Steve Bailey
Financial Analysis Consultant

It's Not How Much Your Company Sells -
It's How Much You Get To Keep!

Sales, sales, sales. Seems every businessperson involved in small business, garden centers owners and managers included, base their success on the amount of sales they generated during a given period.

There isn't a day goes by, especially at the end of the month or year, that a garden center owner doesn't call to report how they "did" in sales. While I'm interested in their accomplishments in the area of sales, I'm more interested in what they got to keep after all the expenses -Inventory, Wages & Wage Benefits, and Operating Expenses were paid. That one resultant number - Profit - and one ratio - Profitability - is the true test of how your center performed.

What is Profit and why do we want it? Profit, in my mind's eye, is the excess of revenues over expenses. To take it one step further, I think of Profit in the form of EBITDA. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In other words, let's talk about true operating profit without all the tax items muddying the water. Let's get as much Profit to the bottom line pre-tax as possible, and let our accountant or CPA advise us as to how to lower our tax liability from there.

Before I go any further, don't think that increasing sales is not important. It is. Owners and managers just have to keep all aspects in perspective and insure that if sales are increasing then profit dollars are increasing at a proportionate rate and profitability at acceptable levels. The garden center in the table on the (right, left, bottom?) illustrates the point.

Which Garden Center Is Your Choice?
Sales		$1,000,000		$2,000,000		$3,000,000		$4,000,000		$5,000,000
Profit %		10.0%		5.0%		3.3%		2.5%		2.0%
Profit $$$$		$100,000		$100,000		$100,000		$100,000		$100,000
Sales		$6,000,000		$7,000,000		$8,000,000		$9,000,000		$10,000,000
Profit %		1.7%		1.4%		1.3%		1.1%		1.0%
Profit $$$$		$100,000		$100,000		$100,000		$100,000		$100,000

A garden center at $1 million dollars in sales and 10% Profitability nets the same amount ($100,000) as a center grossing $10 million in sales at 1% Profitability. Ten times the sales, yet the same amount on the bottom line. The other centers in the chart reflect increasing sales and declining Profitability. What's wrong with this picture? Why go to work each day and manage a $10 million dollar company when one could net the same amount from a $1 million center and experience much less stress and problems in the process. In this case, less is more.

The dilemma above is played out many times over in garden centers across the country. Contrary to where you might think I'm leading you, the question is not how to reduce sales to make our company profitable, but rather how to increase profitability at the current sales level.

Are there simple solutions to declining Profitability? Maybe not simple solutions, but certainly doable ones. The key is finding the area of your business that is eroding your Profitability and enacting measures to reverse the negative flow.

The easiest way to start is to analyze your Income Statement or P&L. A quick glance at your statement, and you're probably thinking "This is easy?". It is if you simplify your statement to five basic line items and their percentages as they relate to sales. The following example shows how it will look when you have completed the simplification -

GreenSideUp GC
		2005
Sales		100%
Less
COGS		53%
Oper Ex		17%
Wages		29%
Equals
Profitability		1%

By taking your statement down to its simplest form, we are able to see what truly affects the percentage of Profitability at your center - Cost of Goods Sold (Inventory plus Freight), Operating Expenses, and Wages & Wage Benefits. If we identify problems within any of those three basic areas, we can then 'drill down' to the culprits and fix them. There may even be opportunity within a line item to improve, thus improving Profitability as well.

Taking a closer look at the statement above, we see there are only those three general areas in which to decrease our expenses to send percentages to the bottom line and increase Profitability. Of the three, Operating Expenses are the most difficult. Think of what falls under Operating Expenses - rent, fuel, insurance, and a number of other line items that we can effect minimal change upon.

Wages & Wage Benefits are increasing as a percentage every year. Does that mean that we should reduce Wages and Wage Benefits? Not necessarily, though if the shoe fits wear it. What it does mean is that productivity needs to match the wages and benefits being paid. If it doesn't, sharpen your management skills and send those percentage points saved down to the bottom line.
As efficiencies increase, the percentage should decrease.

That only leaves one area in which to decrease expenses in order to raise Profitability - Cost of Goods Sold. COGS is the true cost of the inventory sold to produce Sales. The inverse of Cost of Goods Sold is your Margin Percentage. In other words, if you have a 52% COGS, your Margin Percentage is 48% (100%-52%).

Lowering the Cost of Goods Sold and raising Margin Percentage is dependent upon a number of factors that need to be explored within your center. While this subject could be the basis for many more articles, we'll touch on each briefly for an overview of what you should monitor to insure your center is realizing all the margin potential possible.

