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Do You Know Your Numbers? Take The Test!

Nov 15, 2019 9:01:31 AM

5 Minutes. 10 Questions, Take this test to determine your level of financial know-how, and how sufficient
it is to successfully grow your operations into highly profitable small business that, if desired, could
include a chain of kitchen/bath satellite showrooms spilling over into neighboring states.

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Question #1: A markup of 1.40 is what margin of gross profit?
a. 29%
b. 40%
c. 60%

Question #2: The definition of accrual accounting is?
a. Revenue is recognized when a client’s check is received
b. Revenue is recognized when the job is paid in full
c. Revenue is received when the job is substantially completed

Question #3: What kind of annual return on equity (or investment) should dealers earn?
a. 8-10%
b. 33-50%
c. 15-20%

Question #4: How should the cost of showroom product displays be booked?
a. As fixed assets on the balance sheet to be depreciated
b. Expensed on the income statement
c. As current assets on balance sheet not to be depreciated

Question #5: What is the definition for total asset turnover?
a. Revenue divided by total assets
b. Total of company assets on the balance sheet
c. Sales divided by display investment

Question #6: What is considered the optimum annual revenue growth to be achieved?
a. 8-10%
b. 15-20%
c. 20-25%

Question #7: What is the best range for a dealer’s financial leverage multiplier?
a. 2.0-2.5
b. 3.5-4.0
c. 5.0-6.0

Question #8: How many months of fixed assets should a small business save to backstop its
operations?
a. 3-4 months
b. 12 months
c. 6 months

Question #9: How much pre-tax net profit should a small business make after a market-rate salary
to the owner?
a. 12-15%
b. 15-20%
c. 8-10%

Question #10: How much should an owner’s return be for a $3,000,000 operation where the owner
serves as a general/sales manager for up to 4-5 sales designers?
a. $300 -$350,000
b. $375-$450,000
c. $540-$600,000

 

Answer #1 – a. Markup and margin are not the same thing. The proof is dividing 40/140 which equals 28.6% gross profit margin. To earn a 40% gross profit, the markup over job costs must be 1.67.

Answer #2 – c. Many dealers use cash accounting because it’s simpler bookkeeping. But cash
accounting inflates gross and net profits, giving owners a false sense of their company’s profitability. SEN advocates the use of accrual accounting because that’s when dealers have truly earned the income - when the job has been sufficiently completed. At this juncture, there is a direct alignment of the client’s job expenses in the cost of goods sold to the job’s sales price, now showing on the top line of the company Profit & Loss Statement. As a result, company gross and net profits are accurately stated.

Answer #3 – b. Return on equity is defined as a company’s net profit divided by its net worth. American industry typically seeks to earn a 15-20% return for its shareholders. However, because most kitchen/bath dealers neither make an adequate annual net profit, nor rarely leave any profits in the business (as retained earnings) to grow its net worth, SEN recommends that they target at least a 33-50% return on equity. The risk of investment is also much greater in a small, privately-held business. So the return should be greater than for big corporate entities.

Answer #4 – c. SEN endorses the NKBA position on display accounting. In 1978, this trade organization hired a major accounting firm to research the issue. It was found that kitchen/bath dealers typically earned extra discounts for putting many vendor products on their showroom floor – particularly cabinetry. So much so that even 5 years later dealers could actually earn a profit from the sale of these displays. Therefore, the accounting firm recommended that displays not be depreciated. Indeed, they should be listed under current assets on the balance sheet because they could be sold - converted into cash - within the current year.

Answer #5 – a. Most kitchen/bath dealers make the mistake of putting too much investment into their showroom displays, trucks, computer systems, etc. Then don’t invest enough money in marketing to continually generate quality leads and substantial revenue growth. As a result, their total asset turnover (TAT) is considerably weaker than other industries. SEN indentifies it as one key metric dealers need to strengthen for improving their return on investment (ROI).

Answer #6 – b. When companies grow too quickly, the quality of their customer service declines. Yet outstanding customer service typically has built the fine reputation for successful companies. That’s why business experts suggest that a 15-20% annual revenue growth is ideal. Beyond this range, it’s difficult for a firm’s infrastructure to keep up with sales growth.

Answer #7 – b. The financial leverage multiplier (FLM) is defined as the use of other people’s money to acquire company assets (total assets/net worth). Banks will rarely make a loan if that ratio currently exceeds 2.0. Using client deposits as working capital gives dealers a nice advantage for generating a good return on investment. But that can also be a two-edged sword. If the FLM regularly exceeds 4.0, the company is at risk of being overleveraged. During a business downturn it can go out of business rather quickly.

Answer #8 – b. Until the Great Recession, the conventional wisdom was 6 months. Today business
experts recommend that 12 months of fixed expenses - including the owner’s salary – be accumulated in a liquid portfolio where funds can be accessed within 3-4 working days.

Answer #9 – c. SEN advocates small businesses earn an 8-10% pre-tax net profit. Sadly, most don’t
come close because they never learned how to price their projects properly. They never learned that their correct pricing formula is a direct byproduct of a comprehensive budgeting process. By something called “reverse-engineering,” an owner can determine the gross profit margin required to finance a market-rate salary for themselves, their overhead structure, and the desired 8-10% pretax net profit. As a result, research has recently documented the average industry gross profit to be only 29%. By comparison, SEN Members average 37.75% which attests to their superior financial know-how and superior marketing ability.

Answer #10 – c. An owner’s return is defined as the sum of salary, perks, and pre-tax net profit. For the“showroom” business model as described, SEN expects owners to earn a return of 18-20%.

 

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