ROI | INCOME STATEMENT | EXPENSES IN RELATIONSHIP TO GROSS MARGIN | BALANCE SHEET |
FINANCIAL RATIOS | ASSET PRODUCTIVITY RATIOS | MERCHANDISING PROFILE | EMPLOYEE
PRODUCTIVITY RATIOS | SALES VOLUME ANALYSIS | REGIONAL ANALYSIS | TREND ANALYSIS
Vol. 20, No. 1
2011
Profit Improvement
Report
“Back to the Future”
Sponsored By the Door and Hardware Institute
Profit Improvement Report
Prepared for DHI
Vol. 20, No. 1
March 2011
Back to the Future
By Dr. Albert D. Bates
President, Profit Planning Group
Most firms have put the bleeding of the recession behind them. While profitability
is still not back to desirable levels, things are clearly improving. The operative
phrase in most instances is “cautiously optimistic.”
If sales, margin and expenses follow the pattern of previous recessions, most
firms will be okay by the end of the year. The typical DHI member will be far
removed from the massive challenges of the past two years. On the other hand,
they may be equally far removed from optimal profitability. The challenge is that
in the euphoria of getting back to good many firms will miss the opportunity to
make it all the way to great.
Based upon that challenge, this report will examine two issues that are important
add-ons to financial planning for 2011:
•
•
Business as Usual—A projection of financial performance in the industry
based upon a combination of past results and current trends.
Making the Future Better—An examination of how the key factors that
influence profitability can be leveraged for improved results.
Business as Usual
The first column of numbers in Exhibit 1 provides a projection of overall financial
results for the typical DHI member in 2011. Clearly, there is a lot of 2011 left and
a lot of uncertainty still in the economy. However, it is possible to make a
reasonable assumption about how the year will end up given 1) current sales
trends and 2) an analysis of performance following previous recessions.
As can be seen, the typical firm is anticipated to have sales of around
$10,000,000 at a gross margin of 30.0%. This should produce a pre-tax profit of
$350,000, or 3.5% of sales. This is adequate, but not outstanding performance.
This means the profit results for the typical firm are expected to look a lot like
they did before the recession hit. The reality, though, is that the pre-recession
numbers were somewhat unexciting. Certainly, they are better than the
depressed results seen during the depths of the recession. However, they do not
represent the profitability that firms deserve.
It can be argued that the long-term profit results for DHI members are in
something of a rut. Actual results rise and fall in tandem with economic
conditions. However, across the business cycle results always revert back to the
norm. That norm has been in place for an agonizingly long time.
Interestingly, profit levels have remained somewhat constant despite the fact that
firms in all industries, including DHI, have become more sophisticated. For
example, twenty years ago most inventory control systems were run on index
cards. Today, most firms have sophisticated inventory management systems.
Increased sophistication has not lead to better results for one reason. Firms
continue to make the same mistakes at the same exact points in the business
cycle over and over. This is not a criticism of management. Instead, it is an
inevitable aspect of human behavior.
However, improving profitability—now or at any other point in time—must involve
overcoming those normal behavioral tendencies. Management must overcome
the pressures that lead to business as usual.
Making the Future Better
The remainder of Exhibit 1 examines how the firm could produce even more
profit in 2011 by better managing the Critical Profit Variables (CPVs). These are
the factors that have the most power to drive profit in the firm. The three most
important are sales, gross margin and expenses.
Every firm is already managing the CPVs as effectively as they can, of course.
The reality is that in the recovery phase of the economic cycle, firms look at the
CPVs in a very different light than they do in the down phase of the cycle. This
change in perspective limits the profit potential associated with recovery.
As markets stabilize following a sharp recession two things inevitably occur.
First, expenses demonstrate a relentless tendency to increase. More
infrastructure is needed, employees need wage increases to “catch up” and the
like. Second, pricing challenges arise. This is because the excitement inherent
in sales increases automatically reduces the attention paid to pricing that is
essential for desired profit performance.
It is important to note that these pressures have already been accounted for in
the first column of numbers in the exhibit. That is, the exhibit assumes that
human beings will continue to act as human beings. Not so much a failing as a
reality of life.
The remaining columns examine the impact of maintaining greater diligence in
the face of the sheer relief that the recession has ended. The two areas of focus
explored in the exhibit are pricing and employee compensation. In both areas a
2.0% improvement factor is used.
