The below article is based on a study I did a couple of years ago. It is mostly valid today.
By David McMahon
Improvement starts with awareness and desire. The awareness of how you are performing against standards allows you to understand your strengths and weaknesses. It is through the measurement against these standards, or metrics, that you can find your gaps. Knowing your gaps and then having the desire to create a strategy and act upon an improvement plan is what separates average and top business managers.
For the good of the industry and to assist home furnishing retailers in improving their individual operations, we are publishing the financial portion of our performance observations during 2017.
During the course of 2017, I reviewed a wide-range of operations through our consulting and performance groups activities. In doing so, I established a set of metrics that I consider to be an excellent source for use in benchmarking against average and high-performers.
Below I am releasing the Profit and Loss (P&L) percentages observed. Following this I’ll give my interpretation. These numbers are broken down by what is the commonly accepted P&L format amongst industry retailers. The observations are expressed in 3 columns. The first 2 columns produce P&L’s averages. The 3rd column is used to show the top percentages in select metrics. These are the 3 column groupings:
- Average performers
- Average of Double Digit Profit Club (Net-income before tax) performers
- Average of Top-tier performer for each metric (Top 10%er suggestion)
The observations are expressed in terms of percentages of
total retail sales volume. This allows
for operations of different sizes to compare themselves using a “common-size”
format. For the purposes of
compatibility as well, we excluded electronics and appliances merchandise from
the metrics.
Financial Metric Observations:
Financial Metric Interpretation:
Here are my comments on the above numbers:
- Sales
- Separating the percent of warranty and protection sales with respect to merchandise sales is now the accepted way of producing an industry P&L. This is due to the massive importance of increasing the proportion of warranty sales. They are typically the highest gross margin product that a retailer sells.
- The range of average and double-digit operations in % of warranty sales to total sales 3.73 % and 3.43 %.
- Top-tier operations in warranty sales almost double these averages. Their customers spend 6% of their dollars on warranty and product protection.
- Cost of Sales
- This is a prime area where the double-digit profit club outpaces average performers.
- With respect to cost of merchandise, double-digit profit operations had a 3% lower cost of goods % than an average operation.
- The top-tier performers actually even had almost another 3% cost advantage over the double-digit profit operations at 47%.
- A similar pattern occurred with cost of warranties. Better operations are trained and follow systems to sell on value rather than sell on price in my opinion.
- Gross Margin (GM)
- Gross margin percent of sales is just the inverse of cost of goods. So, the operations with the lower cost have the highest margin.
- This data supports the prior 2 years of formal studies we conducted with the HFA (Home Furnishings Association). Average performers show a 48.18% GM. The double-digit club gets almost 51% GM. While top-tier performers achieve 55%.
- These numbers are real! And, wherever you are with GM, believe that you can improve. I’ve personally helped move this number with clients many times by over 10% while simultaneously growing sales volume.
- Gross Realized Margin
- The generally accepted way of producing an industry P&L is by showing a second gross margin line called Gross Realized Margin. This first lists the reduction of costs by vendor rebates and discounts incurred. Then, it increases cost of sales by finance and credit card fees.
- It gives an alternate gross margin number as non-employee direct costs with purchasing the merchandise and making the sale are considered.
- There is a similar step-up in GM % with the 3 groups observed. So before any operating costs are considered, an average operation has 45.91% of sales dollars left to produce a profit. The double-digit profit club has almost a 3% lead already in the race for net-income.
- Administrative Costs
- Admin costs include general overhead expenses such as: Office and owner payroll, training, legal, accounting, travel, meals and entertainment, markets, software, and all other items that do not fall under occupancy, advertising, selling, distribution, and service.
- We find that on average operations spend around 12% of these sales volume on administration of their business.
- We see a ride range with this metric. It often is effected by the number of locations, the number of family members in the business, and of course with how lean an operator runs. The top-tier in this metric came to a very low 7%. In fact this may even be a bit too low for some. I feel that if an operation is under 10% here and can manage their work properly they are doing exceptionally well.
- Some operations here, in fact do not want to be too low as they feel they cannot provide properly for their employees. Certain owners feel that it is important have a proper amount of spend in admin areas such as health care, training, and technology to remain relevant to in the marketplace.
- Occupancy Costs
- These include all brick and mortar showroom facility costs such as rent, loan expenses, real estate charges, maintenance, and utilities.
- This is typically one of the most fixed costs a brick and mortar retailer incurs. It does not change that much from month to month. Whether sales go up or down, the rent, maintenance and utilities are pretty similar dollar-wise. However, as a percentage, as sales grow these cost fall and result in a positive impact to the bottom-line net income. This is one of the reasons why high performing sales floors produce so much more profit than average performers.
