Building Your Business: Building a Profitable Service Department with a Warranty Reserve
by Chris Margarites, owner of EternaBond
If you are serious about building and running a service department as a profit center, and not merely a necessary evil to support your installation work, there are business tools you can use to help ensure your success. One of these tools is called a warranty reserve.
A warranty reserve is a like bank account or a fund that you create so your service department is paid when it does warranty work. The warranty reserve account is funded by deposits you will make into it as you invoice installation, restoration or retrofit work your company has done. When your service department performs a warranty repair, the invoice for the repair is billed at your normal service rates and paid for by the warranty reserve account. In other words, you make withdrawals from the warranty reserve account as you provide warranty service.
It works like this - you choose a percentage, typically 1 to 2% of every new installation job sale price and deposit that money into the warranty reserve account. Over time it grows into a sizeable pool of money to pay your service department for the warranty services they provide. Because the 1 to 2% is a cost which is chargeable against the job, you are funding he warranty reserve account with pre-tax dollars.
If you do not currently have a warranty reserve system in place, then there is a good chance your service department is only getting paid for chargeable repair work, and "losing money" when it does your warranty repair work. Not a good way to run a business. However, once implemented, your service department will be getting paid for all the services it provides, warranty and non-warranty, giving it a chance to be profitable, and as I keep saying, a well run service department can easily be the most profitable department in your company.
Furthermore, you will have a tax deferred pool of money to pay for warranty expenses. Notice that I said "tax deferred". The reason it is tax deferred is that eventually, you may want to start moving some of the unspent money out of the warranty reserve account and to your bottom line. Of course it will become taxable, but whatever is left over is yours to spend anyway you want to! Managed correctly, it is like finding "free money" at the end of the year.
Some companies reduce or increase the 1 to 2% figure to match the true cost of providing warranty service. Personally, I like to keep it a fixed number. If we start spending more than the 1 to 2%, we take a hard look at our installations and look for patterns. Why are we doing warranty repairs on certain jobs? It is a useful management tool shows us where we may need some training, or jobs we need to avoid. Setting up a warranty reserve account and managing it also protects you in the event of an IRS audit. It is one more way that you can show the IRS that you know how to run your business and play by the rules. The same is true if you sell your business. Most buyers will want a "warranty hold back". This is a fund that comes out of the sale price. What I mean by that is customary for the buyer to hold back a percentage of the agreed upon sale price, for a certain period of time, to pay for any warranty issues that may come up after they are the owners of the business. Warranty hold backs create one more variable that can make selling your business difficult. A warranty reserve eliminates this obstacle.
Where else does a warranty reserve help you run your business? When you have to provide labor to re-do work because a com
