Basically all that is noted is how busy the companies were (i.e. sales revenue) and whether the level of sales they generated met with the market’s expectations.
That’s all well and good but this should not be your only barometer for business success and will not tell you how your operation is performing.
This may sound like a fallacious statement but turnover generated does not pay for the stock sold, nor the overheads incurred in selling the product and operating the business.
Remember – it is the profit directly retained from the sale that covers outgoings, not the sale value achieved.
The issue here is that if a major target in an operation is sales, this can lead to irrational management behaviour, particularly as the end of financial year approaches.
Irrational behaviour like trying to cut the opposition out of the picture and capture sales at any price by discounting to generate the sales dollars to climb towards the sales target.
Trouble is, by discounting, Gross Profit Margin is reduced and if in this industry there is not a substantial related increase in turnover, profitability is lost.
WHY DISCOUNTING MAY NOT MAKE SENSE
Here is an example: Product X retails at $120 with a 25% margin after rebate.
To increase turnover, a decision is made to lower the sale price by 5% to $114 to increase turnover.
How much more now needs to be sold to generate the same amount of $ Gross Profit?
The calculation goes like this:
Normal price (25% margin): Gross Profit of $120 x 25% = $30 per unit sold
Discount sale price: Gross profit is $114 Cost price less $90 margin = $24 per unit sold
If the price is $120 a unit, and 10 units are sold then, at a $ Gross Profit of $30 per unit, the $ Gross Profit generated is $300.
If the price is discounted, a $ Gross Profit result of only $24 per drum means you need to sell 13 units to achieve a $ Gross Profit result of $300.
That is an increase in sales or turnover of 30%, just to stand still!
HOW DISCOUNTING PAYS IT FORWARD
A store should not need to lower its prices and forsake good credit management to tempt customers from the opposition. With trade customers in particular, the problem with this method is that it can attract the wrong customers.
This method of increasing sales works great under the accrual system of accounting which all operations in this industry utilise. The accrual method stipulates that the sale is recorded at time of invoicing, whether the invoice is paid or not.
There is only one problem with the strategy of selling to anyone any amount: What if they do not pay?
Yes you made your sales target for the financial year and the awards and bonuses are being handed out – but what are the repercussions in the next financial year of having basically having given these new customers an open credit limit?
To use as a case study, say towards the end of the financial year you have discounted pallets of product with a value of $50,000 by 10% to someone else’s customer and in the next financial year they did not pay.
What does this actually mean? Here’s the calculation:
$50,000 sold at discount = $45,000
Your Net Profit Margin is 2% (Net Profit Margin is the % of profit retained after the total cost of product and overheads to run the operation and tax are taken into account).
So the figure that needs to be generated to recoup a $45,000 bad debt ($45,000 ÷2%) is no less than $2,250,000!
Now do I have your attention?
To sum up, the rebound effect of solely concentrating on turnover to be the goal in target setting may result in:
In achieving set targets remember the old saying: “There is more than one way to skin a cat” – just make sure it is the right one!
Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au