Multi-Unit Franchisee Magazine Issue II, 2014 | Page 74

Finance BY STEVE LEFEVER A Roadmap To Unlock Hidden Profitability Interdependence is the key M example, “high interest” is caused by “high borrowing.” Gross margin is highlighted for a reason: without an adequate margin (long term), you might as well close up shop. Start at “low cash” and take it in all directions until you’ve traveled all through the system. Many people view financial problems or issues as isolated occurrences. One of the primary benefits of this financial cause-and-effect diagram is to highlight the interdependent nature of the financial system in your business. The key here is interdependence. Let’s join our case study client, John Thomas of Thomas Rentals, at the “scene of the crime.” John does about 55 percent of his business in construction equipment rental. Although his sales were up in 2013, John ended making less money than he did in 2012. At one point, John confessed that he was forced to get an emergency line of credit from his bank. As his personal pri- ysteries are solved when we use clues to find the culprits behind the crime. Financially speaking, when the crime results in the untimely demise of a business, we often see three usual suspects: low cash, low gross margin, and low net margin. But low cash and low margins are caused by something. The diagram presents a big picture overview, but also can lead us through a clue-by-clue, cause-and-effect deductive analysis designed to pinpoint potential financial culprits. When combined with industry benchmarks, this diagram can become your personal roadmap to success. First, how to read it. Between any two boxes, in the direction of the arrows, insert the word “causes.” In other words, “low cash” causes “high borrowing.” Now, if you The Road arrows, work against theMap include the words “is caused by” between the two boxes. For vate eye, we can use the roadmap to help John do a little detective work to figure out where he went wrong. We’ll start with gross margin. Using the median financial operating ratios from his latest benchmark report, John sees that his peers who earn 30 to 59 percent of their rental revenue from construction equipment achieved a 70.7 percent gross margin; his high-profit peers did even better, making almost 73 cents. John’s gross margin in 2013 was 69 percent, 4 percent lower. Lest you think a few percentage points is small change, that 4 percent on his $1 million in sales could have dropped $40,000 right to his bottom line. According to the roadmap, low gross margin is caused by the following: no cash discounts on payables, low productivity, poor inventory control, shrinkage, bookkeeping errors, poor buying, and poor pricing. Let’s focus now on low productivity, a key driver behind margins in the rental industry. A highly productive company generates high revenues from its rental investments. Looking at his peers’ productivity ratios, we see that this was indeed an area in which John’s company fell short. As shown above, John gets four cents less in gross margin for every dollar invested in rental assets than his most profitable peers. John Cause-and-Effect Relationships Leading to to Financial Distress Cause-and-Effect Relationships LeadingFinancial Distress High A/R LOW CASH High Current Liabilities Too Much Customer Credit Too Much Inventory Not Enough Inventory High Borrowing Not Enough Customer Credit Low A/R Poor Inventory Control No Cash Discounts on Payables High Interest Low Productivity Shrinkage Bookkeeping Errors LOW GROSS MARGIN Low Sales High Liabilities Low Retained Earnings Poor Buying High Hidden Costs Poor Pricing Poor Expense Control LOW NET PROFITS Profit Mastery profitmastery.net 800.488.3520 [email protected] 72 MULTI-UNIT FRANCHISEE IS S UE II, 2014 © 2013 Business Resource Services