systems and forms are distributed on a non-profit basis. They are available to members and nonmembers at the same price.

153 business, regardless of its size.

Of particular importance

to the small businessmen are records needed for federal and state income tax purposes.

Records are also required for

sales, social security, personal property, and other taxes. Lack of proper record keeping is one of the major causes of business f a i l u r e s . ^

Kelley and Lawyer made the

following statement concerning the importance of adequate, up-to-date records for preventing business failures and increasing the efficiency of management: The importance of maintaining adequate, up-todate records is underlined by the fact that surveys have repeatedly shown a large per cent of all small businesses that fail to have been operated with merely a gingle entry memorandum record of transactions or, in some cases, with no records whatsoever except possibly check stubs. Conversely, the managers of successful concerns have placed "complete and accurate records" on their list of "musts" for efficient management.50

w For a more complete discussion of business failures, see Chapter II.

50 Kelley,

. c i t .,

ojd

p. 661}..

CHAPTER VII FIXED AND VARIABLE COSTS CONTROL OUTLINE OF SUMMARY AND CONCLUSIONS I,

An understanding of fixed and variable costs and the break-even concept will aid the contractor in comparing alternative courses of action and forecasting future results. At any given volume of business the contractor is able to predict total expenses by use of the break-even chart. Therefore, the chart may be used as a tool for flexible budget control, and to aid cost re­ duction and control.

II.

By use of the flexible budget principle, the plumbing and heating contractor is able to correctly distribute overhead to each particular job at any given level of business volume. When stand-by costs are isolated from variable costs it becomes a comparatively simple matter to* de­ termine the amount of overhead burden that should be applied to each job at varying volumes of business.

III.

IV.

Under certain conditions it may be profitable for a contractor to accept a job at a lower price than can be figured by allowing a normal overhead and profit. Any price in excess of material, direct labor, and variable overhead provides a ”contribution to overhead and profits’1 by helping to absorb a greater or less part of the fixed charges. The post-war plumbing and heating contractor is confronted with death-struggle competition, high costs, high break-even points, and low margins of safety. Therefore an understanding of break­ even points, out-of-pocket recovery points, and the concept of 11contribution to overhead and profits’* is essential for success.

CHAPTER VII FIXED AND VARIABLE COSTS CONTROL The break-even chart, although seldom used by the small businessman,

can be a highly useful working tool to

supplement and guide his judgment.

Just as the slide rule

is to the engineer, the break-even chart can be a time saving device to help guide the businessman as he steers the course of the business from day to day, from month to month, and from year to year. The purpose of this chapter is to provide a better understanding of how fixed and variable costs, and the break even concept relate to the plumbing and heating business. It often appears that the experienced,

successful

businessman has achieved success on more or less of a catchas catch can basis.

In most cases, however, the truth is

that success was achieved through a basic plan developed with the aid of experience in advance, with adequate checks upon current progress. By way of illustration, if a person sets out to drive an automobile from Los Angeles to Chicago he must operate his machine while it is in motion.

He must be aware at all

times that the speed with which he is traveling requires constant planning for changes in speed, traffic, and road conditions.

He must synchronize his awareness and control

156

to attain his purpose--to arrive at his destination on time, and without accident.

It takes time to apply force to the

controls of the automobile and time for those controls to produce the desired affects.

Therefore,

the quality of his

driving might be judged in terms of anticipating changing conditions and ability to complete the trip successfully and quickly.^ The case is no different when it comes to driving a business enterprise. is moving. morrow.

A business is not a static thing.

It

Thus, things done now will produce events to­

11Therefore, managers must have today the information

needed to show the effect of yesterday and today upon to­ morrow.”2 The movement of the business is influenced by both internal and external conditions.

If the manager ignores

one set of conditions while watching the others or failes to watch each carefully enough, the result is likely to be, and many times is, a business failure.-^ An understanding of fixed and variable costs together with the break-even concept will aid the manager to take an

1 Pred V. Gardner, Variable Budget Control (New York: McGraw-Hill Book Company, Inc., pT Ij..

2 IJbid., p. ij.-5* 3 C. E. Knoeppel, Profit Engineering (New York: McGraw Hill Book Company, Inc., 1933)> p. 8l.

157 over-all viewpoint by relating all internal and external factors to a given end, and enable him to successfully operate the business machine while it is in motion. I.

THE VARIABLE PRINCIPLE

Almost everyone has heard the statement that it costs 5 cents a mile to operate an automobile.

This statement is

only true provided that the automobile is driven a certain number of miles in a year. No car costs 5 cents a mile to operate.

A car costs

some amount such as 2 cents a mile to operate, plus $22 a month.

This statement is true because certain of the costs

of operating an automobile,

such as depreciation, insurance,

and taxes are fixed and have no relationship to mileage. Other items of costs,

such as gasoline, oil, tires and some

repairs are related directly to mileage. For the purpose of simplicity, assume that the total fixed costs for operating a certain automobile is $22 a month and the total variable, or mileage costs is 2 cents a mile.

The table on the following page will provide a

better understanding of how the number of miles operated affects the cost per mile. An examination of the table reveals that since the variable costs are related directly to mileage, constant to mileage as the mileage changes.

they remain

They are fixed

158

TABLE X HOW NUMBER OF MILES OPERATED AFFECTS COST PER MILE

Miles per Month

Fixed or stand-by costs

Variable mileage costs

Average cost per mile Total Costs

Stand-by

Variable

Total

100

$22

$ 2

$24

$ 0 .2 2

$0*02

$0.2!}.

500

#22

$10

$32

$ 0 ,0 4 4

$ 0 .0 2

$ 0 ,0 6 4

1 ,0 0 0

#22

$20

$42

$ 0 .0 2 2

# 0 .0 2

$ 0 ,0 4 2

3 ,0 0 0

#22

$6o

$82

$ 0 ,0 0 7

# 0 .0 2

$ 0 ,0 2 7

i$9 in relationship to the basis of control which is the number of miles run. Further study of the table reveals that stand-by costs at 100 miles are 22 cents a mile, whereas at 1000 miles they are only 2.2 cents a mile.

”Thus stand-by costs

become variable in relationship to the base.”^* This leads to an underlying rule for emphasis, be stated as follows:

it may

”In dynamic costs stand-by costs be­

come variable, and variable costs become fixed in relationship £ to the base of activity.” Stand-by costs.

There are two classes of fixed ex/ They may be classified as follows:

penses.

1.

Non-variable costs of a long-term nature, such as depreciation, taxes, insurance, and interest. These costs are the least controllable items in the category of fixed costs, since most of them continue for a long time, even when operations are completely suspended.

2.

Management-decision stand-by costs, which do not vary directly with business volume, but which change from time to time as a result of decisions usually following a substantial change in the volume of business. These include promotional expenses, manager1s salary, certain office ex­ penses, etc.

