Profiting From Others

By comparing their operating results to other firms in the industry, kitchen/bath dealers can readily see how they can improve their company's profits, a new NKBA report demonstrates.

1. Comparison of the Critical Profit Variables 
Between 'Typical' & 'High-Profit' Dealers
'Typical' Dealer  'High-Profit' Dealer Sales Per Employee  $167,896  $244,633 Gross Margin Percentage  34.5%  33.0% Operating Expense Percentage  31.2%  22.5% Inventory Turnover (No. of Times)  12.7  44.5 Average Collection Period (In Days)  18.0  11.5  

HACKETTSTOWN, NJ Financial performance apparently varies widely among kitchen and bath dealers, and can be significantly enhanced by developing an understanding of a company's financial structure, as well as a recognition of how similar dealerships are performing throughout the industry.

That is one of several key conclusions contained in a comprehensive new report released last month to Kitchen & Bath Design News by the National Kitchen & Bath Association.

The NKBA's recently com-pleted 2000 Dealer Profit Report produced annually for the Hackettstown, NJ-based trade association was prepared for the NKBA by the Boulder, CO-based Profit Planning Group.

The 18-page report was released recently to participating NKBA-member kitchen and bath dealers as a service that enables them to compare their company's financial performance to other industry firms of a similar size, structure and geographic location. Results of the report were based on the responses of 133 participating dealers, who provided operating results from the 1999 calendar year, according to the NKBA.
The report revealed significant differences between the financial and operating performance of "typical" and "high-profit" kitchen/bath dealerships, and suggested ways for dealerships to monitor, and improve, their profitability.

2. Overview of Financial Results
Among 'Typical' & 'High-Profit' Dealers
'Typical' Dealer  'High-Profit' Dealer Net Sales  $1,200,000  $891,009 Cost of Goods Sold  786,000  596,976 Gross Margin  414,000  294,033 Operating Expenses  374,400  200,477 Operating Profit  39,600  93,556 Other Income/Expenses  0  0 Profit Before Taxes  $39,600  $93,556 Total Assets  $240,000  $114,232 Return on Assets  16.5%  81.9%  

The report also vividly illustrates that controlling key profit variables is of far greater significance in achieving financial success than simply increasing annual revenue a focal point of most dealerships

For example, the "typical" NKBA dealership surveyed for the report posted 1999 revenues of $1.2 million, and a pre-tax profit of 3.3% (or $39,600). In contrast, "high-profit" firms posted revenues of $891,000, but a pre-tax profit of 10.5% (or $95,550).

Also of note, the "typical" NKBA firm had a pre-tax return on assets (profit before taxes, expressed as a percentage of total assets) of 16.5%. For the "high-profit" firm, the return on assets was 81.9%.

"A number of factors led to the differences in results," the report stated, adding that, in most instances, these differences can best be illustrated by what are commonly called the CPVs, or critical profit variables.

These variables include:

  • Sales per employee, which measure employee productivity levels.
  • Gross margin percentage, which reflects a company's abil-ity to effectively manage the cost of goods sold.
  • Operating expense percentage, which focuses on expense control.
  • Inventory turnover, an indicator of how well inventory is managed.
  • Average collection period, which reflects accounts receivable collection practices.

According to the report, "typical" and "high-profit" firms exhibited not only different sales volumes, but rates of growth. For example, for the "typical" dealer, revenue increased by 8.7% from 1998 to 1999; by comparison, the increase was 24.2% for the "high-profit" dealer.

In addition, the dealerships reported substantial differences when it came to the critical 
profit variables. 

3. Comparison of Other Key Operating Results
Between 'Typical' & 'High-Profit' Dealers
'Typical' Dealer  'High-Profit' Dealer Pre-Tax Profit Margin  3.3%  10.5% Asset Turnover  5.0  7.8 Pre-Tax Return on Net Worth  29.7%  114.7% Cost of Goods Sold (As %)  65.5%  67% Payroll Expenses (As %)  19.9%  12.8% Occupancy Expenses (As %)  3.5  3.0 Accounts Payable to Inventory  101.1%  61.6% Accounts Payable Payout Period (Days)  25.5  1.1 Debt to Equity  0.8  0.4 Financial Leverage  1.8  1.4  

"The high-profit firm seldom performs better on all of the CPVs," the report notes. Instead, the report added, it is the sum-total of their performance on the CPVs which can produce a dramatically improved operating performance.

"The nature of the differences between the typical and the high-profit firm, and the underlying reasons, need to be understood by every dealer," the report said.

A profit 'model' Kitchen and bath dealers can utilize a financial management tool known as the "Strategic Profit Model" to get a handle on how profitable their company is, and how that profitability can be improved, the NKBA-Profit Planning Group report states.

According to the report, the "Strategic Profit Model" is simply a graphic representation of comprehensively analyzing return on investment termed "the most meaningful way" to measure the overall profitability of a kitchen/bath dealership.

The report notes that there are two distinct return on investment measures return on assets and return on net worth (sometimes known as return on owner equity). Return on assets examines the economic viability of a company, while return on net worth looks at the return being generated by the company's owners.

The two return-on-investment ratios are driven by a trio of performance indicators profit margin, asset turnover and financial leverage each of which "represents a different strategy, or profitability pathway, to improve return on investment," the report observes.

