Garage door industry magazine for garage door dealers, garage door manufacturers, garage door distributors, garage door installers, loading docks, garage door operators and openers, gates, and tools for the door industry.
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40 International Door & Operator Industry™ Welcome back margin fans … and everyone must be a fan of margin (more correctly gross margin) because as the previous installment made clear, after paying for the product, it's all the money that remains to pay for everything else, including you! In Part I, we made the point that " … management must know how much margin is actually being generated, and understand the logic of the calculation, in order to make correct pricing decisions, set logical product line strategies and affect viable business planning." The basics of "margin appreciation" presented in Part I provide a basis for three critical tools we will consider in this installment. 1. The seriously negative impact of misinterpreting and miscalculating markup 2. The pivotal role of margin for using breakeven analysis as an analytical tool 3. Signifcant gross margin variations within the product mix and the impact on the frm's strategic orientation Recalling Some Fundamentals Before proceeding to new topics, recall that the fundamental equation is Sales minus Cost of Goods Sold (abbreviated COGS) equals Gross Margin (abbreviated GM). COGS consists of "direct product costs", which should include only correctly stated Cost of Materials Used (COMU) and Fully Burdened Direct Labor. Typically, direct labor is installation or feld labor wages plus all employer beneft costs such as payroll taxes, healthcare and 401K contributions. Part- time or contract feld labor is also included as a separate item. All of the COGS components are typically stated in both dollar terms and as percentages of net sales. For example, we may compare two product lines by noting that one produces a 35% GM, while the other is less attractive, holding only a 27% or 28% GM. Percentages relating to costs and margins must be stated using the same base reference, and that base should always be net sales. Thus, a statement to the effect that "… our advertising averages 2.0% and our GM is 37.0%", should be referencing costs and margins relative to net sales, i.e., sales minus all returns, allowances and items such as sales taxes and credit card discounts that never reach the frm's permanent income stream. If any parts of the foregoing paragraphs are unclear, you may want to review some margin fundamentals from Part I - see International Door & Operator Industry, volume 46, issue 6, 2013, pp. 44-50. For the sake of continuity, the business example and exhibit numbering used in this installment will continue from Part I (Thus, the frst exhibit herein is "Exhibit 4"). The data have been extracted from the same 2012 internally prepared fnancial statement of an actual door dealership cited in Part I. The numbers have been rounded for simplicity, and, of course, the identity of the frm is disguised. Misinterpreting and Miscalculating Markup Almost all frms determine selling prices by applying "markups" to the cost of the products being sold. Implicitly, sellers make the assumption that the calculated markup will result in a Gross Margin of equal magnitude when quarterly or annual income statements are produced. In other words, marking up costs by 40% "should" produce a 40% gross margin. There are many reasons why the above reasoning is defective because numerous factors other than markup Continued on page 42 by John Zoller & David Bowen, Zoller Consulting, Inc. MANAGEMENT Margin is all You've Got ... and its Usually Miscalculated This is the second of a multi-part series on understanding margins, and using the concept to make better business decisions. Part II 1/24/14 10:51 AM