Multi-Unit Franchisee Magazine Issue II, 2014 | Page 75

has rental assets that cost him $800,000. If they were as productive as the assets of the top 25 percent, he’d have made another $32,000 in gross profit. Reading through his industry benchmark report, John sees his issue: low gross profit in relation to the investment in rental equipment, along with several specific possible causes (under-utilized rental inventory, high costs of rental assets). Could his low gross margins be caused by any of the other factors listed above, such as poor pricing or poor buying? We checked the competition’s prices and found that John could raise his prices without affecting his position in the market. An increase of only 1 percent on sales of a $1 million, and voila!, we found $10,000 more for the bottom line. Next stop, cash flow. Since John shared with us that he ran into some cash crunches last year, let’s look at how he rates in that department. According to our roadmap, low cash is caused by high current liabilities, too much inventory, and too much customer credit. While John appears to have done a decent job in managing his inventory, one of the key ratios—the current ratio—indicates that his solvency is off, compared with his peer group. In fact, for every dollar of current liabilities (that will need to be paid in the next year), the high-profit group has current assets (assets that will become cash within a year) of $2.43 to pay off their liabilities, compared with John’s $1.75. (For his entire peer group, that figure was $1.39.) Using the roadmap, we find that one of the possible causes behind his low cash is too much customer credit. And, as we’ll see, something that can really drive up that number is taking too long to collect his accounts receivable (A/R). While his highprofit peers took 44 days to collect money from their customers, John took 52 days for his. This 8-day difference is crucial to his low cash situation. If we know the formula for A/R turnover (the rate at which customer debts are collected on an annual basis), we can use these numbers to find out what his receivables “should” have been, had he managed his collections process as well as his peers did: 1) If we know that A/R Turnover = Credit Sales ÷ A/R, then 2) We can rearrange the formula like this: A/R = Credit Sales ÷ A/R Turnover. 3) Then, if we add the word Target to both sides of the equation: Target A/R = Credit Sales ÷ Target A/R Turnover. We know that John’s 2013 sales were $1 million, and that 50 percent of sales were made on credit. We can then divide the credit sales by the high-profit group’s A/R Turnover number of 8.4 (the target): Target A/R = $500,000 Credit Sales ÷ 8.4 Target Turns = $59,524. But John’s actual A/R at year-end was $72,500, an A/R of nearly $13,000 more than his high-profit peers. When you take the $13,000 excess A/R and divide it by 8 days, that’s $1,625 for every day John lets his customers keep his cash. (You might recall that one of the causes behind low gross margin is not taking discounts on payables. With more cash, John might have nabbed some of those discounts and increased his margins—or maybe avoided that last-minute credit line and resulting interest.) John has now found a plan to improve his collections and decides to schedule a management meeting today to put it into action. Let’s summarize the results of our little sleuthing exercise: More Profit Improve asset productivity $32,000 Raise prices $10,000 Other issues yet to be identified $6,000 Total gross margin difference $48,000 Total A/R difference More Cash $13,000 That’s a total of $61,000 of improvements to profit and cash flow we found in just one quick trip around the roadmap— and we didn’t even get into the third area of low net profits! My challenge for you is simple. Use this format to take a trip through your business. As with any trip, you can’t reach your destination without a map, and that’s what this framework is: a financial roadmap. You can’t solve the mysteries until you know what to ask and where to look! Steve LeFever is the founder and chair of Business Resource Services (BRS), a Seattle-based consulting firm that provides financial management education, network benchmarking, performance group facilitation, and bookkeeping services for closely held businesses under its Profit Mastery brand. Learn more at www.profitmastery.net. or contact him at 800-488-3520 x14 or [email protected]. MULTI-UNIT FRANCHISEE IS S U E II, 2014  73