Issue link: https://www.e-digitaleditions.com/i/314415
26 FEDA News & Views Sales to Profit continued sales, operates on a gross margin of 22.5 percent of sales and produces a bottom line profit of 2 percent of sales or $300,000. Three different scenarios are presented in the exhibit. They all enjoy sales growth of 10 percent. The differences in the scenarios are related to what happens to gross margin and payroll expense as a result of the sales growth. The Business as Usual scenario assumes that sales, gross margin and total expenses all increase at the same 10 percent rate. The result is that dollar profit also increases by 10 per- cent. From a percent-of-revenue perspective, shown in Exhibit 1, everything stays the same. Dollars are up but percentages remain flat. The second scenario, Profit Deterioration, reflects the profit challenges currently facing distributors. In this scenario, gross margin dollars increase by only 9 percent while sales increase by 10 percent. Second, payroll expenses increase by 11 percent during the same period. With these minor variations, profit falls from the original $300,000 to $275,250, a decline of 8.2 percent that complete- ly offsets the sales increase. The profit margin also declines from the 2 percent starting point to just 1.7 percent of rev- enue. In simplest terms, even small, seemingly insignificant changes, are not all that insignificant. The final scenario, Profit Enhancement, reverses the prof- it challenges. It demonstrates the effect of an 11 percent increase in gross mar- gin and only a 9 per- cent increase in pay- roll. The profit impact, however, is not simply a mirror image of the Profit Deterioration results. The impact is dramatic, with profit rising to $384,750, an increase of 28.3 percent. In short, sales growth is nice. However, the factors under- lying it are decidedly more important than the sales growth itself. The deterioration in gross margin and payroll expense performance must be reversed. If that can be achieved, the typical FEDA distributor is positioned for strong profit results. More of the Same The profit challenges facing distributors today are nothing more than a repetition of the challenges that have followed every period of economic sluggishness and recovery. The euphoria of sales growth causes managers to forget most of the painful lessons learned in the down period. As demonstrated in Exhibit 1, those lessons are centered on gross margin and payroll expense. While both of these factors are important, gross margin is the real profit driver. For exam- ple, the total profit swing between the Profit Enhancement and Profit Deterioration scenarios in the exhibit is $109,500. Of that amount, $67,500 (or 61.6 percent) comes from gross margin. Experience from prior periods of strong sales growth suggests that the gross margin issue is nothing more than one of focus. The sad reality is that gross margin walks out the door when strong sales growth walks in. Getting the margin focus back requires communication, analysis and emphasis on some mundane operational issues. The communication issue requires reinforcing the impor- tance of price integrity throughout the firm, but especially to the sales team. Without constant reminders regarding pricing, gross margin slippage occurs almost automatically. The analysis component involves finding hidden opportu- nities to improve gross margin. In both good times and bad, firms continue to under-price their slowest selling items and special order merchandise. The improvement potential is more substantial than most firms believe. Finally, it is also essential to deal with the pesky operational issues that are ignored when everybody is busy with growing sales volume. Pricing errors are endemic to firms with lots of SKUs. Cleaning them up creates "free" gross margin dol- lars. Tighter control of shrinkage also represents a significant opportunity. Neither of these topics are exciting, but both are important. Resisting the Urge to Catch Up The keys to payroll control are twofold. The first is eupho- ria. The second is an infrastructure bias. The euphoria problem arises because there is an under- standable tendency to want to help employees "catch up" on payroll increases that may have been deferred during the (866) 327-4159 www.micromatic.com (866) 327-4159 www.micromatic.com Simplifying Draft Beer Dispensing NORTHEAST PENNSYLVANIA SOUTHEAST FLORIDA WEST CALIFORNIA CENTRAL ILLINOIS The sad reality is that gross margin walks out the door when strong sales growth walks in. Getting the margin focus back requires communication, analysis and emphasis on some mundane operational issues.