Higher earnings begin with keeping score

Business is booming in just about every segment of the market. It is increasingly difficult to find great people, and when you do find them, owners and managers frequently resort to a higher earnings package to attract them.

Surprisingly, however, even in the booming housing market, a significant number of building supply businesses are struggling to earn a satisfactory profit. How frustrating! If you can’t produce a higher-than-average bottom line when business is so robust, what are managers going to do when the market begins to shrink?

Improving productivity, and thereby boosting profitability, frequently lies in the willingness of managers to step back from their businesses and figure out what they must do differently to improve results. Underline “step back from the business.”

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I know from experience that one of the most important keys to optimizing profitability and return on stockholder’s equity is setting productivity benchmarks. Without benchmarks it’s difficult to know whether you’re winning or losing. In business, as in sports, setting benchmarks helps bring out an organization’s competitive spirit.

Personal best

It makes sense to me that Olympic records have continued to be broken for hundreds of years because Olympic athletes measure their results each time they compete. When an athlete achieves a personal best, it doesn’t necessarily mean that he or she won a metal. It means that he or she jumped higher or ran faster or lifted more than he or she has ever done in the past.

In business, personal best scores and company best scores may be taking place, but no one is aware of the accomplishment if no one is keeping score.

The moral of the story is: Keep Score! And then raise the bar! Here are a few of my favorite benchmarks for an industry I have observed for many years:

Inventory shrinkage. Companies with systems and procedures in place and the discipline to follow them should hold inventory shrinkage to 0.5% of sales.

Debt to equity. If total capital is made up of debt and equity, then equity should represent 60% of total capital.

Pre-Tax margin. Between 4% and 6% before taxes is just about optimal for a privately owned, independently run building supply business (2.5% to 3% is about average).

Return on assets. 15% pre-tax on beginning assets.

Current ratio. This ratio refers to the relationship between current assets and current liabilities. In the building supply industry, we look for $2 in current assets for every $1 in current liabilities.

Personnel-related expenses as a percentage of gross profit dollars. A building supply business that is able to control personnel-related expenses (compensation, worker’s comp., group medical and payroll taxes) to 60% of gross profit generated will usually earn an optimal level of bottom line profit. (This benchmark is my personal favorite.)

Outside sales expenses. My favorite benchmark for outside salespeople is controlling salespeople’s total expenses (commission, salary, benefits and travel expenses) to 3% of sales and/or 13% of gross profit dollars.

Average collection days. 40 to 45 days is about as good as it gets for about 95% of the businesses in our industry. Dealers who allow average collection days to exceed 60 days become especially vulnerable to credit losses.

When I advocate keeping score, I am not minimizing the importance of work ethic among the individuals in an organization. What I am emphasizing is the importance of both management and individual workers focusing more on measurable improvement, such as higher earnings, than on how tired they are when they go home at night.

If each time a new personal best is achieved in higher earnings, the bar is raised, over time the odds are extremely high that the company’s overall productivity will improve significantly.

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