Beyond the bottom line
Have you been to a movie lately? After you buy your large tub of buttered popcorn, your tray of pretzels, cheese dip and Diet Coke (you wouldn’t want regular Coke with all its calories), the ponytailed 16-year-old behind the counter asks if you want a receipt. After you fill your tank, the pump asks: “Receipt? Yes or No.” Ditto for your ATM.
Someone, somewhere has wondered, “How much do we spend on these rolls of receipt tape?”
The point is no expense is too small to measure. There is an old adage that says, “You get what you measure.” It may be a cliché, but at its core it is quite profound. “What should you measure?” you ask. Answer: Everything.
Most business people start with the profit and loss statement and too many people end there, neglecting completely, or at best, minimizing their scrutiny of their balance sheet. It should be the other way around. Your balance sheet is where your net worth resides.
The most basic balance sheet metric is the current ratio — current assets divided by current liabilities. It should calculate to at least 2-to-1. Receivable days outstanding and inventory turns are the most common assets measured. While the total days outstanding are important metrics, they should also be measured on a customer-by-customer basis. Keep track of what percentage of your sales and receivables are with your largest customer. Your personal risk tolerance will determine what this figure should be. More than 5% should start you thinking. Consider incentiv-izing your collection department based on reducing the amount and percentage of past-due accounts.
Inventory turns in the aggregate should only be the starting point. A truer measure of your purchasing effectiveness is turns by product or at least by product group. Base your purchasing peoples’ bonuses on inventory turns offset by the number of stock-outs.
Your mix of business will determine receivable days outstanding and inventory turns. The extent to which you have to dip into your bank line is a good gauge of how you are managing these assets.
Speaking of bank lines, be sure to pay close attention to any covenants. One that is pretty standard is the ratio of total liabilities to net worth. Liabilities should be less than net worth. Otherwise your bank and other creditors have more claim on your business than you do.
So far we’ve only discussed the balance sheet. Now let’s turn our attention to your P&L statement. Sure, everyone keeps track of sales, gross profit margins, operating expenses and pre-tax net. But what do you measure them against? How about the 30-20-10 rule? Thirty percent gross profit margin, 20% operating expenses and 10% pre-tax net, with about half the operating expenses being wages and salaries. “Ten percent net is a stretch,” you say? You’re right, but it is being done by a number of well-run yards. To achieve this, you need to set specific goals for every aspect of your business, then measure your performance. Remember, you get what you measure.
Have you ever “fired” a customer because you couldn’t make any money? How did you measure that? The obvious first metric is gross profit margin and dollars. Then analyze gross profit margin and dollars per delivery, using your picking ticket or shipping manifest. Then deduct your delivery costs. You need to know the cost per mile for each of your vehicles — fuel, maintenance, depreciation, interest on the cost of the truck, and finally driver wages and benefits. How far is the job site? Then deduct the “nuisance costs.” How much of your staffs’ time does he take up? How often does he ask you to pick up material that he over-bought? Does he pay on time? Only after you measured all these factors can you make an intelligent decision about “firing” this customer. Before you fire him, you might talk with him about the relationship, armed with these facts. He may even change his habits and become a profitable customer.
How do you improve your gross profit margin? By relentless scrutiny of every product category, then drilling down to every SKU. If you belong to a buying group — and everyone should — add the service fee to the invoice cost, plus 1% for shrinkage and mark up from that. Put the rebate in a separate account that has no bearing on setting selling prices. Another technique is to buy full truckloads, then set your cost for pricing purposes as though you bought from distribution.
Cost of goods sold is your largest expense. Next is payroll. Earlier you saw that wages and salaries should be in the range of 10% to 12% of sales. A basic metric for payroll is $400,000 to $450,000 in sales per full-time equivalent employee.
Below these are a whole host of other expenses.
Set new goals periodically.
And remember: You get what you measure.
Tony DeCarlo has more than 35 years experience in the building materials industry, first as CFO then CEO of Lumbermens Merchandising Corporation (LMC), from which he retired at the end of 2009. For the last three-plus years, he has been president of DeCarlo Advisory Services. DeCarlo sits on several industry-related boards and is associated with Anchor Peabody, a financial services firm providing advice to dealers regarding financing and M&A activity. He can be reached at firstname.lastname@example.org or (610) 408-8685.
You need to set specific goals for every aspect of your business, then measure your performance. Remember, you get what you measure.