- Average occupancy is 8.15% of sales. The double-digit profit club is 7.64% and the select top-tier performers in this metric are as low as 4%.
- Advertising Expense
- An average operation runs 5-6% of sales. Depending on the location however a profitable business is possible up to even 10%. I’ve seen higher of course, but not too many that actually made much money above that.
- Oftentimes, it is good to consider occupancy and advertising expenses together percentage-wise. Whatever your mix, it is highly advisable to keep the combined percentage under 15% of sales.
- Selling Expenses
- Selling expenses cover sales managers and sales people’s wages, bonuses, commissions and other payroll costs. Sales training, outside design contactors, point-of-sale material may all be included here as well.
- I commonly see operations in the 5% – 10% range. This data is consistent. Average stores are at 9.21%, the double-digit club is at 7.84% while the top-tier in this metric is at 5%.
- This cost should be mostly a variable cost. That means that when sales go up or down selling costs should go up or down as a dollar amount and remain constant as a percentage. I do not mind if this cost is on the high side for any one client as long as their GM % is also on the high side.
- Customer
Service Expense
- This is actually a net percentage. It represents all customer service costs that are related to solving issues with damaged and defective merchandise. It includes any dedicated employees and the costs of repair. Costs are reduced by any income or amounts in credit that are received back as compensation from vendors.
- A highly functional operation has very low service costs as a net percentage.
- Delivery Income
- This P&L breaks out delivery income as a separate line item from warehouse and delivery activities. It should be the goal of an operations to collect an appropriate amount that covers the direct delivery related expenses. Otherwise, delivery costs come straight out of gross margin dollars.
- On average operations seem to collect around 1.9% of sales in delivery income. However, the top-tier performers in this metric collect double that.
- Warehouse and Delivery Expense
- These costs include all physical merchandise handling and logistics employees, their operating facilities, their equipment and any other resources they use.
- On average operations spend 6.15% of sales here. The double-digit profit club uses 1.6% of sales less cash resources at 4.55% of sales. Top-tier performers are as low as 4% of sales.
- Total Operating Expenses
- Total Operating Expenses add up all expenses that are reduced from Gross Realized Margin. It is total of Admin, Occupancy, Advertising, Selling, Service, Delivery, and Warehousing.
- Whenever I see an in-control operation that is running smoothly, without chaos, with a total operating expense ratio of under 40% of sales, I think: Potential Goldmine.
- Average performers are at 40.14% while the double-digit profit club is very lean at 36.2%. I don’t get alarmed when I encounter an operation at 42% or 43% provided they are spending in areas that add value to their business and employees. Operations who are close to 50% in this metric are usually pulling out profit early or are running a broken business model.
- Net Operating Income
- This is the percent of every sales dollar that remains after all costs of goods and regular operating expenses are deducted.
- Average operations show 5.88% Net Operating Income. The double-digit profit club has more than 100% more profit at 12.63 % Net Operating Income. And, the select top-tier operations for this metric have 14%.
- Net Income before Tax
- This is the bottom-line. Other non-operating income, non-operating expenses and interest expenses are added and deducted. Typically, there is little in either category with the exception of those operations that rent out part of their facilities or who are carrying a large debt and paying significant interest.
- Overall the bottom-line is not significantly different from Net Operating Income. Average operations show 5.67% Net Income before tax. The double-digit profit club has 12.54 %. And, the select top-tier operations for this metric still have a 14% bottom-line.
When I discuss improvement possibilities with business people, they are sometimes skeptical. Sometimes they don’t believe me when I say, you can grow gross margins by 8% of sales. Or that they can increase sales volume by 25%. Or, they can grow profits by 7% of sales. Or, they can double their cash position. Not everyone believe me — at first. It is true for many that vast improvement opportunity exists. I’ve seen it happen time and time again. I’ve been a part of it. I hope that these metrics inspire you to look at your business analytically. I hope you are motivated to seek action to reach new heights.
In our 2017 Retail Observations we also looked at several selling and inventory metrics. These will be published in another well respected industry publication: Furniture World and made available along with these Financial Metrics to the members of the HFA.
Finally, for a limited time, we will be offering retailers an Opportunity Analyzer. You can get a customized side-by-side comparison report with all these metrics. Plus you can get a one-one web-meeting. In the web-meeting we will present and discuss our observations and your opportunity. Just contact me if interested in getting some guidance with improving your profitability and cash flow.