4- Gardner, 0£. cit., p. 44 • 5 Loc. cit. 6 For further study of the classification of stand-by costs see 11The Break-even Chart,” Modern Industry, l6:l{.l> December 15, 1948*

i6o Both fixed and regulated expenses are constant at a given time in relation to income.

Therefore, for the purpose

of the break-even chart, these are lumped together as the total constant, or stand-by expense. The following are examples of stand-by costs in the plumbing and heating business: Owner1s salary Miscellaneous office expense Office salaries Automobile expenses or truck expenses Advertising and donations Dues Interest Legal expense Miscellaneous store expense Bad debts and allowances to customers Non-productive labor Insurance expense Rent Depreciation Damaged materials Tool repairs (including purchase of small tools) Compensation insurance Taxes Miscellaneous shop expense

l6l It should be pointed out that depreciation is taken as a stand-by cost only when it is figured on a straightline basis.

7

If depreciation is calculated by use of the Q production method, it will then become a variable cost. Variable costs.

In addition to the costs associated

with those facilities, which must be provided and kept in readiness more or less without regard to the actual volume of business, there are also cost factors which are provided in a quantity proportionate to the current volume of business. Among these, usually, are costs of direct materials,

direct

labor, and certain kinds of supplies, and services* While these cost factors tend to vary with volume, many of them actually do so only when management acts to control them with volume.

For example, labor cost does not

vary with the volume of orders unless the manager in charge takes steps to reduce the number of man-hours paid for in proportion to a decrease in volume of orders, or authorizes additional hours or work or hires more employees in order to

7 Under the straight-line method of calculating de­ preciation, the difference is found between the price of a piece of equipment new and its scrap value. This sum is then divided by the estimated life to arrive at an annual charge. 8 Under the use of the production method of calculating depreciation, the total productivity of a piece of equipment is estimated in terms of the total hours of life or total number of items it will turn out, and then the depreciation is charged on a proportionate basis as the equipment is used.

162 take care of an. increase in the volume of orders.

Thus,

costs which are ordinarily considered to be variable may, as a matter of managerial policy, not always be controlled Q with the volume of business.' In times of a general labor shortage, there is a noticeable tendency in all types of industry to keep employees on the payroll during temporary periods of low volume.

It

is advantageous for the plumbing and heating contractor to maintain a good crew.

Therefore, the contractor may as far

as possible follow the policy of providing steady employment. Under such conditions the entire labor cost at normal volume might be regarded as fixed.

However, for most cases such

costs will be classified as variable, since variation with volume is an objective whieh businessmen would like to attain. II.

THE BREAK EVEN CHART

Since few businessmen are expert at shifting and weighing statistics that reveal the standing of a business, the break-even chart is of value because it serves as a work­ sheet to provide a better understanding of such statistics. The break-even chart can be a highly significant aid to the plumbing and heating contractor in comparing alternative courses of action and forecasting future results. 9 Walter B. McFarland, "The Flexible Budget" Practical Uses of Break-even and Budget Controls, Production series number 186 (New York: American Management Association, 19^-9)* P* 13-

163 Construction of the break-even chart.

The most

familiar form of the break-even chart is a square on which appear two intersecting lines, one representing sales and the other total expense.

The place at which the two lines

intersect is the rlbreak-even!? point.

The break-even point

is, as it sounds, the point where losses turn to gains or where gains* turn to losses. The vertical scale is in terms of dollars, since dollars are the units in which both sales and expenses are recorded.

The horizontal scale is used to reflect volume.

Thus it may be expressed in a variety of ways such as per cent of capacity, index numbers of volume, or volume in dollars.

For the purpose of simplicity the dollar volume

is often used along the horizontal axis.

By use of the same

scale unit on both the vertical and the horizontal axes, the sales (total business volume) line becomes a simple diagonal line running from the lower left corner to the upper right corner of the square. The location of the total expense line requires an analysis and classification of each expense item.

Each i.tem

must be separated into one of the fixed or variable cost groups as discussed on the previous pages. requires careful consideration,

Such an analysis

since the accuracy of this

expense breakdown will determine the accuracy of the chart itself.

l6i|. The finished product from this kind of expense analysis may be expressed in the form of a summary statement similar to the one shown below. JOHN JONES, PLUMBING AND HEATING CONTRACTOR Total income

. .

...................

$10,000

Stand-by costs Stand-by costs of a long­ term nature .................

$1,000

Management-dec!sion stand-by costs of a short-term nature

2,000

Total stand-by c o s t s ......... Total variable c o s t s ........... Total fixed and variable

3,000 6,000

costs

P r o f i t ................................

9 |000 1,000

The total expense line may now be easily drawn as illustrated in Figure X.

The total expense line begins at

the point on the vertical scale equal to the total stand­ by costs (3,000 dollars) and slopes upward at an angle determined by the variable costs (6,000 dollars). The ratio of variable costs to sales (6,000

~

10,000

or *6 ) is the shorthand expression defining the slope of the total cost line.

In this illustration, for each dollar in­

crease in the volume of business, advance 60 cents.

total costs are assumed to

sands

of 1 llj.

(2

13 12

(5

(6 (7

11

8

Break-even point Variable expense Total fixed expense Fixed expense less depreciation, interest, taxes, etc. Variable expense Out-of-pocket recovery point Loss Profit

10

9

8 7 6

5 k

3 2 1

FIGURE 1 BREAK-EVEN CHART

166 The break-even point on the chart in Figure 1 is at a business volume of $7*$00.

This break-even volume may be

checked by direct computation, which sometimes provides a higher degree of accuracy, assuming the preliminary cost analysis has been carefully done.

The calculation is as

follows Break-even dollar volume —

Constant costs

—

$3,000

—

$7,500.

-4-

-4-

(i —

(1 —

variable cost ratio)

.6)

An out-of-pocket expense line may be added as a final touch to the break-even chart.

it may be easily drawn as

illustrated by the dotted line in Figure 1 .

It begins at a

point on the vertical scale equal to management-decision stand-by costs of a short-term nature (total stand-by costs less depreciation, taxes, interest, etc.) and slopes upward parallel to the total expense line at the angle determined by the variable costs. The point at which the out-of-pocket expense line intersects the sales line is the out-of-pocket recovery point.

This point on the chart in Figure 1 is at a business

volume of $5*000. 10 r . Parker Eastwood, ’’The Break-even Chart as a Tool For Managerial Control,’1 Practical Uses of Break-even and Budget Controls, Production series number 186 (New York: American-Management Association, 19^4-9)^ P* 5*

16? Value of the break-even chart*

The value of the break­

even chart rests upon several apparently obvious but too often neglected facts.

For a given volume of business, the

relationship between sales and profits is predictable.

