Drivers of the Business: Financial Metrics for the Non-CPA 2:00 - - PowerPoint PPT Presentation

• Drivers of the Business:

Financial Metrics for the Non-CPA

2:00 p.m., April 26, 2016

Mike Hedge Birkey’s Farm Store Inc.

• My Background
• CPA.
• Spent 10 years with large companies in both public

accounting and in industry.

• Came into this industry almost 24 years ago

– Spent the first 20 years as CFO – Moved to my current position at the beginning of 2013.

• Early Observations
• In 1992, when I came into this industry there were a

few things I observed rather quickly:

– There weren’t many multi-location dealerships at the time.

• Those who had multiple locations were in uncharted territory.
• Often those multiple locations were operated as if they were still single

stores with a common ownership.

– Most managers and owners coming from the Wholegood Sales, therefore:

• Selling activities dominated the business and overshadowed parts,

service and the financial aspects needed to operate a healthy business.

• It was a challenge to have my perspective heard as the lone financial

person in the organization.

• Goals for Today
• Review how basic financial statements

fit together and what they measure

• Introduce a few key metrics that I

believe are key to helping us maintain a healthy business for the long run.

• Source of Metrics
• 2 Major Financial Statements

– Balance Sheet – Income Statement

• Balance Sheet
• The basic equation of accounting :

– Assets – Liabilities = Equity – “have” “owe” “owner investment”

• Rearranged form:

– Assets = Liabilities + Equity – “have” “owe” “owner investment”

• Balance Sheet, con’t.
• The balance sheet presents the

financial picture of the enterprise on

• ne particular day.
• It presents:

– What the business has today: assets – What the business owes today: liabilities – What the business is worth today: equity

• Assets – What you have

– Cash – Accounts Receivable – Inventory – Prepaid Assets – Fixed Assets (at cost less accumulated depreciation)

• Liabilities – What you
• we

– Accounts Payable – Accrued Expenses – Floorplan Notes Payable – Short-term Borrowings – Long-term Debt

• Equity – Value to Owners

– Capital Stock – Retained Earnings

(Includes historical profits and current year profits left in the business)

• Balance Sheet Takeaways
• Try to give the Balance Sheet the same level
• f attention as the income statement. This

will pay dividends over the long term.

• Many of our most critical metrics measuring

the overall health of the business are calculated using information from both the income statement and the balance sheet.

• Income Statement
• The income statement gives one important

perspective on the health of a business – its profitability.

– The income statement does not tell the whole picture about a company’s financial health.

• It does not report on the company’s assets, liabilities

and equity.

• It does not report on any cash movements.

• Income Statement, con’t.
• The income statement reports on making

and selling activities of a business over time.

• The income statement documents for a

specific period of time the second basic equation of accounting:

– Sales – Costs & Expenses = Income

• Beyond MTD and YTD
• Start looking at your rolling 12 month

income statements.

• Rolling 12 month income statements includes

the most recent 12 month activity (e.g Apr 2015-Mar 2016, May 2015-April 2016, etc.)

• Why Rolling 12 Month Data?
• To smooth out seasonality
• To calculate financial ratios
• To spot trends more readily
• To compare metrics every month-end
• ver time.

• Consistency and Quality of

information is Key

– Monthly Cutoffs – Accounting Treatment – Reporting Package – Branch Reporting – Departmental Reporting

• Familiar Metrics
• Most familiar ratios we look at come

from our income statement accounts:

– Gross Margin % – Contribution Margin % – Net Income/Sales %

• While these are important, I don’t plan

to spend much time on those metrics today.

• So where do we begin?

• Leverage
• What does it really measure?

– Leverage measures how well the business is capitalized and the relationship of internal vs. external financing that is supporting the assets of the company.

• Critical metric that dealers too often

ignore.

• Leverage
• Why is it important?

– It measures the financial stability of our business. – It measures the quality and source of financing of the company’s assets.

