Let me tell you a story of two retailers who were competitors for several years. One is prospering today. The other went out of business.
They had similar footprints and decent locations. They both had similar marketing campaigns, targeted to the same types of customers. On the surface, they both appeared to be fairly equal businesses, but they were not. There was one critical factor that set them apart. One was a student of their business and the other was a victim of it.
The student measured performance, learned from the results, and took quick decisive action to continuously improve. This business had focus.
The victim reacted to the latest situation of the day; flying blind, unfocused, without a pilot’s license.
The focused business produced increasing sales, profits, and cash flows over time. The unfocused business ate into profits and burned cash. When a slight downturn hit, the good business operator had reserves to weather the storm, whereas the reactionary operator had to take on increasing debt and eventually filed for bankruptcy.
The lesson here is simple, listen, understand, and act. Listen to your business. Seek to understand what it is telling you. Act on what you hear to improve. Listening to your business involves looking at key indicators. Understanding them involves not only being educated on what the metrics mean and how they are calculated but knowing what factors determine their results. Acting is execution on improvement. Listening and understanding are useless without this.
Here are seven indicators successful retailers use to be good students so they can surpass their unfocused competitors:
1. Sales to Plan.
Absence of a plan is a plan to fail. Obviously sales volume is critical. Why then is it that many retailers do not set achievable selling targets? I don’t have the answer to that, but I can tell you that if you set proper sales goals, you will have a MUCH greater chance of achieving them.
Sales to Plan = Sales / Planned Sales (Expressed as a %)
You want to be above 100% on this metric. For example, if your retail unit has a target of producing $100,000 for a certain time period and it produced $94,000, you’ve fallen short at 94% of plan. ($94,000/ $100,000). However, if the unit produces $110,000, it has exceeded the goal at 110% of plan ($110,000/ $100,000).
This type of metric should be done for your entire business, for all retail locations, for all sales teams and for all individuals.
Sales to Plan should be monitored each month, each quarter, and each year, without fail. This allows you to react faster if the reactions of your team are falling short.
Many elements can cause a sales goal to be missed. A starting point is to examine the equation for required sales volume: Selling Opportunities x Close Rate x Average sale. Using this formula, you can see what you can do to immediately produce better results.
2. Average Sale.
Simply put, if your sale size is bigger, you move toward your target sales levels faster. It takes fewer transactions to produce greater results.
Average Sale = Sales Volume / # of Sale Transactions
Suppose your sales volume for a period of time is $1,000,000. And 1,000 transactions occurred. Your average sale size is $1,000 ($1,000,000 / 1,000).
Since track average sales, you are able to increase add-ons by group pricing. This results in an average sales increase of $100 per transaction. An extra $100,000 per period is generated (1,000 x $100 = $100,000).
3. Gross Margin (GM).
Revenue keeps you in business but it does not pay your bills. Gross Margin dollars pay your bills. The Gross Margin percent is the portion of sales dollars that you have left to cover costs and make a profit.
(GM $ = Sales - Merchandise cost with freight; GM% = GM $ /Sales $).
Recently, I have seen furniture businesses range from 40% to 75%. 55% GM which is doable if you execute properly. First though, you must track and set goals on this metric. Once that is clearly understood you can move on to acting. Here is a summarized list of six GM improvement actions that others are using (there are many more – be creative!):
- Use a combined “science and art” approach to pricing best sellers and new merchandise.
- Mark slow moving items down on a quick time schedule in a series of steps.
- Private Label and Self-Branding.
- Incentivizing high GM sales.
- Two or three tier pricing on long term financing.
- Group pricing.
4. Gross Margin Return on inventory (GMROI).
This performance metric takes Gross Margin production a step further. It evaluates how many GM dollars are produced for each Inventory dollar carried on average. From this, you can see your return on investment for your largest asset and consumer of cash. As you become more efficient in GMROI, you use less cash to produce greater margin dollars. In doing so, both cash flow and profitability increase.
GMROI = GM $ annualized / Inventory $ averaged
Here is an example of how to use GMROI and a few actions you can execute to improve it. Let’s suppose your goal is to keep GMROI at a minimum of $2.5 overall each month, then your GMROI falls to 2.45. “Red Flag!” You should not just sit and say, “Well, let’s just watch it and hopefully it will turn around next month.” Instead, first seek to understand what caused the decline. Study the possible factors that could affect GMROI by asking questions such as:
- Were sales targets hit?
- Was the minimum performance standard (MPS) for gross margin achieved?
- Was average inventory at the budgeted level?
Now, suppose that sales to goal was above 100% and gross margin performed over minimum performance standard (MPS) at 52%. If your average inventory rose, causing a decline in ROI, you could then dig into why inventory on hand increased. Ask questions such as:
- Was receiving as expected?
- Were deliveries and pick-ups at the projected level? Capacity?