Thus,

for any given volume of business the manager can predict total expenses.

This relationship of expense to volume of

business is constant, since only the variable costs vary directly with the volume of business, while stand-by costs do not vary. The ramifications of break-even points and their possible uses to the plumbing and heating contractor are limited only in degrees proportionate to the thought and time that ean be spent on them.

It is impossible to cover

all of the possibilities in the scope of this chapter; how­ ever, among the specific uses to which the break-even chart may be applied, the following are the more significant: 1.

As a tool of flexible budget control.

2.

As a tool to aid in cost reduction and control.

3.

To show the variable spread above and below the break-even point.

Ij..

To show the future effects of a change in the volume of business.

5.

To show the future effects of a change in the price policy.

6.

As an aid to apply the proper overhead rate to

l68 each job at any given level of business volume. 7*

To provide out-of-pocket information.

8.

As an aid to determine when and why to accept business for volume *s sake.

Distribution of overhead to jobs.

The labor-hour

method is one good way to assure equitable distribution of operating overhead (stand-by costs) to the various jobs. Assume a plumbing and heating business has an over­ head of $1,000 a month.

If the shop has a potential ca­

pacity of lj.00 labor hours a month, and operates at capacity, the overhead-hour cost is $2 .50, or $1,000 divided by !j_00. A job that takes 5 labor hours carries $12.50 of the over­ head expense.

When the overhead per labor hour is known, it

is easy to multiply it by the labor hours estimated for the job and charge the customer the overhead cost on the work. By use of the flexible budget principle, this method of distributing overhead may be used effectively at any given level of business volume.

With the stand-by costs

definitely and correctly isolated from the variable costs, it becomes a comparatively simple matter to determine the amount of overhead burden that should be applied to each job at varying volumes of business.

Obviously the burden

rate of a particular job is reduced as a result of spreading the stand-by costs over a larger volume of business.

169 Inversely, the burden rate of a particular job increases as the total volume of business decreases. If a shop with an overhead of $1,000 a month and a normal capacity of 1^.00 labor hours a month is able to secure additional part-time labor and is able to bring the total business volume to a point that requires 500 labor hours a month, the overhead-hour cost is then only $2.00 or, $1,000 divided by 5 0 0. ^ Whether the additional savings brought about as a result of the increase in business volume will be reflected in the price to the customer or in additional profits to the 1P contractor will depend to a large extent upon competition. ^ Contribution to overhead.

When a contractor estimates

a job he attempts to arrive at a price that will include the costs of labor and materials (variable costs) plus a normal overhead (the jobfs share of stand-by costs) and profit. The question arises frequently as to the acceptance of business at a lower price than can be figured by allowing 11 it is assumed that the increase in labor and the volume of business did not increase the overhead, or stand-by costs. However, due to extra bookkeeping and labor losses as a result of greater volume, the overhead cost is sometimes increased. If the men are not kept working on income-producing jobs for e'very hour paid to them, the contractor is penalized for the amount of the difference. 12 in case of a decrease in the volume of business, competition will govern whether or not increases in the burden applicable to each job will be reflected in the price to the customer or in losses to the contractor.

170 for a normal overhead and profit.

Such action may be per­

missible where the new business is not of a competitive nature that would establish a price precedent, and where the business would be lost if it were not taken at a lower p r i c e . ^ In such cases the following principles based upon the chart in Figure 2 can be adopted to determine the minimum price.which a concern can afford to quote.

After a careful

analysis has been made in order to split the overhead into f!variablel! and ’^ i x e d 11 on a basis of the job being considered, the job may be figured on a basis that anything beyond (1 ) plus (2 ) plus (3 )> that is, material plus direct labor plus variable overhead will help carry the burden of the fixed overhead. Any price less than (1) plus (2) plus (3), that is, material,

direct labor, and variable overhead,

simply means

not only failure to absorb the fixed charges, but actually gives dollars away. 13 It is imperative that any business accepted as a contribution to overhead on a basis of out-of-pocket expenses should not in any way interfere with the concern1s existing market. Every effort must be made to avoid the establishment of a price precedent. This problem is not as inherent in the construction industry as it is in the manufacturing in­ dustry. Small manufacturing concerns are in some cases able to avoid the establishment of a price precedent by privatebranding for a large concern. The problem then becomes, one of a small producer confronted by a large purchaser, and the question of just how much the small producer can safely private-brand without becoming too dependent upon any single market. Private-branding should not be undertaken to the extent that requires undue additional investment.

(1 )

(2 )

(3)

(

5)

•

Materials

Direct Labor

Variable Overhead''**

Fixed Overhead^ Profit

Management-decision stand-by costs of a short term nature.' ^ Stand-by costs of a long term nature*

FIGURE 2 COST CLASSIFICATION 171

172 Any price in excess of this combination provides a contribution to overhead and profits by helping to absorb a greater or less part of the fixed charges. The post war plumbing and heating contractor is confronted with high costs, high break-even points, and low margins of safety.

He is also confronted with death struggle

competition brought about as a result of the many persons who started their own shops following the war.*^

An understanding

of break-even points and out-of-pocket recovery points as well as the concept of Mcontribution to overhead and profits11 is almost essential if the contractor is to achieve success in this present high-level economy. Mr. Parker Eastwood wrote the following with regard to the value of the break-even concept: In this period of economic uncertainty when business managers are forced by circumstances to do some Mblind flyingM they need every possible device to help them keep on their appointed course. The B-E chart will not assure safe landing any more than flying instruments will assure that a pilot will reach earth without a flcrack-up.,f It can, however, be a powerful aid to human judgment-which is all that you can expect of any gadget. . . . If all efforts to reduce the B-E point fail, the chart serves as a constant reminder to management that it is operating on a thin margin of safety.

Death struggle competition arises as a result of firms which are competing on a basis of out-of-pocket costs. A firm may operate on a basis of out-of-pocket expenses for many months in an effort to drive a competitor out of business. Often an uninformed, inexperienced con­ tractor will operate on a basis of out-of-pocket expenses simply because he is not aware of the existence of overhead.

Under such conditions all decisions must be weighed in the light of their effect upon that margin. As a result programs may be undertaken to stabilize the margin and protect it in the event of a business recession. Herein lies hope for the immediate future.15

15 Eastwood, Q£. cit., p. 10.

174 CHAPTER VIII ESTIMATES, BIDS, AND CONTRACTS OUTLINE OP SUMMARY AND CONCLUSIONS I.

The small repair and maintenance jobs are often priced on a time-and-material basis. The cus­ tomer should be charged the going selling price for labor, the cost of materials plus a reason­ able mark-up, and a fee for any special equipment used. These charges must be sufficient to cover the contractor's overhead and profit for the job.

II.

