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The 2016 NFDA Profit Report is Now Available For Purchase

Thursday, August 25, 2016   (0 Comments)
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NFDA Member Price: $250 • Non-Member Price: $500


Purchase Report Online Here


 

Generating Adequate Profit In Turbulent Times

 

The year 2015 could be characterized with the Dickensian phrase: It was the best of times, it was the worst of times. Economic growth was steady, albeit unexciting. With lower energy prices, there were few economic storm clouds to worry about. This allowed distributors in almost every line of trade to improve their profitability. It was the best of times.

 

Towards the end of the year though, manufacturing output turned down which created uncertainty across all of distribution. In addition, the threat of increased competition from web-based competitors made it increasingly difficult to generate higher gross margins. Finally, wage rates started to turn up after a long period of virtually no increases. Cost escalation seemed inevitable. It was the worst of times.

 

Some companies were able to address both the opportunities and the challenges to generate outstanding profits. They did so by managing the three major Critical Profit Variables (CPVs). Those crucial CPVS are (1) the ability to increase sales a little faster than inflation, (2) the ability to maintain an adequate gross margin in the face of competitive pressures and (3) maintaining control of expenses, especially payroll, despite an upward trend in expenses associated with an improved economy.

 

Interestingly, the high-profit firms almost never truly excelled at any one of the CPVs. Instead, they were able to manage the collection of profit drivers just a “little bit” better than the typical firm in the industry.  This small delta in performance was enough to generate dramatically higher profit.

 

The NFDA financial benchmarking study provides some key insights into exactly how the high-profit firms generate better profit numbers. It focuses intently on the three profit drivers identified earlier—growth, gross margin and expenses. The report provides a roadmap for any firm wanting to improve its financial performance.

 

Typical Versus High Profit

The term “Typical Firm” in the report means the firm that is most representative of the industry.  This typical firm is the one with financial performance in the exact middle of the results for all participating firms. That is, on any given measure, half of the firms performed better than the typical firm and half performed worse. It is the best measure of industry performance on the profit drivers.

 

In 2015 the typical firm generated sales of $14,438,306. On that sales base, it produced a pre-tax profit of $750,792, which equates to a profit margin of 5.2% of sales. Stated somewhat differently, every $1.00 of sales resulted in 5.2 cents of profit.

 

In contrast to the typical firm, the high-profit firm generated a profit margin of 12.2%. This means that even if the high-profit firm had produced the same sales volume as the typical firm, it would have generated more profit for reinvestment in the firm. It is a reinvestment factor that tends to multiply over time.

 

 

Managing the CPVs

In trying to move from typical to high-profit, the key is to understand the CPVs with greater precision. To facilitate that understanding, the CPV results for the typical firm and high-profit firm in the industry are summarized in Exhibit 1. While there are other factors that could be examined in evaluating performance, these are the ones that really drive performance.

 

Exhibit 1
The Critical Profit Variables

 

 

Typical

 

High Profit

 

Performance Results

 

 

 

 

    Net Sales

$14,438,306

 

$7,926,241

 

 

Profit Margin (pre-tax)

5.2%

 

12.2%

 

 

The Critical Profit Variables

 

 

 

 

 

Sales Change

-0.1%

 

10.9%

 

 

Gross Margin

34.3%

 

40.0%

 

 

Payroll Expense

20.8%

 

19.9%

 

 

Non-Payroll Expenses

8.3%

 

7.9%

 

 

 

At first glance, some of the differences in the CPVs between typical and high-profit may appear to be so small that they don't even deserve management attention. In fact, it is these small differences that combine to produce major changes in profit margin. This means that the typical firm doesn't have to dramatically improve performance on the CPVs, but simply do a little better across the board. There is a multiplier impact when performance is better in a few areas, even if "better" is relatively small.

 

From a management perspective, it is not even necessary to do a little better everywhere. Statistically, only about five firms out of a hundred out-perform the industry on all of the CPVs.  However, being “good on everything” is not necessary to generate a high level of profitability. What is important is to be good on what counts.

 

It is important to emphasize once again that the CPVs that are the most important to enhancing profit results are sales growth, gross margin and total operating expenses (both payroll expenses and non-payroll expenses). Each factor needs to be planned carefully to ensure adequate profits.

 

  • Sales Growth

The level of sales growth is always a key issue in generating adequate profits. However, there is a misunderstanding that very rapid sales growth is required for success. In fact, it is not necessary to achieve dramatic sales growth, just a growth rate that results in improved profitability.

 

The minimum rate of sales growth that a firm should plan for equals the rate of inflation plus three percentage points. Consequently, if the inflation rate is 2.0%, then ideal sales growth would be at least 5.0%. Again, this should be viewed as a minimum. Growth faster than 5.0% will help improve profits a little.  Growth less than 5.0% will almost never lead to higher profit.

 

Sales growth that is too slow means that expenses, which tend to be tied closely to inflation, out-pace the rate of growth so that expenses as a percent of sales increase. While very few firms believe so, sales growth that is too rapid is also a problem. Financing rapid growth is always a challenge, and operating systems tend to get taxed when growth is too rapid.

 

The reality is that almost no firm will ever turn down a rapid rate of sales growth. However, firms should be aware that sales growth solves a lot of problems, but very rapid sales growth tends to create as many as it solves.

 

Again, the ideal level of sales growth is to beat the rate of inflation by somewhere around three percentage points. Firms should make such an effort a central part of their planning process.

 

  • Gross Margin

Price pressures never go away, even as the economy recovers. It would seem that as sales growth takes hold, firms would enjoy a pricing advantage. The reality is just the opposite. The excitement associated with increasing sales tends to cause firms to become lax with regard to pricing control.

 

In almost every industry an adequate gross margin is a major determinant of profitability. The real driver behind improved, or at least maintained, gross margin performance is continual monitoring. There is no firm in any industry that could not make a modest improvement in gross margin.

 

  • Payroll Expenses

Payroll is always the largest expense factor, which means that controlling payroll is essential to controlling expenses. Payroll is another area where a specific improvement goal can be established. Ideally, payroll costs should increase by about 2.0% less than sales. For example, if sales increase by 5.0%, then payroll should only be allowed to increase by 3.0%.

 

At first glance, controlling payroll growth would appear to be a relatively simple, and probably easy, to achieve target. The reality is a different story. Controlling payroll becomes even more difficult in a growth market. Firms often hire in expectation of even more sales growth. In addition, as labor markets tighten, employee retention becomes a larger concern and payroll has the potential to get out of control.

 

  • Non-Payroll Expenses

The non-payroll expenses are the "least difficult" of expenses to control. Most of these expenses can be brought into line as long as sales really are rising faster than inflation. The vast majority of these expenses are directly related to the rate of inflation. As long as sales growth is maintained above the inflation rate, there is the potential to lower the non-payroll expense percentage.

 

Moving Forward

The high-profit firms produce great results virtually every year. They also reflect the fact that there are no industry barriers to success. The key to improved performance is to develop a specific plan for each of the CPVs and combine them in a positive way. The goal is not perfection. The goal is to do a little better across the board. It is an opportunity that is open to every firm.

 


NFDA Member Price: $250

Non-Member Price: $500

 

Purchase Report Online Here



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