The Value of Strengthening Your Financial I.Q.

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The kitchen and bath industry is an industry where there may be too much emphasis on design and sales – quite often at the expense of business management expertise.

You don’t need an MBA to make a hefty bottom line in this business. But kitchen and bath dealers do need an understanding of how to structure their financial statements properly, how to read them properly, how to know what ratios are important, and how to use these critical management tools to make intelligent business decisions.

Without a good grasp of the financial side of this business, few owners will ever approach the 30% return on income that a “studio business model” can generate (see September 2005 column entitled “Pay Yourself First”).

Few owners will ever be in an enviable position of developing and managing a chain of kitchen and bath showrooms where economies of scale fatten the bottom line to the point where there are buyers clamoring to send owners into a retirement of riches.

Indeed, a lack of owner financial know-how has kept this industry fragmented, causing many independents to fall by the wayside during business slowdowns and depriving their vendors of consistent, positive growth.

REASONS FOR EDUCATION

What follows are three leading reasons why kitchen and bath design firm owners need to strengthen their financial acumen:

1. Ignorance Can Lead to Disaster. More than 70% of the hundreds of financial statements I’ve analyzed use cash accounting. That is, these companies recognize revenue when they receive a check. Big mistake! Cash accounting basically posts the job income well before any job costs are incurred. As a result, gross and net profit margins are inflated, leading owners to believe their companies are profitable when many are actually not! (To understand the other negative impacts of cash accounting for a kitchen dealer, see the February 2005 column entitled, “The Critical Importance of Accrual Accounting.”)

For example, have you ever wondered why your P&L statement shows a 45% gross profit on income when historically you have marked up all costs 50% (which would generate a maximum 33% gross margin)?

Armed with erroneous information, business owners will make all kinds of poor decisions – like buying a new delivery van, adding staff, purchasing a building, taking a sizeable bonus check – at a time that they can ill afford them. Then, if business slows down, a nasty spiral to oblivion could begin: fewer deposit checks can’t cover the increased overhead, vendors and subcontractors don’t get paid, products aren’t shipped, jobs aren’t completed, clients sue, and the business closes.

2. Gain Control over Your Bookkeeper. Most owners I have met in this industry are trusting souls. They pretty much believe that their bookkeepers know what they are doing. So when these owners learn they should run their operations based upon accrual accounting, they will check with their bookkeepers to see if they are doing the right thing.

Even when their bookkeepers say “yes, we’re on accrual accounting,” the fact is, most are not! That’s because most have not been trained properly in accrual accounting with software packages such as Quickbooks. They assume, incorrectly, that by checking off the box marked “accrual” on the computer screen, an accurate P&L statement will be produced. But if the information isn’t entered properly, then the report will be erroneous. The old saying “garbage in, garbage out” clearly applies here.

With education, it’s pretty easy for business owners to determine whether their financial statements are set up properly. In fact, even with a little bit of education, it’s pretty easy to read monthly reports, catch mistakes and make sound business decisions based upon an accurate financial performance. So as owners become more financially knowledgeable, they can provide better leadership to their bookkeepers. In return, they’ll gain respect and reduce any possible risk of embezzlement to the firm. (This last benefit should not be underestimated, since I know of at least five kitchen dealers who’ve each had their bookkeepers embezzle tens of thousands of dollars!)

3. Compare Financial Performance with Your Peers.Have you ever wondered where and how your firm could be doing much better? Imagine sitting at a roundtable with a dozen respected peers, none of whom are competitors, comparing your financial statement to a composite report of the group’s performance. To be included in the report, everyone’s financials must be based upon accrual accounting. So you know it’s a fair comparison, but you need to be able to understand the nuances of reading financial statements to appreciate the fabulous advice you will receive from your peers.

And there will be no better advice than from non-competing peers! Says Mark Palmer of Jacksonville, FL: “The key benefit I received from my roundtable group is that if they can earn more than a 40% gross profit, then I can do it, too. We were at a 25-26% gross profit when we started. Now we are coming in at 36% and heading higher. You can’t put a value on gaining the confidence and the means to achieve higher margins!”

GETTING THE RIGHT TRAINING

Years ago I took a one-day course in New York that was marketed as “Financial Management for the Non-Financial Manager.” As someone who had grown up on the design and sales side of this business, it was a real eye-opener! As much money as I was making as a sales designer in the kitchen and bath industry, I recognized that I would never realize my full income potential until I mastered what was presented in that class.

So I kept studying the workbook until I grasped all of the meaningful financial ratios and could use them intelligently in conversation. As a result, I was able to ask better questions of my advisors and accountant – and get much better advice. I was also able to develop three additional showroom locations that operated at 51.5% gross profit margins – well above the 32-33% average industry margins back then. My owner’s return on income soared.

A similar program, specifically tailored to the kitchen and bath industry, is now available. Entitled “Managing for Maximum Profit,” it will be offered in three cities in 2007: Chicago on March 30, Boston on June 22 and Atlanta on November 2. The program is co-sponsored by Kitchen & Bath Design News. For additional information, please visit www.SENseminars.com.

Read past columns on Bettering Your Bottom Line by Ken Peterson, and send us your comments about this story and others by logging onto Kitchen & Bath Design News’ Website at www.kitchenbathdesign.com.

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