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
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MULTI-UNIT FRANCHISEE IS S UE II, 2014
© 2013 Business Resource Services