Contrary to popular industry belief, a 40% gross profit margin may not be the magical number that leads to the best bottom line in the kitchen and bath business. The correct number for a particular business may be significantly higher or lower. It really turns on three things: (1) a “market-rate” owner’s salary, (2) the operation’s overhead including a “market rate” rent, and (3) the owner’s desired annual return on his investment.
Here are the five steps involved to discovering the gross profit margin necessary for you and your operation to make serious money. This budgeting process is the single most significant action a business owner can undertake to gain control of his firm’s financial future.
Step 1: Project Income For 3 Years. Most businesses fail to realize their goals because there is an absence of good planning. By thinking out three years, owners will better anticipate when an additional salesperson – or support staff person – will be needed to reach higher income levels. Also when additional space or capital expenditures (i.e. displays, trucks, computers, etc) may be required. In doing so, owners gain greater visibility, discipline, and control over the direction of their operations, becoming less susceptible to whims or influences from outside.
Step 2: Detail Sales & Administrative Expenses. While this may be the most tedious step in the budgeting process, it may also be the most critical to get right. Using your most recent financial statements as reference, carefully go through each Sales and Administrative account and estimate the expected expense for each of the three years. It is best to “zero-base” each account – that is, build the expected cost for each item in the account from zero rather than just taking the expense total for the latest year and adding an inflation factor for that account in the coming year. Your personnel, of course, represent the biggest expense in these two categories. Make certain you budget “market-rate” salaries for yourself and your staff. If you don’t, you will underestimate the gross profit in dollars necessary to earn a significant annual income and profit from your kitchen and bath business.
Step 3: Detail Other Income/Expenses. Other income might include a variety of accounts that you would not want to distort your true sales and gross profit figures on your core kitchen and bath business – like gain on sale of equipment/displays, design fees, interest income, employee sales, and commissions for referring business to other companies. So they get recorded “below the line”. Two other accounts to be budgeted here are cash discounts and buying group rebates earned. Both can be sizable sources of income that are (a) the result of sound management practices, (b) not to be shared with salespeople in our opinion, (c) a direct hit to your bottom line, and (d) therefore very valuable. Other expenses to be budgeted “below the line” include cost of employee sales, interest on loans, and warranty work.
Step 4: Select The Desired Net Profit. Most owners look for guidance when asked how much net profit they want their firms to earn. American industry aims to consistently achieve an 8-10% pretax net profit and a 15-20% return on equity. For all the time and effort it takes to transform a client’s dysfunctional space into a beautiful new kitchen or bath that fits like a glove, there is no reason why dealers/design firms cannot achieve, or exceed, similar results. All it takes is solid business planning, effective marketing, and attentive management. In creating a 3-year budget, dealers will typically choose a 6-7% pretax net profit for the first year, 8-9% for the second, and 10% for the third. The owner’s mindset will be the dominant influence on the outcome - not local market conditions or the competition’s business practices.
Step 5: Reverse Engineer To The Required Gross Profit Margin. To arrive at the necessary gross profit margin to finance your “market-rate” owner’s salary, employee salaries and benefits, marketing program, administrative expenses, and desired pretax net profit is simple arithmetic. Just add the following: net profit + other income/expenses + sales and administrative expenses (i.e. overhead) to equal the gross profit in dollars. Then divide the gross profit in dollars by the budgeted “income” to determine the required gross profit margin.
Mindset & Marketing Drive Higher Gross Profit Margins
It is not unusual for owners to be stunned at the gross profit percentage to earn serious money. It may require a 15-20% price increase on all their projects. The most common response is “I won’t be able to sell anything at that markup.” However, an elevated marketing approach that focuses on communicating the tangible value of their services will make a tremendous difference, giving owners the foundation to ask and earn higher prices. Experts agree that when clients perceive a greater value, they will pay more for a product or service.
The time it takes to become a more effective marketer is a direct function of the owner’s willpower and access to the necessary marketing education, strategies, and tools. SEN Members have been very successful in substantially increasing revenue and increasing gross profit margins – in a single year. Indeed, there is documented proof they earn a 31% higher gross profit percentage than the 29% industry norm as reported by RICKI in the June/2017 issue of Kitchen & Bath Design News.
Therein is the value proposition of a SEN membership. You will earn more (and learn more) with us than without us. As proof, we invite you to attend our next, industry-specific 4-Day Business School. You do not have to be a SEN Member to attend. However, there is a good chance you will want to join the group after this unique educational experience.
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