• Leverage
• Rearranged form of Balance Sheet

– Assets = Liabilities + Equity – “have” “owe” “owner investment”

• 2 Leverage Ratios

– Financial Leverage = Assets / Equity – Debt to Equity = Liabilities / Equity

• Leverage Examples
• Example #1

– $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity) – Financial Leverage: 9/3 = 3.0 – Debt/Equity: 6/3 = 2.0

• Example #2

– $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity) – Financial Leverage: 15/3 = 5.0 – Debt/Equity: 12/3 = 4.0

• Leverage Examples
• Example #1

– $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity) – Financial Leverage: 9/3 = 3.0 – Debt/Equity: 6/3 = 2.0

• Example #2

– $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity) – Financial Leverage: 15/3 = 5.0 – Debt/Equity: 12/3 = 4.0

• How would we support the additional assets of

$15mm in Ex. 2 and maintain the leverage ratios from the first example?

– We would need and additional $2mm of equity in the place of $2mm of liabilities.

• Drivers of Leverage

Inventory!

• Inventory Turnover
• What is it?

– In its simplest form, it is the number of times you can sell through your inventory in a year.

• Eg. – Selling 4 units in a year while averaging

1 unit in stock would be a turnover of 4.

• Inventory Turnover
• Can you calculate it?

– Cost of Sales last 12 mo. / Average inventory last 12 mo.

• Used Inventory Turnover
• Why is it critical to the management of
• ur dealerships?

– Turnover = Solvency = Cash Flow

• Turnover Examples
• Example #1

– $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity)

• Inventory: $6mm
• Debt/Equity: 6/3 = 2.0
• Turnover: 4 =

– Cost of Sales of $24mm / Avg. Inventory of $6mm – Sales @5% gross margin =>$25.26mm

• Example #2

– $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity)

• Inventory: $12mm
• Debt/Equity – 12/3 = 4.0
• TO: 2 =

– Cost of Sales of $24mm / Avg. Inventory of $12mm – Sales @5% gross margin =>$25.26mm

• Can Wholegood turnover be

too high?

• Used Inventory Turnover
• What should it be?

– For optimal cash flow, 4 has been our target.

• This can be a challenge to maintain in a high

horsepower market.

– Depending on your product mix and market, your

• ptimal turnover could be much different.

– In today’s market which in many places is down over 50% in the last 2 years

– I suspect that many of us have seen the used turnover drop to 1 and 2, which puts great strain on our

• businesses. We must correct this!

• “I can sell my way out of this!”
• For those who make their living selling equipment, this

is usually the only logical response.

– In markets with smaller corrections this is often the best strategy.

• We slow our ordering of new equipment.
• Focus our sales department on selling used inventories.
• Ongoing market demand or an improvement in the markets will help us

work out of the problem.

– In this market, it will likely require us to think a little more deeply about our approach.

• Reducing Used Inventory
• There is not a quick fix.

– Unless you only need to remove a few units and can wholesale them to get it off the balance sheet. – Even with great diligence, it may take 18-24 months to work your way out of the problem.

• Establish a plan.

– We need to set a target number and work to get there.

• Ex. 1 If I sold 12 used combines last year and I want a 3 times turn. I need

to reduce my current inventory from 8 units to 4.

• Ex. 2 I may want to think in $. If my used cost of sales in the last 12 months

is $6,000,000, then I need to reduce the inventory from $4,000,000 to $2,000,000.

• Understand that if we have a target to get back to a 3 times turn, as the

rolling 12 month retail sales contract, the target inventory number will also shrink.

• Do not allow yourselves to get distracted!

• The Bad News
• In my experience, in the high horsepower market that

we operate in, the used problem often worsens until we can work through our excess new inventory.

– New inventory ordered months in advance keeps coming. – New inventory on our lots gets stagnant.

• Falling used values make higher trade differences unacceptable to

potential buyers and the inventory sits.

