Profiting

by WOHe

ProfitingFrom
Others

By comparing their operating results to other firms in the
industry, kitchen/bath dealers can readily see how they can improve
their company’s profits, a new NKBA report demonstrates.

1. Comparison of the Critical
Profit Variables 
Between ‘Typical’ & ‘High-Profit’ Dealers

 
‘Typical’ Dealer 
‘High-Profit’ Dealer
Sales Per Employee 
$167,896 
$244,633
Gross Margin Percentage 
34.5% 
33.0%
Operating Expense
Percentage 

31.2% 
22.5%
Inventory Turnover (No. of
Times) 

12.7 
44.5
Average Collection Period (In
Days) 

18.0 
11.5
 

HACKETTSTOWN, NJ Financial performance apparently varies widely
among kitchen and bath dealers, and can be significantly enhanced
by developing an understanding of a company’s financial structure,
as well as a recognition of how similar dealerships are performing
throughout the industry.

That is one of several key conclusions contained in a
comprehensive new report released last month to Kitchen & Bath
Design News by the National Kitchen & Bath Association.

The NKBA’s recently com-pleted 2000 Dealer Profit Report
produced annually for the Hackettstown, NJ-based trade association
was prepared for the NKBA by the Boulder, CO-based Profit Planning
Group.

The 18-page report was released recently to participating
NKBA-member kitchen and bath dealers as a service that enables them
to compare their company’s financial performance to other industry
firms of a similar size, structure and geographic location. Results
of the report were based on the responses of 133 participating
dealers, who provided operating results from the 1999 calendar
year, according to the NKBA.
The report revealed significant differences between the financial
and operating performance of “typical” and “high-profit”
kitchen/bath dealerships, and suggested ways for dealerships to
monitor, and improve, their profitability.

2. Overview of Financial
Results
Among ‘Typical’ & ‘High-Profit’ Dealers

 
‘Typical’ Dealer 
‘High-Profit’ Dealer
Net Sales 
$1,200,000 
$891,009
Cost of Goods
Sold 

786,000 
596,976
Gross Margin 
414,000 
294,033
Operating Expenses 
374,400 
200,477
Operating Profit 
39,600 
93,556
Other Income/Expenses 
0
 0
Profit Before Taxes 
$39,600 
$93,556
Total Assets 
$240,000
 $114,232
Return on Assets 
16.5% 
81.9%
 

The report also vividly illustrates that controlling key profit
variables is of far greater significance in achieving financial
success than simply increasing annual revenue a focal point of most
dealerships

For example, the “typical” NKBA dealership surveyed for the
report posted 1999 revenues of $1.2 million, and a pre-tax profit
of 3.3% (or $39,600). In contrast, “high-profit” firms posted
revenues of $891,000, but a pre-tax profit of 10.5% (or
$95,550).

Also of note, the “typical” NKBA firm had a pre-tax return on
assets (profit before taxes, expressed as a percentage of total
assets) of 16.5%. For the “high-profit” firm, the return on assets
was 81.9%.

“A number of factors led to the differences in results,” the
report stated, adding that, in most instances, these differences
can best be illustrated by what are commonly called the CPVs, or
critical profit variables.

These variables include:

  • Sales per employee, which measure employee productivity
    levels.
  • Gross margin percentage, which reflects a company’s abil-ity to
    effectively manage the cost of goods sold.
  • Operating expense percentage, which focuses on expense
    control.
  • Inventory turnover, an indicator of how well inventory is
    managed.
  • Average collection period, which reflects accounts receivable
    collection practices.

According to the report, “typical” and “high-profit” firms
exhibited not only different sales volumes, but rates of growth.
For example, for the “typical” dealer, revenue increased by 8.7%
from 1998 to 1999; by comparison, the increase was 24.2% for the
“high-profit” dealer.

In addition, the dealerships reported substantial differences
when it came to the critical 
profit variables. 