It is risky to take remodeling work on a straight contract basis because of the unknown or un­ predictable factors which are usually found in remodeling work.

III.

With regard to new jobs, the nature and size of the job should be reasonably related to the con­ tractor's financial resources. If there is any ambiguity in the specifications for a job it is far better to find out their meaning in advance, and decline to bid, or bid high, rather than take a chance on a favorable interpretation after the contract has been signed.

IV.

Except in the case of small repair jobs, the con­ tractor should, before submitting the bid, in­ vestigate the credit rating of the prospective customer and his ability to pay. The bid should be submitted in writing, clearly outlining the extent of work to be performed.

V.

Relative to contracts, the contractor should never sign anything he does not clearly understand, never promise to do anything which he cannot accomplish, and seek advice as often as advice is necessary. The mechanic's lien is an important safeguard. The contractor should be thoroughly acquainted with the mechanic's lien law in the area in which he is operating.

CHAPTER VIII ESTIMATES,

BIDS, AND CONTRACTS

The success or failure of a heating and plumbing business is determined largely by the p r oprietors ability to estimate correctly and accurately, submit a bid, and secure a satisfactory contract*

This chapter is a dis­

cussion of the methods of taking these steps* I.

ESTIMATING-

The methods of estimating and applying overhead to jobs was discussed in Chapter VII.

Special attention is

given in this chapter to the problems of estimating materials and labor costs. The decisions involved in estimating the cost of a job are entirely the responsibility of the estimator*

He

must, therefore, predict accurately the amount of time which will be consumed by the workmen in performing the job, and carefully note everything in the way of materials needed. As pointed out in the preceding chapter, the estimator must know what overhead expenses are born by the business and he must determine what profit is necessary for the continuing success of the business. 1 For further study of both the methods of estimating overhead and the methods of estimating labor and materials see Appendix A*

176 Methods of payment.

There are certain basic methods

of payment that have been developed for various types of plumbing and heating jobs.

The contractor should become

familiar with them before attempting to estimate and bid on a job. The lump-sum straight contract method is in common use.

The price quoted covers direct expenses, overhead,

profit, and everything involved in handling a complete in­ stalled job, and the customer knows that is the limit that he will be charged. A cost-plus job is one in which the customer is charged the actual cost of the job to the contractor, plus a certain percentage of that cost for overhead and profits. The cost-plus method is similar to the time-and-material method, in which the customer is charged for the actual cost of labor and material that goes into the job, plus a reasonable percentage. S*naT 1. repair jobs.

The small repair and maintenance

jobs are often priced on a time-and-material basis. The first step is to establish a selling price for labor on an hourly basis.

It is difficult to charge more

than the prevailing rate in the community, therefore, the prevailing price per hour charged in the local vicinity will be a guide to follow.

177 A higher price must be charged for materials used op. small repair jobs than for materials used on larger jobs where a substantial amount of material is used.

Many con­

tractors in the industry sell such small items as nuts, screws, tank balls, and washers for at least double the cost of the article. A charge should also be made for any special equipment that is used in connection with a job. Many contractors establish a minimum service charge, which is usually not less than the labor selling- price for one hour• Large time-and-material jobs.

lfWhen larger jobs are

done on a time-and-material basis . . . the mark-up on the

2

materials might be somewhat reduced.”

However, in no case

should the mark-up be less than sufficient to cover the operating expense plus a reasonable profit. The labor charges on the larger time-and-material jobs should be the regular hourly selling price, as on the small repair jobs, since supervision must be provided and there is always some loss of time.

2 Lawrence P. Mutter and Kenneth R. Davis, Establishing and Operating a Heating and Plumbing Contracting Business Industrial (Small Business) Series No. 36, (Washington D. C.s United States Government Printing Office, I9I4-6), p. l\.7 .

178 Estimating remodeling jobs.

It is risky to take

remodeling work on a straight contract basis because of the -unknown or unpredictable factors which are usually found in remodeling work.

However, the customer may wish

to have the job performed on a straight contract basis to be certain that the charge for the job will not exceed a definite sum.

If this proves to be the case, the contractor

must make allowance for the unseen extra work which he may encounter.

Consideration should be given to the possibility

of having to make alterations in the old work under the floor or in the partitions. After the allowance for unpredictable factors is made the estimate is made in the same manner as for new work, discussed on the following pages. Estimating new jobs.

The nature and size of jobs

should be reasonably related to the contractors financial resources.

Some diversification of risk is desirable,

however, ”there are a number of other factors besides the o rule of thumb limiting work to ten times working capital. The specifications for the job should be clear, definite, and reasonably possible to meet.

If there is any

ambiguity in the specifications it is far better to find out their meaning in advance, and decline to bid, or bid 3 ffThe Banker and the Contractor,ft Western Plumbing and Heating Journal, .3 0 April, 19^-9«

high, rather than take a chance on a favorable interpretation after the contract has been signed.^* ,fThe bidder, of course, must know the costs of the various operations involved in the job— and these must be up-to-date costs.

Without accurate cost figures the con­

tractor has no basis for bidding. Another factor influencing bidding is the current and future trend of material and labor costs.

It would not

be advisable to bid on the assumption that costs will be much below those now existing. ffDangerous, too, is to permit competition, real or fancied, to influence bidding.

Better to lose the job than

take it at a figure which allows no margin for profit.11 After consideration has been given to the laws and regulations governing the installation of plumbing in the local community, the first step in estimating the cost of a job is to estimate the cost of the work that will be per­ formed first— the roughing-in procedures.

The contractor

should check with the municipal sewer department or local board of public works to obtain information concerning the location and depth of the main sewer line.

At the same time

180 it will be convenient to inquire about the sewer entrance fees.7 If the installation is to be made in a rural community the contractor will be concerned with running the waste line to a septic tank or cesspool.

He may be required to install

the septic tank and piping. It should be pointed out that the type of material which is encountered in excavating will greatly influence the cost of excavating*

Consideration must be given to whether

the ground is easily dug sand, gravel, hardpan, or rock. frequently, both the sewer pipe line and the water

8

line can be placed in the same ditch at different levels.11 After the steps necessary to estimate the outside work have been completed, the next step is to examine the proposed work inside the building.

The building specifi­

cations will usually give the type and make of fixtures to be used* Use of estimate sheets.

In compiling the estimate it

is an excellent plan to use an estimate sheet. tration in Appendix B. )

(See illus­

By using such a form the contractor

is less likely to fail to consider some part of the job. i

7 gome communities require a fee for each new entrance into a sewer main. 8 Mutter, o£. cit*, p* 50.

181 Many types of estimate sheets are available from various sources.

They are all printed and ready for use.

To become a consistently accurate

estimator, the

con­

tractor must constantly rely on past experience even more than shrewd judgment.

