Drivers of the Business: Financial Metrics for the Non-CPA 2:00 p.m., April 26, 2016 Mike Hedge Birkey’s Farm Store Inc. ●
My Background • CPA. • Spent 10 years with large companies in both public accounting and in industry. • Came into this industry almost 24 years ago – Spent the first 20 years as CFO – Moved to my current position at the beginning of 2013. ●
Early Observations • In 1992, when I came into this industry there were a few things I observed rather quickly: – There weren’t many multi-location dealerships at the time. • Those who had multiple locations were in uncharted territory. • Often those multiple locations were operated as if they were still single stores with a common ownership. – Most managers and owners coming from the Wholegood Sales, therefore: • Selling activities dominated the business and overshadowed parts, service and the financial aspects needed to operate a healthy business. • It was a challenge to have my perspective heard as the lone financial person in the organization. ●
Goals for Today • Review how basic financial statements fit together and what they measure • Introduce a few key metrics that I believe are key to helping us maintain a healthy business for the long run. ●
Source of Metrics • 2 Major Financial Statements – Balance Sheet – Income Statement ●
Balance Sheet • The basic equation of accounting : – Assets – Liabilities = Equity – “have” “owe” “owner investment” • Rearranged form: – Assets = Liabilities + Equity – “have” “owe” “owner investment” ●
Balance Sheet, con’t. • The balance sheet presents the financial picture of the enterprise on one particular day. • It presents: – What the business has today: assets – What the business owes today: liabilities – What the business is worth today: equity ●
• Assets – What you have • Liabilities – What you owe – Cash – Accounts Payable – Accounts Receivable – Accrued Expenses – Inventory – Floorplan Notes Payable – Prepaid Assets – Short-term Borrowings – Fixed Assets (at cost less accumulated – Long-term Debt depreciation) • Equity – Value to Owners – Capital Stock – Retained Earnings (Includes historical profits and current year profits left in the business) ●
Balance Sheet Takeaways • Try to give the Balance Sheet the same level of attention as the income statement. This will pay dividends over the long term. • Many of our most critical metrics measuring the overall health of the business are calculated using information from both the income statement and the balance sheet. ●
Income Statement • The income statement gives one important perspective on the health of a business – its profitability. – The income statement does not tell the whole picture about a company’s financial health. • It does not report on the company’s assets, liabilities and equity. • It does not report on any cash movements. ●
Income Statement, con’t. • The income statement reports on making and selling activities of a business over time. • The income statement documents for a specific period of time the second basic equation of accounting: – Sales – Costs & Expenses = Income ●
Beyond MTD and YTD • Start looking at your rolling 12 month income statements. • Rolling 12 month income statements includes the most recent 12 month activity (e.g Apr 2015-Mar 2016, May 2015-April 2016, etc.) ●
Why Rolling 12 Month Data? • To smooth out seasonality • To calculate financial ratios • To spot trends more readily • To compare metrics every month-end over time. ●
Consistency and Quality of information is Key – Monthly Cutoffs – Accounting Treatment – Reporting Package – Branch Reporting – Departmental Reporting ●
Familiar Metrics • Most familiar ratios we look at come from our income statement accounts: – Gross Margin % – Contribution Margin % – Net Income/Sales % • While these are important, I don’t plan to spend much time on those metrics today. ●
So where do we begin? ●
Leverage • What does it really measure? – Leverage measures how well the business is capitalized and the relationship of internal vs. external financing that is supporting the assets of the company. • Critical metric that dealers too often ignore. ●
Leverage • Why is it important? – It measures the financial stability of our business. – It measures the quality and source of financing of the company’s assets. ●