The 2.0% figure is not arbitrary. The better-performing firms across a wide range
of industries tend to do about 2.0% better than the typical firm each year. The
2.0% differences add up to a dramatic improvement in overall profitability.
Pricing remains the Achilles heel of every recovery. As sales rise due to
improving economic conditions, there is a natural tendency to want to recover
sales volume at an even faster pace. This invariably leads to a diminished level
of price monitoring.
In the Margin Control column in Exhibit 1 the firm generates 2.0% more gross
margin dollars. The cost of goods remains constant, so the entire 2.0% increase
is the result of improved pricing. The net effect is that profit increases by 17.1%.
The Payroll Control column reflects the human tendency towards fairness. When
sales growth returns, the pressures on payroll become enormous. Employees
naturally want a share of the good times just as they shared in the pain of the
down market. If the payroll increase can be moderated so that it is 2.0% less
than might otherwise occur, profit would increase by 10.9%. Sharing is fine,
controlled sharing is much better.
The real payoff, of course, comes from doing both things simultaneously. The
final column of numbers demonstrates how the firm would look if both gross
margin and payroll were controlled more systematically. The 28.0% improvement
changes the entire profit profile of the firm.
Moving Forward
After a brutal economic recession there is a tendency to dramatically under
perform compared to the potential profit that could be generated. There are two
serious challenges that must be overcome. First, the firm should think in terms of
producing a strong profit increase rather than accepting any improvement as
being good enough.
Second, the firm must be on guard for the factors that eat up the profit
improvement that comes with higher sales. The firm must be especially mindful
of ill-conceived expense increases and price reductions.
About the Author:
Dr. Albert D. Bates is founder and president of Profit Planning Group, a
distribution research firm headquartered in Boulder, Colorado.
©2011 Profit Planning Group. DHI has unlimited duplication rights for this manuscript. Further, members
may duplicate this report for their internal use in any way desired. Duplication by any other organization in
any manner is strictly prohibited.
A Managerial Sidebar:
Setting a Profit Goal
Probably the oldest concept in all of financial planning is that small changes in
the Critical Profit Variables (CPVs) cause profit to increase. Despite the fact that
the concept is ancient, it is often overlooked in a period of economic recovery.
The following chart indicates how much dollar profit would be increased for the
typical DHI member if each of the following four items were increased by one
percent. That is, if prices were increased by one percent, items were purchased
at a cost that was one percent lower and the like.
The figures provide some useful insights into how firms can use these small
improvements to make profits even greater than they would be otherwise.
Are a of One Pe rce nt
Im prove m e nt
Pe rce nta ge
Incre a se
Dolla r Profits
Pricing
27.1 %
Buying
20.0
Net Sales
7.1
Payroll Expense
5.4
Exhibit 1
The Impact on Profit of Greater Control of the CPVs
For the Typical DHI Member
Projected
Results
Income Statement
Net Sales
$10,000,000
Cost of Goods Sold
7,000,000
Gross Margin
3,000,000
1,900,000
Payroll and Fringe Benefits
All Other Expenses
750,000
Total Expenses
2,650,000
Profit Before Taxes
$350,000
Increase in Profit--%
Margin
Control
$10,060,000
7,000,000
3,060,000
1,900,000
750,000
2,650,000
$410,000
Payroll
Control
$10,000,000
7,000,000
3,000,000
1,862,000
750,000
2,612,000
$388,000
Both Margin
and Payroll
$10,060,000
7,000,000
3,060,000
1,862,000
750,000
2,612,000
$448,000
17.1%
10.9%
28.0%
Sponsored By:
The Door and Hardware Institute (DHI)
is the only professional association dedicated
to the Architectural Openings Industry.
With the purpose of advancing life safety and
security within the built environment, DHI
represents the North American openings marketplace as the advocate and primary resource
for information, professional development
and certification. With the focus on our
members, DHI strives to be the indispensable
resource for industry trends, best business
practices and advanced education. DHI
remains a powerful advocate for creating a
favorable code environment in the life safety
and security industry.
Door and Hardware Institute
14150 Newbrook Drive
Suite 200
Chantilly, VA 20151-2232
phone: 703.222.2010
fax: 703.222.2410
www.dhi.org