Cost records of each job may be kept

on file for figuring on other jobs.

For example, after

arriving at the total price for a new installation,

the

contractor may look up his price on the last similar job. If there is a great discrepancy, he can check items on the new job against those of the old to see if he can account for the difference• Estimating labor cost.

"Heating and plumbing con­

tractors have always found it rather difficult to estimate the amount of time that will be consumed

by workmen in

performing a given assignment."^

and Davis, intheir

Mutter

study for the United States Department of Commerce made the following statement concerning the determination of labor costs: The amount of time a job will require is depen­ dent largely on the construction of the building, the type of floors, the location of the fixtures, the amount and type of equipment, and the skill of the workmen. Weather seriously influences the progress of construction. Extreme heat fatigues workers, while severe cold hinders them. It is not implied that a large number of failures can

9 Ibid.T p* 52.

182 be attributed to weather conditions, but the season of the year in which the work is to be performed should be considered in arriving at your estimated labor cost. Most contractors find that the best basis for estimating labor on a moderate-sized job is to assume that a journeyman and helper will work as a team, or, in the case of larger jobs, that several journeyman-helper teams will be used. To arrive at your final labor estimate you should go over each part of the work and calculate, on the basis of your past experience, about how much of the work could be accomplished each day until completion. 0 The beginners attempts to estimate labor will naturally, be uncertain, however, he is not likely to go too far wrong if he uses good judgment and allows reasonable lengths of time for each step of the work. II.

BIDS

A bid is a firm offer to do a particular job for a specific sum of money.

When the bid is submitted, the con­

tractor is under obligation to perform the work and when the bid is accepted the customer assumes an obligation to pay. As has been stated before, the contractor will usually be obliged to extend credit.

Before submitting the bid, he

should, therefore investigate the credit rating of the pros­ pective customer and his ability to pay. 10 Ibid., pp. 52-53*

(See Chapter ¥1.)

183 Oral and written bids.

It is obviously impracticable

to file written bids for small repair jobs, however a written order should be approved for the work that is to be performed before the job is undertaken.

If the work is to be priced

on a lump-sum basis, the total price should appear on the order.

If the work is to be done on a time-and-material

basis, it is customary to specify the rate of pay per hour and leave the charges for material open, to be filled in as the job progresses.^ On any jobs other than small minor repairs, a written bid, clearly outlining the extent of work to be performed, should be submitted.

!fIf there are any indefinite terms, or

12 contingencies, these should be clearly set forth in the bid.”

After the bid has been prepared, it is well to discuss it with the customer to insure that it is thoroughly under­ stood. Clauses on specifications.

When plans and written

specifications are available for the job, the plumbing and heating contractors bid customarily contains a clause to the effect that his work will conform to the plans and speci­ fications of the job.

This necessitates a careful examination

of the plans and specifications before the estimate is completed. 11 Ibid., p. 6 3 . 12 Log* cit.

III.

CONTRACTS

A contract, as it relates to the plumbing and heating business, !tis an agreement on the part of one person to perform some piece of work for a consideration received from another. Guiding principles.

The plumbing and heating con­

tractor will do well to follow the following principles relative to making contracts. 1.

He should:

Never promise to do something he has no intention of doing or which is beyond his capacity to ac­ complish.

2.

Never sign anything that he does not clearly ■under­ stand. Seek advice as often as advice is necessary.

ij..

Retain the services of a lawyer if the amount of money involved warrants the expenditure.

Contract forms.

Special contract forms for the plumbing

and heating contractor may be obtained from the National Association of Master Plumbers, Inc., 1105 K Street N. W. Washington 5> B. C., or from the Western Plumbing and Heating Journalj 3&65 S. Vermont Avenue, Los Angeles 7 > California.

3-3 Ibid., p. 65.

185 For an example of a Uniform Contract Form for the plumbing and heating industry see Appendix C.

No contract

form can be printed and generally distributed which will serve the needs of every contractor under all circumstances. If the contract forms contain some conditions that the con­ tractor does not like, it may pay him to engage the services of a lawyer to draw up a form to suit his particular needs. Many times revisions are made in the accepted plans for heating or plumbing installations.

”Any changes in,

additions to, or subtractions from a job undertaken during the life of a contract impair the legality of the contract. "ii* In fact, generally speaking, any change in the terms of a contract brings about a situation wherein the contract no longer exists in the eyes of the law. The United States Department of Commerce manual on Establishing and Operating a Heating and Plumbing Contracting Business presents' the following: The inexperienced heating and plumbing contractor may undertake to make changes, additions, or subtractions, under oral instructions from the owner, without having a clause incorporating such changes inserted in the contract covering the job. Each change or addition requested by the owner, his agent, or architect should be in writing. The contractor, before accepting the instruction and performing the work, should make an estimate of the amount of work involved and either add to or sub­ tract from the contract price as the circumstances

1I4. IbidT, p. 69.

186 warrant* In no instance should you accept any oral instructions to deviate from the conditions of the plans or specifications; the terms and con­ ditions to which you agree must be in writing. If you fail to follow that procedure, trouble is in­ evitable .15 Often, contracts prepared by prime contractors or owners for plumbing and heating work contain a ^penalty" clause.

Such a clause sets forth stipulations with respect

to the amount of money the plumbing and heating contractor forfeits if he fails in his performance, usually at some specific terminal date.

The master plumber should read these

clauses carefully and make every effort to avoid becoming involved in legal difficulties.

Often times penalty clauses

can be rewritten to take care of possible contingencies which are beyond the plumbing and heating contractors control. Mechanic*s lien.

The provisions of the mechanic*s

lien law applicable to the local area Is one of the first things the contractor should learn when he enters business. Dillavou and Howard, in the text, Principles of Business Law have prepared a good definition of mechanic*s lien laws.

The definition reads as follows:

Mechanic*s lien laws are statutory laws making possible liens upon real estate, where such real estate has been improved by construction work or otherwise. The purpose of such legislation is to

15 Loc~cit*

187 protect the laborer and materialman in the event of the insolvency of the owner or the contractor. The laws of the states vary slightly in the pro­ tection accorded and the procedure required to obtain i t . ^ Anyone to whom a distinct part of the contract has been sublet, has a right to a lien. the plumbing and heating contractor.

This, of course, includes However, there are

certain formalities required to perpetuate the lien.

The

master plumber must be aware of them and make the lien a matter of record before the lien rights expire.

The filing

of a mechanic’s lien in the customary fashion does not imply that there is doubt in the contractor’s mind as to the re­ sponsibility of the owner of the property in which the work is to be done, and it should not be interpreted as such. The following statement was taken from the Principles of Business L a w .

It provides important information concerning

the formalities required to perpetuate the lien.