Leverage • Rearranged form of Balance Sheet – Assets = Liabilities + Equity – “have” “owe” “owner investment” • 2 Leverage Ratios – Financial Leverage = Assets / Equity – Debt to Equity = Liabilities / Equity ●
Leverage Examples • Example #1 – $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity) – Financial Leverage: 9/3 = 3.0 – Debt/Equity: 6/3 = 2.0 • Example #2 – $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity) – Financial Leverage: 15/3 = 5.0 – Debt/Equity: 12/3 = 4.0 ●
Leverage Examples • Example #1 – $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity) – Financial Leverage: 9/3 = 3.0 – Debt/Equity: 6/3 = 2.0 • Example #2 – $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity) – Financial Leverage: 15/3 = 5.0 – Debt/Equity: 12/3 = 4.0 • How would we support the additional assets of $15mm in Ex. 2 and maintain the leverage ratios from the first example? – We would need and additional $2mm of equity in the place of $2mm of liabilities. ●
Drivers of Leverage Inventory! ●
Inventory Turnover • What is it? – In its simplest form, it is the number of times you can sell through your inventory in a year. • Eg. – Selling 4 units in a year while averaging 1 unit in stock would be a turnover of 4. ●
Inventory Turnover • Can you calculate it? – Cost of Sales last 12 mo. / Average inventory last 12 mo. ●
Used Inventory Turnover • Why is it critical to the management of our dealerships? – Turnover = Solvency = Cash Flow ●
Turnover Examples • Example #1 – $9mm(Assets)=$6mm(Liabilities)+$3mm(Equity) • Inventory: $6mm • Debt/Equity: 6/3 = 2.0 • Turnover: 4 = – Cost of Sales of $24mm / Avg. Inventory of $6mm – Sales @5% gross margin =>$25.26mm • Example #2 – $15mm(Assets)=$12mm(Liabilities)+$3mm(Equity) • Inventory: $12mm • Debt/Equity – 12/3 = 4.0 • TO: 2 = – Cost of Sales of $24mm / Avg. Inventory of $12mm – Sales @5% gross margin =>$25.26mm ●
Can Wholegood turnover be too high? ●
Used Inventory Turnover • What should it be? – For optimal cash flow, 4 has been our target. • This can be a challenge to maintain in a high horsepower market. – Depending on your product mix and market, your optimal turnover could be much different. – In today’s market which in many places is down over 50% in the last 2 years – I suspect that many of us have seen the used turnover drop to 1 and 2, which puts great strain on our businesses. We must correct this! ●
“I can sell my way out of this!” • For those who make their living selling equipment, this is usually the only logical response. – In markets with smaller corrections this is often the best strategy. • We slow our ordering of new equipment. • Focus our sales department on selling used inventories. • Ongoing market demand or an improvement in the markets will help us work out of the problem. – In this market, it will likely require us to think a little more deeply about our approach. ●
Reducing Used Inventory • There is not a quick fix. – Unless you only need to remove a few units and can wholesale them to get it off the balance sheet. – Even with great diligence, it may take 18-24 months to work your way out of the problem. • Establish a plan. – We need to set a target number and work to get there. • Ex. 1 If I sold 12 used combines last year and I want a 3 times turn. I need to reduce my current inventory from 8 units to 4. • Ex. 2 I may want to think in $. If my used cost of sales in the last 12 months is $6,000,000, then I need to reduce the inventory from $4,000,000 to $2,000,000. • Understand that if we have a target to get back to a 3 times turn, as the rolling 12 month retail sales contract, the target inventory number will also shrink. • Do not allow yourselves to get distracted! ●
The Bad News • In my experience, in the high horsepower market that we operate in, the used problem often worsens until we can work through our excess new inventory. – New inventory ordered months in advance keeps coming. – New inventory on our lots gets stagnant. • Falling used values make higher trade differences unacceptable to potential buyers and the inventory sits. • OR If we do make a trade, we are unwilling to book a loss on a new sale, and therefore, book the trade in too high making it difficult to price and move, making the used situation more difficult. • Hopefully we are far enough into this cycle that new levels have lowered and we can begin to see progress with our used inventories. ●
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