• OR If we do make a trade, we are unwilling to book a loss on a new sale,

and therefore, book the trade in too high making it difficult to price and move, making the used situation more difficult.

• Hopefully we are far enough into this cycle that new

levels have lowered and we can begin to see progress with our used inventories.

• Wholegood Considerations
• If we are selling a new combine

– Understand that we will need to sell 4-5 additional used units to get our used inventory back to where we started. – Its impact is not merely adding a single unit to our inventory.

• If we are selling a 1-2 year old tractor.

– Realize that the trades on this sale may require us to sell an additional 3-4 unit sales in the future before we are washed

• ut.
• Do not overbook trade ins.

– If you need to do a deal and it lost money, recognize the loss

• now. Get the trade booked right!

• More Wholegood Considerations
• As we are trying to focus our sales staff, consider how to

create fewer future transactions to get to cash.

– Focus on sales with higher trade differences/older trades. – Utilize leases to move inventory off the books without generating a trade-in unit.

• Caution: If there are residual guarantees, I would accrue these fully on your

balance sheet and into your transaction cost, even if it pushes a deal to a

• loss. With all of the lease returns in the market place of all colors, I

personally don’t feel comfortable in closing my eyes to the future liability. If the values are there, there will be income to book on the back end.

– While wholesale losses are something that is very difficult for most of us, in a market with falling demand, it is one way to immediately move inventory off the books without all of the sales that must follow to get to cash.

• New and Used Sales Mix
• Learn what your proper Sales Mix should be.

– The mix will likely vary and be different for each of

• ur dealerships.
• I have found in when our used turnover has been

around 4 or above, our ratio is around 51% new sales and 49% used sales.

– A dealership with a higher mix of smaller units or more leasing than we do might find a much higher mix of new to used.

– The mix will give us a good indicator of which direction used turnover will be moving.

• Too much new and the used turnover is likely falling.
• If the used % is exceeding our target, then we are likely

making progress on our used turnover.

• WG/Parts/Service Sales Mix
• This ratio will be unique by dealership

and the type of market you serve.

• What we want to know it that we have a

healthy mix of sales in parts and service to help us absorb the expenses

• f the dealership.

• Absorption
• What is it?

– =(Parts GM + Service GM)/Total Expenses

• Why is it important?

– In times like these, when wholegood margins may be close to 0, at $100% absorption, we could show a profit with the volume we receive from our manufacturer. – If we find our leverage higher than we desire, increasing our absorption is certainly helpful in generating the necessary cash flow.

• Service Productivity
• There is a high cost of unapplied labor

– Lost opportunity

• Labor
• Parts

– Think of labor as inventory

• Productivity-Creating Visibility
• Create visibility for Unapplied time

– Don’t bury it in cost of sales

• Track productivity by technician
• Report on unapplied time daily

• Growing Service

– Expanding Service Facilities – Adding Technicians

• Incremental Benefits per tech

– Up to $150,000 labor sales per tech – Additional Parts revenue approximating $100,000 per tech. – Gross margin of approximately $125,000

• Parts
• Parts Turnover
• Fill from Stock

– Controlled fill

• Ordering efficiencies
• Excess Stock / Obsolete Inventory

• Can Parts turnover be too

high?

• Headcount Productivity
• Sales by headcount
• Contribution margin by headcount
• Net profit by headcount

• Benchmark against yourself
• If you have multiple locations, one of

the best sources of information is to compare metrics of your own locations against each other.

• Spend time understanding what top

performing locations are doing that

• thers are not.

• Engage Key employees in the

value of this information

• We found it valuable to open our books to

key employees.

– Requirements to participate: Training and Confidentiality

• Train them to understand the information
• Consistency in keeping them informed

– Empower them to make decisions that help to drive the business forward – Compensate them in a way that is consistent with the desired outcomes even if we don’t share our books with them.

• Questions?

• Contact information

If you have thoughts or questions or would like more information please feel free to email me: mhedge@birkeys.com