3. Comparison of Other Key
Operating Results
Between ‘Typical’ & ‘High-Profit’ Dealers

 
‘Typical’ Dealer 
‘High-Profit’ Dealer
Pre-Tax Profit
Margin 

3.3% 
10.5%
Asset Turnover 
5.0 
7.8
Pre-Tax Return on Net
Worth 

29.7% 
114.7%
Cost of Goods Sold (As
%) 

65.5% 
67%
Payroll Expenses (As
%) 

19.9% 
12.8%
Occupancy Expenses (As
%) 

3.5 
3.0
Accounts Payable to
Inventory 

101.1% 
61.6%
Accounts Payable Payout Period
(Days) 

25.5 
1.1
Debt to Equity 
0.8 
0.4
Financial Leverage 
1.8 
1.4
 

“The high-profit firm seldom performs better on all of the
CPVs,” the report notes. Instead, the report added, it is the
sum-total of their performance on the CPVs which can produce a
dramatically improved operating performance.

“The nature of the differences between the typical and the
high-profit firm, and the underlying reasons, need to be understood
by every dealer,” the report said.

A profit ‘model’ Kitchen and bath dealers can utilize a financial
management tool known as the “Strategic Profit Model” to get a
handle on how profitable their company is, and how that
profitability can be improved, the NKBA-Profit Planning Group
report states.

According to the report, the “Strategic Profit Model” is simply
a graphic representation of comprehensively analyzing return on
investment termed “the most meaningful way” to measure the overall
profitability of a kitchen/bath dealership.

The report notes that there are two distinct return on
investment measures return on assets and return on net worth
(sometimes known as return on owner equity). Return on assets
examines the economic viability of a company, while return on net
worth looks at the return being generated by the company’s
owners.

The two return-on-investment ratios are driven by a trio of
performance indicators profit margin, asset turnover and financial
leverage each of which “represents a different strategy, or
profitability pathway, to improve return on investment,” the report
observes.

What follows is a thumbnail look at the three profit pathways
outlined in the NKBA-Profit Planning Group report:

Path 1: 

  • Profit Margin. Management of profit margins is the most
    important profitability pathway, since it focused on sales
    productivity, gross margin management and operating expense
    control, the report states. Expressed as a percent, it is a
    calculation that is arrived at by dividing profit before taxes by
    net sales. As an example, if a company produces 3.3¢ for every
    $1.00 of sales, the pre-tax profit margin would equal 3.3%.
    “Typical” NKBA dealers reported a pre-tax profit margin of 3.3%;
    “high-profit” dealerships reported a pre-tax profit margin of
    10.5%.

Path 2: 

  • Asset Turnover. Asset turnover reflects the sales the company
    produces per dollar invested in assets. It is arrived at by
    dividing net sales by the value of a company’s total assets. As an
    example, a ratio of 5.0 means that a company is able to generate
    $5.00 in sales for every $1.00 in assets.
    “If a firm’s assets cash, accounts receivable, inventory, property,
    equipment and other assets can be used as efficiently as possible,
    then a maximum amount of sales can be generated from a given asset
    investment,” the report states.
     
    “Typical” NKBA dealers reported an asset turnover of 5.0;
    “high-profit” dealerships reported an asset turnover of
    7.8%.
  • Return on Assets (ROA). This is the direct result of the first
    two pathways profit margin multiplied by asset turnover, expressed
    as a percent. “This measure of performance is a good indicator of a
    firm’s ability to survive and prosper,” the NKBA-Profit Planning
    Group report states, adding that a company’s pre-tax return on
    assets should at least equal the cost of capital.
     
    For the “typical” NKBA dealer, the ROA is 16.5%; for the
    “high-profit” dealer, it is 81.9%.

