Guest Editorial
By Dr. Albert D. Bates
President
Profit Planning Group(Boulder, CO)
For most firms, 2008 qualifies as a year to file and forget. However, financial statistics for recession years provide valuable insight into what distinguishes the outstanding firm from the typical firm.
Based on results of the NTDA’s 2009 Dealer Financial Performance Survey (visit the “Member Services” section of NTDA.org to learn more about this survey), many members struggled, but some continued to prosper despite sales and margin pressures. The survey report revealed significant differences between the typical and high-profit firms.
Typical vs. High-profit
The typical NTDA member company generates sales of $14,598,820. On that sales base, it produces a pre-tax profit of $29,198 — a profit margin of 0.2% of sales. In other words, every $1 in sales results in 0.2 cents of profit.
Most companies produce results that are relatively close to those of the typical firm. However, being typical is not always good enough — especially in troubled times.
The high-profit firm, operating with the same economic and competitive challenges as the typical firm, generates a profit margin of 4.2%. So even if the high-profit company had the same sales as the typical firm, it would generate more profit for reinvestment. This is an ongoing advantage that is magnified over time.
The Route to High-profit
In good economic times, businesses have the advantage of a strong sales tailwind, which provides a margin for error. They can rely on sales growth to overcome poorly managed financial aspects. But in tougher conditions, profits are more problematic, and reaching high-profit performance is a matter of identifying the most important factors for achieving profit, known as critical profit variables (CPVs). See Figure 1 below.
When comparing typical and high-profit firms, remember that no company produces superior results for every CPV. Rather, successful firms combine CPV performance in ways that maximize overall profitability.
Planning
In planning CPV goals in a soft market, four factors have the greatest potential impact on profit: sales growth, gross margin, payroll expenses and non-payroll expenses.
Note that these factors are all from the income statement rather than the balance sheet. While balance sheet factors such as accounts receivable, inventory and fixed assets should not be ignored, profit pressures associated with recession make them secondary concerns.
Firms that successfully control these four critical factors have a major financial advantage in slow times, which can carry over into good times.
Sales Growth
Sales growth is a precious commodity in a sluggish economy. However, the need for rapid sales growth has been overstated because it is possible to increase profits with slow growth. The real challenge occurs when growth becomes negative, making profit improvement impossible.
Managers need to stop thinking about sales growth in absolute terms. For example, rather than targeting 5% growth, they should focus on relative sales growth in relationship to expense growth. Ideally, firms should target sales increases somewhere between 1–2% faster than operating expenses to improve profits. This is a realistic objective for most companies, even in slow-growth markets.
Gross Margin
The ability to generate adequate gross margin continues to be a major determinant of profitability. Long-term financial success demands strong gross margin performance. In periods of slow growth, there are intense pressures on gross margin, but most firms can still find opportunities for significant margin enhancement.
Payroll Expenses
Payroll is the most important expense factor, which means that controlling it is essential to controlling expenses. Recently, payroll has rivaled gross margin in importance as a driver of profitability. This is because payroll expenses, especially fringe benefit components, have increased relentlessly in good times and bad.
Non-payroll Expenses
Most non-payroll expenses usually require only minor adjustment. Unfortunately, numerous expense categories must be examined and adjusted. Controlling non-payroll expenses will likely always involve examining every expense category with a goal of making modest improvements in several different areas.
No one ever claimed that managing a company in a sluggish economy was easy. The economy’s impact on performance, however, can be minimized with proper planning and control.