Imagine a world without measurements. That scenario is scary, given my love for numbers. How would we tell how much we weigh, our blood pressure reading or our body temperature? These are all very important to our personal health. In business, it’s vitally important we measure performance in order to expound on those parts of our business that are doing well and improve the parts of the business that are, well, not doing as well – in other words, to ensure our business remains as healthy as possible.
KPIs Are Not Real Money, But They Sure Tell A Story
Key Performance Indicators (KPI) are just that – vital measurements of business health. They might not be real world dollars we can deposit in the bank, but they are indicators of why we are (or are not) able to make those deposits. Usually in the form of percentages or just plain numbers, the relationship between one business’s KPI to another gives us another scorecard with which to manage.
The most basic, yet one of the most important KPIs to measure, is margin percentage. Directly related to cost of goods sold (see Profit & Loss Part 1), it is that percentage of the selling price of a product that we get to “keep” after paying for the inventory we sold. Margin percentage can be calculated as: (Sales – Cost of Goods Sold) / Sales.
If you already know your cost of goods sold percentage, another way to quickly calculate your margin percentage is to simply subtract your COGS from 100 percent as in the following example: 100 percent–45 percent (COGS) = 55 percent (Margin Percentage).
I won’t go into the details of COGS again, but suffice it to say that if we have a low COGS, we will have a high margin percentage. And a high margin percentage gives us money to pay for operating expenses, wage & wage benefits, and profit.
Who performed best in the KPI of margin percentage? Let’s look at our sales groups, total group and best practices first (Figure E).
Garden centers in the $1.5–$2.5 million range had the clear advantage here. They were a full 2 percent better than the smaller centers, and almost the same (1.8 percent) higher than the group of larger centers. It might not seem like much, but that’s 2 percent more to cover expenses and a 2 percent head start on profitability.
Total Group’s percentage may not seem impressive compared to the best practices, but it is to me. Consider that our Group’s average was 45 percent when first measured five years ago. Seven percent improvement over a short span of time is in itself a testimony to the owners and staff working to improve their garden centers’ profitability. It’s also a necessity, since the very costs covered by margin percentage – operating and wage & wage benefits – are rising steadily, as well.
What more can we say about best practices? Most of the reason they are in best practices is that they performed so well in the KPI of margin percentage. Several centers reached into the low 60s, which is phenomenal buying and inventory management.
There was almost an 8 percent difference between the highest and lowest performing regions. A number of reasons can be cited, including management styles, inventory mix and regional economy. The Northwest centers were the winners here, higher even than the best practices centers (Figure B).
What are the largest determining factors of margin percentage attained? My three Ps are – People, Product and Phacility. All three have to be in place and functioning to their utmost in order for your center to achieve high margins. One of the most telling exercises I conduct at garden centers is allowing owners and staff to grade themselves in the three Ps. The results show the margin they feel they deserve. This one can be all over the board, but it usually points to one or two of the three as a major roadblock to high margins.
Moving Water Turns The Mill Wheel
And moving inventory turns the garden center … into a profitable one. Inventory turns, that long misunderstood but very important KPI, are the backbone of a successful business. Expressed in a numerical value, the calculation is as follows: Cost of Goods Sold / Average Inventory at Cost.
We defined cost of goods sold previously as Beginning Inventory + Purchases – Ending Inventory. Average inventory is the average value of inventory on hand at cost over the last 12 months. We usually take this measurement once a month, add the total inventory value, and then divide by 12.
The key words on both sides of the equation above are “cost.” Cost is the lowest common denominator that can be used in any turns formula. Other inventory turn formulas use retail dollars and units, but these are skewed by differing margin percentages and unit sizes.
Inventory turns are a measure of the number of times you sold and replaced your inventory during the course of an entire year. When I said inventory turns were misunderstood, I meant we normally try to over-simplify in our heads how turns work. We generally think that if we received five shipments of trees in one year and sold them all, we turned it five times. But the timing of those deliveries and when we sold them over the course of the year are the determining factors. Buy them all at once early in the year and sell most of them late in the year equals slow turns. Buy them in smaller amounts, sell them quickly and then replace them with new stock equals faster turns.
With that in mind, let’s look at inventory turns achieved in the P&L Study (Figure C).
Remember, faster turns usually mean better performance. When I say usually, I have to remind owners and staff that trying to turn inventory too quickly can lead to a loss in sales due to too low an average inventory. Your own management practices will have to determine where that threshold is. Hey, I didn’t say this was going to be easy!
In the results, you will notice a marked difference between categories in inventory turns. This is due to the seasonality of the category and the management practices employed. How is this tied to profitability? The faster the turns, the fresher the inventory to sell, which means less discounting, which leads to higher margins. Whew, that was a mouthful! But that’s not all. With lower average inventory, we have fewer wages & wage benefits and operating expenses to pay, which leads to higher profitability. An added benefit is that we have our own money to buy in new inventory, which means we have less dependence on borrowed money/lines of credit.
But Wait . . . There’s More!
Just as important but lacking the space to explain them in detail, the remaining key performance indicators measured are presented in the sales and regional group format (Figures D and A).
A quick explanation of the ratios is necessary, however. Plus or minus 2006 sales is merely the percentage up or down. Days sales in ending inventory is the number of days’ sales the ending inventory would support without ordering another dollar of inventory in. Margin $ per labor hour measures the efficiency of your sales and support staff per hour in attaining margin dollars. Average sale is the total sales (sales tax not included) divided by the number of transactions. While all are important, the average sale is even more important in the face of declining transaction counts at most garden centers.
So far, we have covered revenues (sales), cost of goods sold, operating expenses, wage & wage benefits and the key performance indicators. How did Group centers’ revenues and expenses line up to equal profit? What did the best practices group do to attain 10 percent or better profitability? Hopefully you’ve been keeping score. Even if you haven’t, next month we will wrap up this series with the results we’ve all been waiting for – the bottom line – profit.