0381: The Value Of Service Agreements In Your Construction Company

This Podcast Is Episode Number 0381, And It's About The Value Of Service Agreements In Your Construction Company

It goes to the heart of the question of the difference between a customer and a client. Service agreement holders are more likely to be clients who add more value to your construction company because they represent your customer base's most loyal segment. 

Every service agreement customer represents future work. In the meantime, service agreement clients are a source of cash flow and are predetermined to call you instead of your competition when repairs are necessary.

Non-service agreement customers are more likely to be customers and fickle. They may call your contracting company for future work or decide to shop the competition and use the information they find to negotiate for a lower price. In some cases, they may not even remember you or your construction company name.

Besides, your replacement sale close-ratio usually is higher with service agreement clients, and your overall pricing and related service care level can be much higher, resulting in even more raving fans. Service agreement clients trust you, follow your recommendations, and do not frequently shop around. 

When and if you ever decide to sell your company, potential buyers understand the value of service agreements, and your company will be more attractive if you have a strong base of service agreement clients and are generally willing to pay even more for it than you expected. 

Service Agreements Place On The Financial Reports

The Balance Sheet is the summary report which shows all of the assets minus the liabilities, which equals the "Book Value" or owner's equity. In theory, the owner's equity is what would be leftover if you liquidated the company, sold the assets, and paid all of the debts or liabilities. 

Your service agreement clients' true value will not show on the Balance Sheet before the business is sold; however, it is used to calculate "goodwill" if the buyer pays more than book value for the company.

Construction Accounting As It Relates To Service Agreements

The price of a service agreement must pay for the corresponding maintenance, and whatever is left after the cost of material, labor, and other expenses is gross profit. This means every service agreement carries a hidden cost for future maintenance work, which equals the total value of services yet to be performed.

For example, a plumbing contractor might sell an annual service agreement that entitles a restaurant to four follow-up drain cleaning package visits each calendar quarter for $600 and a 20% discount on all additional services.

This means you will send a plumbing drain technician to clean the restaurant's main drain four times a year at a cost to your company of $75 for labor and overhead each = $300. The service agreement's income is $600 - your cost is $300 = $300 additional income.

Keep The Service Agreement Cash Separate

One of the best parts is that you have an immediate increase in cash flow. Successful contractors put the cash in another interest-bearing bank account and do not transfer it until the work is performed. It is not even necessary to recognize it as income until the job is done.

Maintenance That Is Never Performed

Some clients will not return phone calls and never let you schedule their service. Here are two suggestions to consider:

#1 Disconnect The Work From The Payment 

Think about a pre-paid annual gym membership. It gives you the right to use the gym for the next year, but if you fail to take advantage of this benefit of membership, you do not receive a refund after the fact.

#2 Maintenance Is One "Free" Benefits 

The obligation to schedule the maintenance should rest with the client. We recommend that your customer service representative contact each service agreement client to schedule services; however, if the client refuses to set an appointment, the contractor's obligation is met.

Five Benefits

#1 Your dispatcher can group service agreement calls together saving travel time

#2 It can be used to fill in slack times when there is not enough work to go around

#3 It is a great way to train new technicians by having them shadow experienced technicians

#4 Add on sales while the technician is onsite they can ask if there is anything else that needs to be fixed or upgraded

#5 Immediate increase in cash reserves

Five Drawbacks

#1 Your dispatcher may not be able to group calls together

#2 You may not have any slack time to fill

#3 It costs more in the short run to train technicians this way

#4 It will require you to have a way to track the upcoming service agreement dispatches

#5 It requires a bit more construction accounting than most bookkeepers know how to do

Final thoughts

Service Agreements raise your construction company's value if you ever want to sell it for much cash because investors buy income streams, not worn out broken down equipment and stale customer list.

The final decision rests with you to decide if adding service agreements to your contracting company makes sense. It requires a bit more construction accounting than most bookkeepers know how to do, and if needed, we can help train them.

About The Author:

Sharie DeHart, QPA is the co-founder of Business Consulting And Accounting in Lynnwood, Washington. She is the leading expert in managing outsourced construction bookkeeping and accounting services companies and cash management accounting for small construction companies across the USA. She encourages Contractors and Construction Company Owners to stay current on their tax obligations and offers insights on how to manage the remaining cash flow to operate and grow their construction company sales and profits so they can put more money in the bank. Call 1-800-361-1770 or sharie@fasteasyaccounting.com