It reads

as follows: Under the law of most states the contractor’s lien arises as soon as the contract is entered* into. In order to protect the contractor against claims of innocent third parties who might purchase the property or obtain a mortgage thereon, the law provides that the lien must be made a matter of record within a certain time, usually four months after all work is completed. As between the owner and the contractor, however, the time limit may be extended somewhat beyond this period. 15”Essel R. Dillavou and Charles G. Howard, Principles of Business Law, Second Revised Edition (New York: PrenticeHall, Inc• , l^Ifo), p. l\.6$.

188 To establish their liens, the subcontractors— materialmen, laborers, and others— must, within a relatively short period of time after they have furnished the last of their materials or labor, either make the liens a matter of record, or serve written notice thereof on the owner, according to the particular state statute. The period most frequently mentioned by the various states is sixty days.3-7 The California State Law holds that where a valid notice of completion of the work of improvement as a whole is filed for record, an original contractor has sixty days, and all other claimants (plumbing and heating contractors) have thirty days, after the date of filing such notice within which to file claims of lien. If no notice of completion is filed, then all claimants prime contractors, subcontractors, materialmen, and laborers— have ninety days after completion of improvement as a whole within which to file their claims of lien.

(California Land

Titles, 19i4.0 Ed., Sec. 3 6 .09) Public property or public buildings are not subject to a mechanic*s lien.

The claiment’s security is by way of

a bond required by statute on public construction work. (Mayrhafer v. Board of Education, 89 Cal. 110.) The mechanic’s lien is an important safeguard.

The

plumbing and heating contractor should be thoroughly ac­ quainted with the mechanic* s lien law in the area in which he is operating. 17 Ibid., p. If.67.

189 CHAPTER IX BUILDING THE BUSINESS OUTLINE OP SUMMARY AND CONCLUSIONS I.

The master p l u m b e r ^ advertising should be geared to the seasons, and when possible, tiedin with local news events, such as home shows, county fairs, etc.

II.

Price advertising will usually pull better than copy without prices*

III.

IV.

V.

The steady pull of regular week to week advertising is much better than occasional spot advertising. A customer prospect file will provide the plumbing and heating contractor with a selective mailing list through which he is able to concentrate his sales efforts only on live prospects. The master plumber should try, not to sell the plumbing fixtures themselves, but to sell the convenience and satisfaction that the plumbing fixtures will provide.

VI.

The master plumber must create a desire in the minds of the customers for the products and services that he has to offer, and he must con­ vince them that he is the person best qualified to satisfy that desire.

VII.

Heating and plumbing equipment should be sold in keeping with the economic status of the customer. Overselling the customer will create ill will.

CHAPTER IX BUILDING THE BUSINESS This chapter deals with some of the methods of adver­ tising and salesmanship that may be used by the plumbing and heating contractor to build business and increase profits, I.

ADVERTISING

Two types of advertising are recognized; first, selling the business; and second, that

selling the products and services

the business has tooffer.

Both

arenecessary,

although

the plumbing and heating contractor will usually devote most of his limited advertising funds to the latter type, since it is the direct action type. Selling the business and selling the products and services are in many respects similar.

Some of the business

attributes that advertising sells are: Services

Prestige

Integrity

Location

Brands carried

Size

Courtesy

Price

Credit terms

Quality

Some operators attempt to set themselves in the public mind as possessing all of the above virtues, however, it is usually best to stress one or two at a time.

191 It is quite possible to tie-in advertising with seasons and local news events of the community.

Walter J#

Lutz, a master plumber at Harrisburg Pennsylvania, has developed a three-point program for advertising that sells. In his-own words, it is as follows: Seasonal: We slant most of our newspaper and radio advertising to the products most needed during the each appropriate season. For example, during the first cool days of autumn, our ads lead off with the direct question, ’’Has your heating system been put in shape for the winter?’1 Other appropriate themes are used during the remaining seasons of the year, including Christmas, when the ’’family gift” angle is stressed. As a result, there is no chance for townsfolk to for­ get their seasonal plumbing and heating needs.

2 . Tie-in: More ’’mileage” for the advertising dollar-and increased sales--are obtained by using every opportunity to tie-in our advertising with local news events, editorial comment, manufacturer and utility ads, home shows, country fairs, and others. We often provide the editor of our local paper with a news release on some piece of equipment being featured in our advertising. More often than not, the news release is published as an editorial item--at no eost to us. Price: We have discovered that price advertising will pull much better than copy without prices. There are many forms of advertising media that may be used effectively by the plumbing and heating contractor. In small and moderate sized cities, contractors find it profitable to advertise in their local papers in developing an effective sales approach to the public. 1 Walter J. Lutz, ”A Three-Point Program for Advertising That Sells,” Domestic Engineering, 175-111> May, 1950.

192 ‘Local newspaper advertising.

Well-planned and

sensibly-presented newspaper advertising is of great value to the plumbing and heating contractor.

Newspapers have

become more alert in servicing the contractor and now offer a variety of services that were not available in the past. The newspaper publisher will even assist the contractor in setting up his advertising budget. The first step in starting an advertising program is to lay out an over-all program.

The market potentialities

must be analyzed as well as the services to be offered by the contractor. The next step is to lay out a budget.

It should be

based either on market potentialities or on past business, both of which are sound methods. funds to carry out the program.

It will provide adequate Seasons should be considered

and the advertising adjusted and scheduled to meet the varied demands of the public during a given period.

Merchandising

methods will have to change with the time of the year.^ Labor availability should be projected into the plan so that the contractor can deliver the type of service that the customer will expect. 2 A. H. Schroeder, ’’Getting Started on a Local Adver­ tising Program,’1 Merchandising Guide for Plumbing-Heating Contractors, (A reprint of articles which originally appeared in Plumbing and Heating Business), (New York: Plumbing and Heating Business), p, 29•

One© til© budget has been determined, the mechanics or copy preparation and placing can be handled on a month-tomonth basis,.

An up-to-date newspaper will be able to help

with copy material and illustrations of merit.

The contractor

is also often able to secure illustrations of definite items as well as copy material from the various manufacturers whose products he sells. In carrying out an advertising plan it is well to keep in mind that every advertisement need not be of equal size. It is well to vary the size with the pre-determined job to be done,

’’Proper timing of service copy and merchandise copy

is e s s e n t i a l . ”3 tageous.

Oftentimes a combination of both is advan­

’’Regular, week to week advertising is a must—

perhaps smaller some weeks and larger in others--but regular advertising is essential.”^* Mr* A. H. Schroeder, the advertising manager of the Pond Du Lac Daily Gommonwealth Reporter of Wisconsin, gives as a summary, seven simple steps to get started in local newspaper advertising: 1,

Decide what you want to sell*

2,

Establish an annual ad budget.

3*

Divide the money you will spend by the number of ads you want to run, adjusting for size of ads in various seasons.

