To measure one company against others, you must compare apples to apples. One obstacle to that comparison is owner's compensation, because each remodeling company tends to account for it differently.
To begin with, C- and S-corporation owners are often paid regularly as employees, but owners of LLCs and sole proprietors are not. Instead of writing themselves a regular paycheck, they draw money out of their company as needed to pay the bills. This makes it difficult to determine true net profit because the total amount the owner will draw out of the company is unknown until year's end.
How Much? To resolve this issue, I insert a “salary equivalent” line item into the profit and loss statement to represent the amount of money pulled out of the company on the owner's behalf —regardless of company legal structure.
How much should this “salary equivalent” be? Remodeling industry gurus have long suggested that an owner's salary should equal 10% of annual volume. But company owners are also compensated through standard benefits, such as health insurance and vacation pay, as is any other employee. Plus, what about the cruise you took with your wife and family that also included two morning seminars on sales techniques? Or how about vehicle expenses, including purchase, repair, and maintenance of that new truck you're driving? And do you include the year-end bonus you gave yourself but not your employees? (By the way, how you account for these benefits for tax purposes is a completely different question. Here we're just trying to level the playing field so you can measure your company against others.)
I solve the problem by thinking of total compensation as a triangle. Side 1 is base salary and should amount to 10% of company volume. Side 2 is bonus, which can be either conditional or guaranteed. Side 3 represents standard benefits. A good rule of thumb is to base owner's benefits on those granted to your best-paid employees. In the typical remodeling company, these benefits amount to about 25% of salary (not including FICA and other legally required labor burden).
The table shows two hypothetical owners with companies of different sizes, both of whom earn more than the industry standard in total compensation. To normalize their net profit — something an interested buyer might want to do — salary or bonus can be reduced by the “Difference” in the bottom row, which would increase net profit by the same amount.
— Judith Miller is a Bay Area construction business consultant and trainer specializing in accounting, finance, and computerization.