Changing the Profit EquationExcerpted from AED's 2004 Cost of Doing Business/Profit Opportunity Report
Article Date: 11-01-2004
Copyright (C) 2004 Associated Equipment Distributors. All Rights Reserved.
Start by identifying how a successful firm produces superior results.
Financial performance varied widely among AED dealers in 2003. AED’s 2004 Cost of Doing Business/Profit Opportunity Report suggests there are major profitability differences within the industry and too many firms are leaving profit dollars on the table. A comparison of the typical dealer with a high-profit dealer (the median of the top 25 percent of firms based on return on assets) of the same size reveals exactly what it takes to be high-profit.
For 2003, the typical AED dealer reported sales of $26,360,744, profits of $421,772 and a pre-tax profit margin of 1.6 percent. In simplest terms, every $1 in sales produced 1.6 cents.
In contrast, the better-performing high-profit dealers generated a profit margin of 5.4 percent. With the same sales volume, a high-profit dealer would generate a profit of $1,423,480, an additional 3.8 percent in profit every year and that’s a significant difference.
Of greatest consequence, the typical firm had a pre-tax return on assets (profit before taxes expressed as a percentage of total assets) of 2.9 percent. For the high-profit firm return on assets was 9.7 percent.
A number of factors led to the differences in results. In most cases, these differences can best be illustrated by what are commonly called the critical profit variables. While the high profit firm seldom performs better on every critical profit variable (CPV), the cumulative results of their performance on the CPVs produces higher overall results.
Identifying the nature of the differences between the typical dealer and the high-profit firm and understanding the underlying reasons are the first steps in changing the profit equation.
The typical AED dealer reported sales per employee in 2003 of $406,429, while the high-profit dealer reported $450,346. Gross margin, which reflects effective management of cost of sales was 21.8 percent for the typical dealer and 23.8 percent for the high-profit firm.
Operating expenses percentages, which reflect expense control, were 19.3 percent for the typical dealer and 17.9 percent for the high-profit dealer. Inventory turnover is another CPV, and the typical dealer reported 2.9 turns in 2003, while the high-profit dealer generated 3.2 turns.
Accounts receivable collection practices generate an average collection period of 37.8 days for the typical AED dealer, while the high-profit dealer averages just 35.9 days.
Rental fleet utilization in 2003 for the typical dealer was 39.8 percent, but it was 43.3 percent with high-profit dealerships. And finally, absorption (operating expenses covered by gross profit on parts, service and rent-to-rent revenues) for the typical dealer was 62.6 percent in 2003, while high-profit dealers were at 72.8 percent.
Moving To High Profit
No dealer is exactly “typical”; each firm has a unique set of strengths and weaknesses. Because every firm is unique, it is impossible to specify exactly what should be done to improve the CPV. However it is easy to indicate what every firm should NOT do: Do not try to move from typical to high-profit in a single year. Instead, try to improve slowly and systematically over time.
For example, to be successful over the long term, it is essential to generate at least moderate growth. A modest growth rate of 3 percent in sales, although not necessarily every year, is enough to offset inevitable expense increases. Anything less has the potential to allow expense pressures to overwhelm the dealership.
Also, the ability to generate an adequate gross margin is one of the major challenges facing almost every dealer. Pressure comes from both suppliers who desire more-efficient product distribution and customers who are increasingly price aggressive. At the same time, margin improvements are essential because getting the margin right takes the pressure off other operating areas of the business. For gross margin, pursue an improvement of .1 to .3 percentage points per year.
If the typical firm is to move towards high profit, it must identify exactly how the successful firm produces superior results. In doing so, it must re-examine the critical profit variables and set realistic improvement targets for each measure. Without such planning, high-profit performance will always remain an elusive target.
Excerpted from AED’s 2004 Cost of Doing Business/Profit Opportunity Report, printed in the November 2004 issue of Construction Equipment Distribution.
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