194 2j.«

determine a subject for each ad.

5.

Call upon the newspaper for aid in writing, illustrating and arranging the ads.

6.

Supplement your ads with store window, truck body, and possibly direct mail publicity on the same themes.

7.

Do not get discouraged. Let the campaign run until budget is exhausted before trying to determine the resuits.5

Other advertising media.

Other advertising media

should be used along with newspaper advertising.

The use

of radio, classified telephone books, signs, handbills, and direct mail for advertising purposes may all be used to good advantage. By making use of "wasted" advertising space that has previously been going unused, many contractors have found that they are able to increase their advertising coverage without additional costs. The contractor may take a small part of his letter­ heads to tell the store of his services.

He can use bill­

heads and invoice forms to sell additional work to the customers who receive his statements.

By using the sides

of his trucks, cars, and other rolling equipment, the contractor may tell his sales messages to the general public.

6

£ Ibid., p. 26. 6 For further study of this type of advertising see David Markstein, "Increase Your Advertising Coverage Without Increasing Cost," Western Plumbing and Heating Journal, 30:26, 7I4.-76, December, 19^4-9-

195 II.

CUSTOMER PROSPECT PILE

One of the best methods of building business is to keep a customer prospect check system.

The following is a

description of a customer prospect system devised by Jack Reeves, editor of the Western Plumbing and Heating Journal, The system is designed to provide valuable sales information on prospective customers for the plumbing and heating contractor. The first step is to make out a card in the name of the customer or prospect, and then list on the card all available information.

Actual customers* cards should be

filed alphabetically in one space and prospective customer cards should be filed in another.

Assume it is a customer

for illustration, and refer to Mrs. John Doe job ticket No. 61^5, Illustrated in Figure 3.

The ticket shows the date;

the nature of the work, which was, cleaning sink waste, repairing toilets in the south and main bathrooms, and're­ pairing the sink faucets; and the total price of the work, which was $2 7 .11-8 . An examination of Figure I4., which is the back of the job ticket, shows that the service man has turned in a fairly good record of this customer’s plumbing and heating appliances. This may seem like a lot of work for the service man, but it actually takes very little time.

It would perhaps be

2

3

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5

6

7

8

10 ii

9

12

13

14 15

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TR U C K S

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(ynTsT^s}Jr*~yy OTHER EXPENSES

Selling Price ($72.19 -h 90 and X 100) ............................ $80.21 Less: C o s t .................................................................................. 72.19 Profit ($80.21 X 10%) ................................................. $ 8.02 The 90% divided into Total Cost is obtained by subtracting from 100% that percentage of profit which is desired. If a profit of 15% on selling price is desired, then the Total Cost (Direct Cost plus Overhead) should be divided by 85% to obtain the selling price.

m

///£— TOTAL

Total Direct C o s t s ................................................................... $49.77 Overhead ($49.77 X 4 5 .0 4 % ).............................................. 22.42

17 PULLK R BA LL S

On the Job Record of Job No. 2 we have computed separate selling prices on material, labor and truck trip. The same selling price would be obtained if the calculation was made only on the Total Cost due to the fact that the same percentage of profit has been used. It may be desirable to obtain varying margins of profit on the different items of Direct Cost, in which case the total selling price should not be less than if it were computed on the basis as previously explained. The Cost Recap is then completed and posted to the Sales and Cost Record.

PIO LBAD

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CLO SBT REP.

FA UC E T RBF.

C U S T O M E R 'S S IG N A T U R E

9

OB Number 1 illustrates one method of filling out the Job Record. That is, by using the cost column and the selling column for each item while Job Number 2 illustrates the method of using the cost column only for the individual item and selling column for the total selling price only. Either of the two methods will give the desired results.

J

Job N um ber 3. Jan. 7. E. B. Harris, 43 Stall Street, signed a contract to have a number 4 Heater installed. Contract price $385. After completing the Job Record and listing all materials and filling in Cost and Selling price, etc., the cost recap shows the following: Material, $192.70, Labor, $56.70, Overhead, $112.78, Truck trips, $1.00, Selling price, $385.00, Gain, $21.82. Trace the posting of this Cost Recap in the Sales and Cost Record.

Job Num ber 4. Jan. 8. James Summers, 24 Clark Street, phoned in to send a plumber to repair toilet and sink. The workman after having completed these repairs turned in the Workman’s Order to the bookkeeper. A fter. listing the Material and Labor, filling in costs and selling price, cost recap is made out, revealing the following information: Material, $3.30, Labor, $4.00, Overhead, $3.40, Truck trip, 25c, selling price, $12.40, gain $1.45. Trace the posting of this cost recap in the Sales and Cost Record.

Job Num ber 5. Jan. 9. Secured a contract from John Smith for the plumbing in his residence at 120 Main Street. Contract price $861.00. The architect was C. Moore. Two job records will be used in completing this contract. One for roughing-in all wastes and vents and the other for setting fixtures and completing the contract. After having completed the roughing-in, the workman re­ turns the Workman’s Order to the bookkeeper who transfers the information which the workman has put on the Workman’s Order to the Job Record and then fills in costs; then makes up the cost recap. The cost recap shows the following: Material, $116.10, Labor, $64.90, Permit, $5.00, Incidental expenses, $.35, Truck, $1.00. Direct cost, $187.35. Overhead, $84.38, Selling price, $301.92. Gain, $30.19. Trace the posting of this cost recap in the Sales and Cost Record. In estimating the total contract price of $861.00 we have used the method and rates as described in Job No. 2. The selling price of $301.92 for the roughing-in was determined in the same maimer after the Direct Costs were known.

Job Num ber 6. Jan. 11. Mrs. N. Heins, Colonial Apartments, asked us to send the plumber to repair the sink, lavatory and bath faucets. The workman having completed these repairs turns the Workman’s Order over to the bookkeeper. The bookkeeper lists the material and labor, fills in cost and selling price, then makes up the cost recap, which shows the following: Material, $3.28, Labor, $5.50, Overhead, $3.95, Selling Price, $14.25, Gain, $1.52. The bookkeeper then posts the cost recap to the Sales and Cost Record. Trace this posting.

Job Num ber 7. Jan. 14. Wm. Jones, 20 South Street, places his order for the installation of a closet combination.

We believe the two illustrations given will suffice for instructions on using the Job Record. Therefore, the remaining jobs will contain only the Cost Recap, the posting of each of which you should trace through the Sales and Cost Record.

The Job Record and Workman’s Order is made out in the usual way. The workman after having completed the installa­ tion returns the Workman’s Order to the bookkeeper who com­ pletes the record of the material and labor and makes up the Cost Recap. The Cost Recap shows the following: Material, $60.00, Labor, $6.00, Truck, 50c, Overhead, $29.95, Selling Price, $110.00, Gain, $13.55. These amounts are next posted from the Cost Recap to the Sales and Cost Record. (See Job No. 7 in the Sales and Cost Record.)

