Yearly review KPI #3: Your margin of safety

By February 03, 2014 Industry news

This is the third in a series of five articles that looks at the Key Performance Indicators (KPIs) of your store’s financial performance and what you should be targeting to achieve. In my last article we reviewed how a financial institution might examine your operation. But what is the real key indicator of financial performance?

The most important calculation is not sales per person or even return on investment. They are important but to get a quick gauge on to how your business is performing is to measure risk.

That is the “Margin of Safety” ratio. It is calculated as follows:

$ Net Profit ÷ $ Gross Profit x 100 = Margin of Safety

This simple calculation allows you to check how risky your business is. The result gives you the percentage of sales you can afford to lose before you cannot cover your overheads which includes your salary.

In simple terms it is benchmark for your survival. The great thing about this ratio is that it can be calculated monthly.

So where should your hardware store be placed? I would look for a result of between 30% and 40%.

If your result is less than 30% it is important that you begin to plan to improve your result. In reviewing the calculation, the result is driven by $ Gross Profit and $ Net Profit therefore any strategies to improve margin and control expenses will improve your Margin of Safety.

 

GROSS PROFIT STRATEGIES

Here are 10 steps towards improving your Margin of Safety:

  1. Improve your booking out procedures – I am still amazed at the amount of product not invoiced to the trade in this industry! The simple calculation to replace the tin of paint not booked out is its cost ($50) divided by the average net profit margin after tax (2%, which has also not changed over the last two decades) which equates to sales of $2,500…
  2. Reduce customer and staff theft through technology and checking stock levels.
  3. Ensuring you only pay for what you receive.
  4. Check the freight bills.
  5. Pick up settlement discounts when you can.
  6. Mechanise products around the counter.
  7. Increase staff product knowledge and selling skills to make add-on sales.
  8. Reduce uncontrolled and unauthorised discounting.
  9. Reduce damaged stock.
  10. Check your pricing.

In trying to improve a store’s Margin of Safety I always attack the area of margin improvement first. Why?

Just fine tuning day by day procedures to fix these 10 points can have a dramatic improvement in $Gross Profit generated and as such improve the Margin of Safety.

Of course the other part of the calculation is to reduce expenses – it is important to monitor expenses historically and against your increase in activity, that is sales.

Your store is in an industry that has long been recognised as highly competitive and over-serviced. The Margin of Safety is the most important statistic for your business, especially in a changing market where price is used as a weapon against you.

If you have to discount, remember it will affect your Margin of Safety. By cutting price you reduce your Gross Profit margin and your net profit result.

There is only one direction your Margin of Safety is heading and that is South – unless you can improve in the other nine areas of margin management and control your expenditure.

_________________________

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

share this