Five keystone pillars of profit (Part III): Cost of goods and product gross profit performance

Third article in a series

By Jim Yount

In the second article of this series in November 2013 Outdoor Power Equipment, you may recall that I referenced a case history taken from Jim Yount Success Dynamics (JYSD) consulting files. Because of the ongoing recession, I determined the subject would be best served by selecting a dealer/retailer prior to the year 2008.

I am pleased to report that the case history dealer we selected had followed his personalized JYSD strategic business plan. He made recommended adjustments and began tracking results to confirm profit margins were improving. At the end of four years, he had enjoyed sales growth of nearly 50 percent.

Reviewing Product Performance and Net Sales Mix Ratio pages from the case history, which were completed during the process of developing a personalized Strategic Business Plan, we at JYSD were able to create the following analysis.

Together, let’s expand the analysis of items listed in article two and discuss how to make a difference. Remember in article two, annual NET SALES (No brand ID) were $3,400,000. By combining the actual cost of equipment, parts and accessories, COST OF GOODS (which is the second “keystone pillar of profit”) sold totaled $2,400,000, or 70.59 percent of NET SALES.

Since there are no cost of goods directly related to tech service dollars earned, tech salary/wages are accounted for in the total cost of payroll. At JYSD, we track service department labor earnings as 100-percent profit. Cost of parts and accessories associated with completing service department work orders are accounted for in the cost of total parts and accessories sold. Service department numbers are not included in this analysis. The service department is a stand-alone subject. As we progress, remember: “The only way to keep score in business is to count the money.”

When counting and dividing most things for distribution, we use percentages. The total amount of that which is being divided becomes 100 percent. Here is a mathematical example of dividing and spending money. You sell an item for $100.00. The item costs $65.00. The gross profit is $35.00. What percent is $35.00 of the $100.00, which is the whole? The math for determining the percentage: Enter $35.00 into your calculator and divide by $100.00. The answer is .35 or 35 percent.

I share this exercise for one reason. There are business owners whose accounting departments provide this information and give an oral review. Seldom, are they involved in using mathematical formulas.

However, that’s not a good practice. It is important for business owners to review performance numbers at least monthly. I know owners that review performance numbers daily, be it at the end of the day or the next morning. It is critical that business owners stay in touch with profits earned and the cost of operating expenses. Dealers/retailers that keep in touch with everyday cash flow are the most profitable. Why? Because while reviewing invoices in preparation to pay bills, they have experienced frequent ever-rising costs of goods and services. Owners know from experience that increases in the cost of goods and services must be passed on to the consumer.

If you don’t recognize the changes, you can’t make the necessary adjustments. If you do not make adjustments to selling price, your margin of profit shrinks. Every company must have a person responsible for managing margins and generating gross profit dollars. The best person for that task is the business owner. You must not allow the law of averages to take control of your responsibility. You must not become the average business.

Business owners must hold themselves responsible for judicious management. We all will be judged.

Let’s take a look at the following two evaluation performance charts.

ANALYSIS CHART: Equipment defined as engine driven. Brand not identified.

ANALYSIS CHART: Manufacturers of engines, parts, accessories and miscellaneous items.

Supplier
Group
Net Sales
Cost of Sales
Percent Total Sales
Gross Dollars
Gross Profit

Supplier 1
Parts/Access.
 217,000
 123,000
 6.40
 94,000
 43.32

Supplier 2
Engines
 125,000
 81,000
 3.68
 45,000
 36.00

Supplier 3
Equipment
 59,000
 34,000
 .017
 25,000
 43.30

Supplier 4
Parts/Access.
 56,000
 35,000
 .016
 21,000
 37.50

Supplier 5
Parts/Access.
 42,000
 36,000
 .012
 6,000
 14.29

Supplier 6
Parts/Access.
 40,000
 24,000
 .011
 16,000
 40.00

Supplier 7
Parts/Access.
 35,000
 30,000
 .010
 5,300
 15.14

Supplier 8
Parts/Access.
 34,000
 19,000
 .010
 15,000
 44.12
The objective of this analysis is to determine what it costs to produce $3,400,000 in NET SALES. NET SALES is the first of the “five keystone pillars of profit.”

The combination of the top three major equipment selling brands produced $1,723,000 in sales, or 50.68 percent. These three top-selling brands produced half of total annual sales of $3,400,000. Add the other two of the top five major equipment selling brands, and the total becomes $2,240,000. If you recall in article two, the COST OF GOODS is listed as $2,400,000. That leaves $160,000 assigned to miscellaneous sales.

Analyzing the numbers, what would be your first comment or question? The top five brands represent $2,240,000 of total sales. Wow! That’s 93 percent of the total. That means there are other components on the floor and shelves not making sufficient contribution to profit. But there is a problem: 10.04-percent margin of profit on the equipment sales is not sufficient. Parts and accessories margin is 27.59 percent. How much of a contribution does this make toward paying operating expenses when total operating expenses seem to be above 30 percent?

I am not suggesting the margin should be 30 percent. However, both margins can and should be much, much better. These margins will not leave an acceptable amount of, if any, cash in the bank as a return on the owner’s investment?

Let’s take a quick but different look at brand number 2, which is handheld equipment. Sales produced $99,000 in profit with a margin of 19.48 percent. Good, but should and can be improved. How much improvement? I’ve seen margins on this equipment as high as 26 and 27 percent. Margins on parts/accessories were 38.37 percent. That’s good, but I have seen 48 and 49 percent. In a few cases, I have seen above 50 percent. My point is there was lots of room for improvement in our case history. I can say they improved their margins.

Having the lowest-price product is not the ultimate weapon in closing sales.

Look at brand number 3’s equipment margins. Gross profit margin is at 8.38 percent. Being a full representative of an outdoor power equipment retailer, this product brand will not have a long life on the showroom floor. An 8.38-percent margin of profit is not a sustainable margin. Regardless of how hard the dealer works at trying to produce acceptable profits from such product, it does not seem to produce the profit dollars. I am not suggesting that dealers stop selling this brand.

What I am suggesting is to increase margins to the much-needed level and let the product stand on its own value. A season or two will lead the business owner to a proper decision.

Do not misinterpret what I have stated. Take time to look at these charts of products for sale. There is lots of room for adjustments in profit margins. Compare your own numbers and profit margins to these charts. Take a very, very close look at your pretax net profit.

How important are these numbers? They dictate GROSS PROFIT earnings, which is the third “keystone pillar of profit.” From GROSS PROFIT, operating expenses are paid.

In part four, we will review these charts and discuss how to effectively improve the profitability of your business. During our consulting sessions while developing Strategic Business Plans for customers in the United States and Canada, we remind the dealer/retailer that we share the information — owners make adjustments and applications. It is always the owner’s decision.

At JYSD, our wish for all is to have a happy and prosperous New Year 2014!

 Jim Yount is the founder and chief executive officer of Jim Yount Success Dynamics LLC. For more than 30 years, he has hired, trained, managed, sold, marketed, and motivated. Extensive real-world experience in retailing, distribution and working with manufacturers, both domestic and international, has earned Jim the reputation as a trustworthy and knowledgeable professional in his field. As a results-oriented speaker, he is dedicated to inspiring groups of 30 to 3,000 to develop their talents and realize their full potential. As a business consultant, teacher and coach, Jim is experienced at challenging leaders to explore their operational procedures and change unacceptable practices that are producing poor results. For more information, contact Jim at jimyount@hughes.net or (903) 796-3094 or visit his website at www.jimyountsuccessdynamics.com.