What follows is a thumbnail look at the three profit pathways outlined in the NKBA-Profit Planning Group report:

Path 1: 

  • Profit Margin. Management of profit margins is the most important profitability pathway, since it focused on sales productivity, gross margin management and operating expense control, the report states. Expressed as a percent, it is a calculation that is arrived at by dividing profit before taxes by net sales. As an example, if a company produces 3.3¢ for every $1.00 of sales, the pre-tax profit margin would equal 3.3%.
    "Typical" NKBA dealers reported a pre-tax profit margin of 3.3%; "high-profit" dealerships reported a pre-tax profit margin of 10.5%.

Path 2: 

  • Asset Turnover. Asset turnover reflects the sales the company produces per dollar invested in assets. It is arrived at by dividing net sales by the value of a company's total assets. As an example, a ratio of 5.0 means that a company is able to generate $5.00 in sales for every $1.00 in assets.
    "If a firm's assets cash, accounts receivable, inventory, property, equipment and other assets can be used as efficiently as possible, then a maximum amount of sales can be generated from a given asset investment," the report states.
    "Typical" NKBA dealers reported an asset turnover of 5.0; "high-profit" dealerships reported an asset turnover of 7.8%.
  • Return on Assets (ROA). This is the direct result of the first two pathways profit margin multiplied by asset turnover, expressed as a percent. "This measure of performance is a good indicator of a firm's ability to survive and prosper," the NKBA-Profit Planning Group report states, adding that a company's pre-tax return on assets should at least equal the cost of capital.
    For the "typical" NKBA dealer, the ROA is 16.5%; for the "high-profit" dealer, it is 81.9%.

Path 3: 

  • Financial Leverage. A measurement of the total dollars of assets per each dollar of net worth (arrived at by dividing the former number by the latter), financial leverage reflects the extent to which a company uses outside financing. The higher the ratio, the more the company relies on non-owner sources for funding. A ratio of 1.8, for example, suggests that for every $1.00 in net worth, the firm has $1.80 in total assets. If for every $1.80 in total assets the owners put up $1.00, then outsiders put up the remaining $0.80.
    The financial leverage ratio for the "typical" NKBA dealer is 1.8; the ratio for the "high-profit" dealer is 1.4.

The end result of the three profitability pathways is return on net worth. This figure, expressed as a percent, can be calculated by multiplying profit margin by asset turnover, and then multiplying that number (return on assets) by financial leverage. It can also be arrived at by dividing pre-tax profit by total net worth.

For the "typical" NKBA dealer, pre-tax return on net worth is 29.7%. In other words, for every $1.00 of net worth, the company produced 29.7¢ of profit before taxes. By comparison, the pre-tax return on net worth for the "high-profit" dealer is 114.7%, meaning the company produced $1.147 of profit for every $1.00 of net worth.
The NKBA-Profit Planning Group report points out that it is seldom possible to generate an adequate rate of return on net worth by emphasizing just one of the three profitability pathways.

Instead, "each pathway should be examined carefully for improvement opportunities, and then trade-offs made in order to increase overall profitability," the report advises.

"An improvement plan should not be based upon any single measure of performance, but be developed with the complete picture in mind."

Other tips for improving financial performance offered to kitchen/bath dealers by the 2000 Dealer Profit Report include the following:

  • A company's income statement serves as the "primary scorecard of management's effectiveness, " since it "reflects the ability of management to generate sales, produce a reasonable margin on those sales, control expenses and earn an equitable profit," the report noted. Specific expenses should be viewed as a reflection of percent of sales, since this provides a basis for evaluating margin and expenses in relationship to the underlying sales volume.
  • The balance sheet is "an under-utilized financial statement," according to the NKBA-Profit Planning Group report. If properly analyzed, both the assets and liabilities sides of the balance sheet provide significant insights into the financial structure and investment posture of a company, the report continues. The assets side reflects where investments are made; the liabilities side identifies which business stakeholders made the investment.
    Ideally, cash balances should equal at least two to three percent of total assets. "For firms below that level, the potential for cash flow problems continually exists," the report stated.
    Pointing out that most kitchen/bath dealerships are cash short, the report also notes that the bulk of asset investment for most dealerships is in accounts receivable and inven-tory. For the typical NKBA dealer, these two items are 28.2% and 12.5% of assets, respectively. For high-profit dealers, the numbers are 27.2% and 3.9%, respectively.
  • Additional financial terms that dealers need to familiarize themselves with include current ratio (current assets divided by current liabilities), which assists in cash-flow management); quick ratio (cash plus accounts receivable divided by current liabilities), a measure of the extent to which liquid resources are readily available; and debt to equity (total liabilities divided by net worth), the proportion of financing obtained from owners.

Dealers are advised to work closely with their accountants in developing an understanding of the financial structure of their businesses, and how profitability can be increased, the NKBA noted. Dealers should also continually benchmark their businesses against others in the industry if they're to obtain a true understanding of how their business is performing, the association added.

Editor's Note: All of the figures provided in this story, and for the purposes of the graphs, are medians. This is the middle number of all values reported, from lowest to highest and represents the "typical" company's results.
To determine the group of high-profit firms, participating companies were ranked on the basis of pre-tax return on assets (ROA). The high-profit category includes the top 25% of the companies, based on ROA. The figures reported for the high-profit firms represent a median for this group.

Additional information on the 2000 Dealer Profit Report can be obtained from the NKBA, at (908) 852-0033.