Job Num ber 8. Jan. 16'. Filled order from Jack Johnson, 24 North Street, to install kitchen sink. The Cost Recap in the Job Record having been completed reveals the following information:- Material, $48.00, Labor, $6.00, Truck, 25c, Overhead, $24.43, Selling Price, $87.50. Gain, $8.82.

Job Num ber 9. Jan. 18. Received contract from Ray Winters, 46 Spring St., to install new boiler. Contract price, $410. Work having been completed and the Workman’s Order turned in to the office, the bookkeeper completes the Job Record and makes up Cost Recap. The result of this recap is as follows: Material, $238.00, Labor, $31.00, Truck, $1.00, Over­ head, $121.61, Selling Price, $410.00, and the Gain, $18.39. This cost recap is posted to the Sales and Cost Record. (See Job No. 9, Sales and Cost Record.)

Job Num ber 10. Jan. 21. This Job Record and Workman’s Order is made up for setting the fixtures and completing the John Smith con­ tract, the roughing-in of which was done on Job No. 5. After the workman has returned the Workman’s Order, the bookkeeper completes the listing of the Material and Labor on the Job Record putting in the various costs after which he makes up the Cost Recap. The items on the Cost Recap are as follows: Material, $338.08, Labor, $33.75, Truck, $1.00, Over­ head, $167.92, Selling Price, $559.08, Gain, $18.33. In arriving at the Selling Price ($559.08) we simply subtract what has already been charged to John Smith on Job No. 5 ($301.92) from the Contract price of $861.00, which leaves the amount to be charged to complete the contract price (559.08).

Job Num ber 11. Jan. 25. When the new books were opened there was $300 of material and $50 productive labor in unfinished jobs. This was James Summers Job at 24 Clark St. Therefore, a Job Record is made for completing this contract. The contract price is $560. Due to the fact that all the material was on the job and practically all the work done, the Workman’s Order was not used on this job but the material was listed on the Job Record and the Cost Recap made up in the usual way. The result of the Cost Recap was as follows: Material, $300.00, Productive

10

Labor, $65.00, Truck, 50c, Overhead, $164.62, Selling Price, $560.00, Gain, $29.88.

Job Num ber 12. Jan. 28. Cash sales made from the store. All sales for cash are listed on a Job Record and when the Job Record sheet is filled, one Cost Recap is made for the total cash sales on the sheet. The Cost Recap for Cash sales on Job No. 12 are as follows: Material, $15.60, Overhead, $7.03, Selling Price, $24.00, Gain, $1.37. This Cost Recap is posted to the Sales and Cost Record in the same way as Customers Accounts and treated just as though it were “Mr. Cash.” By handling it this way all sales are kept together in the Customers Accounts columns. Instructions for posting from the Sales and Cost Record will be explained later.

Job Num ber 13. Jan. 28. Ray Winters, , 46" Spring St., complained about the new boiler installed in his home on the 18th. The workman was sent out to check over this new boiler and see that it was working all right. As there was no material used all that is recorded on the Job Record and Workman’s Order is Uie time put in by the workman which according to the Recap was $2.00 and Overhead of 90c. Now as this was not chargeable to Ray Winters it becomes a loss and is entered as , a*loss in the Cost Recap section. It is then posted to the Sales Cost Record in the Productive Labor column and Overhead column and in the Gain column but the $2.90 placed in the Gain column is written in red ink which shows that it is a loss. (W e have illustrated the red ink entry by using par­ enthesis around the $2.90.) Now in ascertaining the total gain, this $2.90 red ink item will be deducted from the total of the black ink entries in the Gain column.

Job Num ber 14. Jan. 29. Arthur Brown, 18 State Street, engaged us to install all new fixtures in his bathroom at a contract price of $490.00. This work was not completed until the following month and therefore will not be entered in the “Sales and Cost Record” in January. At the end of the month the Workman’s Order showed material and labor used, which were computed to cost $138.00 and $90.15 respectively. No record of the material used, or out on unfinished jobs (other than on the Workman’s Order) is necessary as the balance in the Material account represents inventory on unfinished jobs as well as in stock. It will be noted that the labor on this job to January 31 is the same as the balance in the Productive Labor Account at January 31. These two amounts (balance in Productive Labor Account and labor on unfinished jobs) should always agree as wages paid for time charged to jobs should be debited to the Productive Labor Account.

Chart of Overhead Expenses Compiled by Ernst and Ernst from their interpretation o f returned, usable questionnaires covering detailed operating cost; weighted as to sales volum e classification from a tabulation o f questionnaires returned directly to th e N ational Association o f Master Plum bers o f the U. S., Inc.

VOLUME OF BUSINESS

Up to

$5,001. to $10,000.

$10,001. to $25,000.

Total $25,001. $50,001. $100,001. $200,001. Over Weighted to to to to $500,000. Average $50,000. $100,000. $200,000. $500,000.

Relative D istribution o f Direct Cost of Sales 61.47% 63 .56% 60.30% 63.04% 64.91% 67 .55% 75.18% 66.18% 62.59% Material 28.47 23.07 31.87 32.58 33 .60 31.26 34.54 34.50 34.80 Productive Labor .47 .16 .74 .19 .50 .17 .55 .55 .63 Permits .77 1.17 .28 1.17 1.34 .23 1.63 1.53 Incidental Expense .39 1.22 1.32 1.50 1.64 .86 .41 .29 1.52 1.55 Truck Expense 1.23 1.08 1.02 1.02 .03 .92 .97 .31 Freight and Drayage 1.17 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% TOTAL DIRECT COST OF SALES 100.00% 100.00% 100.00% Overhead (Expressed in percentages to Total Direct Cost of Sales) Miscellaneous Administrative and Office Expense— Includes Collections, License Fee, Telephone and Telegraph, Trade Papers, Light, Heat, Power, Water, Stationery, Printing, Postage, Business Magazines and Traveling.

Office and Administrative Salaries

7.16%

4.05%

2.54%

2.05%

1.53%

1.69%

1.35%

•67%

3.67%

27 .75

20.78

16.57

13.31

11.24

12.04

10.27

5.12

18.56

6.69 2.83 .98

4.55 1.01 .52

3.41 1.23 .47

2.76 1.00 .32

2.17 .87 .25

1.53 .50 .22

1.31 .52 .21

.48 .09 .18

4.06 1.46 .54

.98 1.38 .52

.25 1 in e i« « i> n t f M i u t r P lu m b m o f t h « U. S .

OVERHEAD

ACCOUNTS

ACCOUNTS

CHARGEABLE

18. M iu . S h o p Exp.

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AND

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