Buying is one of the most important yet least understood margin management tools we use. Buying 'right' means purchasing at a price that will support your center's margin needs. Negotiating with suppliers can be a large part of a buyer's job. Just remember that negotiating a lower price or terms with a supplier has to fit into their game plan as well. My motto is it has to be a win-win-win situation. The supplier wins, the retailer wins, and the customer wins. If all of these line up, you can't lose.

Pricing your product should be a no-brainer. Yet, run a report on your POS system to determine your average margin percentage on items within a category and total category average. If you have pre-determined item margin percentage floors and have items within a category that are priced below your floor limit, you either have a problem in Buying or Pricing. Determine which before it costs you too much in Profitability.

Discounting can be a major drain on Profitability. Overstocking is a major cause of discounting. Improved inventory control reduces the need to discount entire categories, but rather focus on planned sales and items to match events in order to drive customer traffic and full margin purchases. Bonus Bucks and coupons come in a close second as discounting factors that reduce Profitability.

While we can't eliminate Discounting entirely, we can control it. Begin by measuring your amount of discounting and estimate the effect on total sales. When you've reached the point of diminishing return, end the discounting. Then in subsequent years, use that amount of discounting in your business plan. You do have a business plan, don't you? Ahh, the subject of yet another article!

Internal Transfers between retail and landscape divisions can be major robbers of Profitability. A retail center that lacks systems to transfer inventory from their retail books to their landscape division has no one but themselves to blame. Sure, the landscape division is going to look great when you are simply giving them plant material to sell!

Dead and Broken inventory will lower your margin percentage as well. Reducing the amount raises the margin by the same percentage, it's as simple as that. MIA (Missing in Action) inventory might be called Shoplifitng or Theft. Allowing these actions to continue can mean a major difference in your attained Margin Percentage.

Your staff, your facility, and your product are probably the largest determining factor of margin percentage. If your center has low standards in any of the three, your margin percentage declines. This is very important. The cause and effect relationship here can't be overemphasized. Step back and take a look at your center. Can you identify the true problems that are lowering your Margin Percentage and thus Profitability? Many centers need an outside opinion of mystery shoppers and/or consultants. Get them. Use them for all they're worth.

Now let's take the simplified statement to the second level and analyze your center's trends over the past several years. As in the example above, use the simplified income statement to chart your company's performance over a three-year period.

GreenSideUp GC
		2003		2004		2005
		100%		100%		100%
Less
COGS		50%		52%		53%
Oper Ex		21%		19%		17%
Wages & WB		24%		27%		29%
Equals
Profitability		5%		2%		1%

The trends here are pretty obvious. Cost of Goods Sold is increasing (Margin Percentage declining), Operating Expenses are declining (a good thing), and Wages & Wage Benefits are increasing. Which areas need the most attention? The red flags are flying all over COGS and Wages. Possible solutions are outlined above. Use your management skills to fix the problems.

Now let's take the simplified Income Statement to the highest level. This is the business planning level. We can use the simple statement to not only reveal past trends, but to outline goals for future years.

GreenSideUp GC - Proj 2006-2009
		P2006		P2007		P2008		P2009
		100%		100%		100%		100%
Less
COGS		49%		47%		46%		46%
Oper Ex		17%		18%		18%		17%
Wages & WB		249%		28%		27%		27%
Equals
Profitability		5%		7%		9%		10%

In the example presented, GreenSideUp Garden Center posted a 1% Profitability in 2005. Diligent work in reducing Cost of Goods Sold through the next four years will send an additional 7% to the bottom line. Operating Expenses will remain the same as a percentage, and Wages will be reduced by 2%. All together, this four-year plan will raise Profitability from 1% to 10%, which is considered a reasonable level of Profitability for a small business investment.

An acceptable level of Profitability should occur at any sales level. If you are not realizing your potential, find out why. Use the simple steps outlined above to identify your past, present, and future trends. Then use that information every year to improve those areas of your garden center that are eroding Profitability. Managing your business is a never-ending process. Financial management should be the same. Plan, Measure, Adjust, Plan, Measure, Adjust, Plan, Measure, Adjust . . .

******************************

Steve Bailey is the Financial Analysis Consultant for The Garden Center Group, a business resource alliance of 0ver 100 independently owned
U.S. and Canadian garden centers.
Steve can be reached at stevebailey@gardencenterprofit.com