Path 3: 

  • Financial Leverage. A measurement of the total dollars of
    assets per each dollar of net worth (arrived at by dividing the
    former number by the latter), financial leverage reflects the
    extent to which a company uses outside financing. The higher the
    ratio, the more the company relies on non-owner sources for
    funding. A ratio of 1.8, for example, suggests that for every $1.00
    in net worth, the firm has $1.80 in total assets. If for every
    $1.80 in total assets the owners put up $1.00, then outsiders put
    up the remaining $0.80.
     
    The financial leverage ratio for the “typical” NKBA dealer is 1.8;
    the ratio for the “high-profit” dealer is 1.4.

The end result of the three profitability pathways is return on
net worth. This figure, expressed as a percent, can be calculated
by multiplying profit margin by asset turnover, and then
multiplying that number (return on assets) by financial leverage.
It can also be arrived at by dividing pre-tax profit by total net
worth.

For the “typical” NKBA dealer, pre-tax return on net worth is
29.7%. In other words, for every $1.00 of net worth, the company
produced 29.7¢ of profit before taxes. By comparison, the
pre-tax return on net worth for the “high-profit” dealer is 114.7%,
meaning the company produced $1.147 of profit for every $1.00 of
net worth.
The NKBA-Profit Planning Group report points out that it is seldom
possible to generate an adequate rate of return on net worth by
emphasizing just one of the three profitability pathways.

Instead, “each pathway should be examined carefully for
improvement opportunities, and then trade-offs made in order to
increase overall profitability,” the report advises.

“An improvement plan should not be based upon any single measure
of performance, but be developed with the complete picture in
mind.”

Other tips for improving financial performance offered to
kitchen/bath dealers by the 2000 Dealer Profit Report include the
following:

  • A company’s income statement serves as the “primary scorecard
    of management’s effectiveness, ” since it “reflects the ability of
    management to generate sales, produce a reasonable margin on those
    sales, control expenses and earn an equitable profit,” the report
    noted. Specific expenses should be viewed as a reflection of
    percent of sales, since this provides a basis for evaluating margin
    and expenses in relationship to the underlying sales volume.
     
  • The balance sheet is “an under-utilized financial statement,”
    according to the NKBA-Profit Planning Group report. If properly
    analyzed, both the assets and liabilities sides of the balance
    sheet provide significant insights into the financial structure and
    investment posture of a company, the report continues. The assets
    side reflects where investments are made; the liabilities side
    identifies which business stakeholders made the investment.
    Ideally, cash balances should equal at least two to three percent
    of total assets. “For firms below that level, the potential for
    cash flow problems continually exists,” the report stated.
    Pointing out that most kitchen/bath dealerships are cash short, the
    report also notes that the bulk of asset investment for most
    dealerships is in accounts receivable and inven-tory. For the
    typical NKBA dealer, these two items are 28.2% and 12.5% of assets,
    respectively. For high-profit dealers, the numbers are 27.2% and
    3.9%, respectively.
  • Additional financial terms that dealers need to familiarize
    themselves with include current ratio (current assets divided by
    current liabilities), which assists in cash-flow management); quick
    ratio (cash plus accounts receivable divided by current
    liabilities), a measure of the extent to which liquid resources are
    readily available; and debt to equity (total liabilities divided by
    net worth), the proportion of financing obtained from owners.

Dealers are advised to work closely with their accountants in
developing an understanding of the financial structure of their
businesses, and how profitability can be increased, the NKBA noted.
Dealers should also continually benchmark their businesses against
others in the industry if they’re to obtain a true understanding of
how their business is performing, the association added.

Editor’s Note: All of the figures provided in this story, and for
the purposes of the graphs, are medians. This is the middle number
of all values reported, from lowest to highest and represents the
“typical” company’s results.
To determine the group of high-profit firms, participating
companies were ranked on the basis of pre-tax return on assets
(ROA). The high-profit category includes the top 25% of the
companies, based on ROA. The figures reported for the high-profit
firms represent a median for this group.

Additional information on the 2000 Dealer Profit Report can be
obtained from the NKBA, at (908) 852-0033.

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