Too much emphasis is probably placed on sales volume in the kitchen and bath design business. It’s always the first thing we compare with colleagues. Meanwhile, gross profit percentages, despite having a great influence on relative sales volume, are not addressed nearly as often. And I have never heard comparative returns on investment (ROI) mentioned.
But with sound financial management, it is quite possible that a kitchen and bath design firm can consistently earn between a 30% and 50% return on investment. Given other investment choices, that is a pretty fair rate of return.
In a sales- and design-oriented industry, perhaps the omission of ROI in industry conversations is natural. But understanding the financial concept of return on investment in our own business does not have to be difficult. We think in these terms within our family life, so we should be able to apply it to our business life.
For example, let’s say your Aunt Clara leaves you $20,000. You need to consider different investment possibilities, weighing the yield (i.e. return) versus liquidity and safety factors. You can put the $20,000 in a safe passbook savings loan yielding 1-3/4% interest, a certificate deposit yielding 5%, or possibly make a deposit on a resort condo with an expected appreciation rate of 8%. Of course, the real estate deal comes with a lot greater risk and is relatively illiquid, meaning it could take months before it is sold and your original investment and subsequent profit converted into cash.
Now suppose you considered investing that same $20,000 in your kitchen and bath design firm. What return on investment would you want, or expect to earn? This is a tough question for most dealer-owners. Yet it is crucial to understand and use the concept of return on investment to make sound business decisions. Indeed, it is the single, most important factor in kitchen and bath firm owners realizing their full profit potential. So, to determine what return you should expect from a $20,000 investment, you will need to examine your latest financial statements.
Consider the balance sheet (at right) and simplified income statement (below, right):
Customer Deposits Enhance ROI
Understanding the components of the ROI formula will give you clues where the $20,000 would be best invested. For example, the financial leverage multiplier is excellent at 4.44, substantially higher than the 2.0 that bankers look for. It’s higher because the 50-40-10% terms with consumers make this a “near cash” business. In effect, customer deposits are used to finance our working capital needs whereas most other industries would require short-term financing.
Conversely, the relatively low percentage return on assets (7.5%) is the major formula deterrent to a higher return on investment. The following areas might be in need of attention, thereby directing where the $20,000 investment can be best made:
- At 3%, the net profit is low. Using the $20,000 in cash as negotiating leverage, extra discounts in business and/or health insurance could be secured in return for prompt payment in full.
- To boost the net profit, the $20,000 could also be used to buy materials better. Joining a buying group should be a primary consideration. After all, at 59%, the cost of goods sold is the largest expense on the income statement. Just a 1% decrease in the cost of goods sold directly improves the bottom line by 1%. And a 4% Net Profit increases the ROA to 10%, leading to a 44.4% ROI. That’s a 1/3 improvement over last year’s 33.3% with just a 1% improvement in the net profit!
- At 2.50, the TAT is weak. The $20,000 could be used to launch an effective marketing campaign to generate more income from the existing displays.
Mastering the return on investment concept and applying it to everyday decisions is the key to financial success in the kitchen and bath design field. To build your comprehension of this critical piece of knowledge, owners can attend the “Managing For Maximum Profit” seminar, co-produced by KBDN and SEN Design Group. For more information, visit www.senseminars.com.