You might discover that merchandise dollars in the warehouse grew due to a slowdown in delivery and pickups. Once you identify this issue, you can act fast to focus on improving customer scheduling and filling trucks to capacity.
5. Net Income or Profit.
At the end of the day there is only one way to be successful: to consistently be as profitable as possible. At the end of the day, cash is made from one area of the business: profit.
Net Income = Sales – Cost = Gross Margin – Operating Expenses = Profit Before Tax
Financial statements are the only place to get this critical data. These statements must be:
- Acted upon
This may sound obvious. Believe me it is not. In the world of independent furniture businesses, financial statements often take a back seat. However, operations that perform constantly better in net income are most often the ones that use financial reporting as the key management report. Statements must be properly organized so they can be easily benchmarked to top industry performers. They must be materially accurate and verified against supporting information so that the Businesses’ Leaders can believe what they are looking at. They should be generated on a timely basis (by the 10th of each month for the prior month) so data is current. It’s critical that the management team spends time every month analyzing performance. Finally, the information detailed in financial reports should be acted upon, focusing on areas of desired improvement and acting appropriately.
6. Cash Ratio.
Cash is called “King” for a reason. It dictates what a business can and cannot do. Even though all cash is derived from profit, it can be gained or lost in many ways. In fact, I have seen profitable businesses go out of business because they failed to watch their cash metrics as well as attend to all the items that affect cash flow.
Cash Ratio = (Cash + Marketable Securities) / Current Liabilities (balances due under 1 year)
A cash ratio of .5 is fairly decent for a retail furniture operation. Regardless of what your actual number is, the most important thing is to know your cash ratio number. The next most important thing is that you know what affects it. Other than net income, the biggest factors that move this ratio under normal conditions are fluctuating inventory, accounts payable, customer deposits, and accounts receivable.
Theoretically, if all these factors are maintained at the same balance each month, the only thing that causes cash to change will be profit. We know that in the real world this never happens. Inventory is often the biggest culprit on the balance sheet causing cash flow fluctuations at retail.
For example, if you discover that balance sheet elements are causing a consistent cash drain even though sales and profits are increasing, here are some possible actions that you can consider:
- Keep tighter controls on open to buy for new merchandise. Reduce inventory to sales cap i.e., 15% Inventory to Sales from 17%.
- Maximize Customer Deposits. Ask for 100% down, require 50% down, Collect 100% before delivery.
- Extend Payables to the maximum point, especially on vendors without discounts. Evaluate any vendors requiring prepayment.
For an alternate example, let’s assume inventory is at a good level to sales and that your product mix is efficient. Also assume that AP, AR, and customer deposits are at good levels. In this situation, you might focus on lowering operating costs to improve the cash ratio. Generally, operating costs in our industry range between 37%-43% of sales. I consider under 40% to be lean for most operations in my consulting practice. For evaluation purposes, your business should establish budgets that are based on common industry expense categories. They include: General Administrative, Occupancy, Advertising/Marketing, Selling, Warehouse, Delivery, Finance, and After Sale Service.
Having targeted budgets set-up properly will help you spot an issue that negatively effects cash flow, faster. Improvement actions can be executed sooner, saving you huge dollars.
7. Customer Feedback.
Retail performance indicators would be incomplete without a customer driven element. You need to know what your customers are saying about you so you can seek to improve your service. Over time this is perhaps the most important factor determining success and growth in the marketplace. The challenge is that customer’s thoughts are outside any report that you can process in your management system. There is no line item on a sales or financial report that says, “Customer Value Rating”. So, smart retailers seek their customer’s opinions.
Surveys are nothing new. The way they are being approached is different. Start by doing two things: Keep it simple. Ask after delivery. Here are three basic questions:
- How did we do?
- What could we do better?
- Would you recommend us?
It is important that results are tracked and reviewed. Any trends, good or bad, should be spotted. Ratings can be established for minimum performance standards. Actions to improve should be executed to improve the customer experience.
For example, suppose you notice that customers are reporting that they would appreciate a shorter time window and advanced notice on their deliveries. Bingo – an opportunity is realized to improve the customer experience. You could seek to implement faster routing and follow-up technology that is available today. This is just one example of hundreds of possibilities. But to really find the opportunity, you need to ask and to listen. The big thing to remember is that your ultimate performance judges are the people you do business with.
Be a student of your business, not a victim of it.
These seven performance indicators will help you stay on top of your business from many operational perspectives. Sales to Plan and Average Sales focus on top line performance. Gross Margin and GMROI then hones in on what you make from transactions and your return on investment. Net Income, Profitability, and the Cash Ratio are concerned with what you have left after all your expenses and the strength of your cash flow. And finally, customer feedback gives you valuable indicators as to how you are performing in the eyes of those that purchase your products and services. Use these indicators routinely and continuously together to keep the pulse of your business strong. Seek to improve them by digging into what affects their outcome and take quick and decisive actions within your operation. Doing this better than your competition will give you the advantage.