April 2015

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>> PROFIT IMPROVEMENT REPORT DR. ALBERT D. BATES T oday, most distributors are experiencing strong sales gains. e serious concerns about generating adequate sales are largely a thing of the past. Unfortunately, the strong increases in sales are not translating into strong increases in profit. e problem is that expenses, especially payroll expenses, are absorb- ing an excessive amount of the increase in sales. e key to overcoming this problem, and generating substantially higher profits, is to produce what is commonly called a sales-to-payroll wedge. Simply put, sales must grow faster than payroll expense. It is an incredibly simple concept to understand, but a maddeningly difficult one to implement. is report will examine the nature of the sales-to-payroll wedge from two perspectives: n e economics of a sales-to-payroll wedge – An examination of how sales growth and payroll control combine to produce higher profits. n Implementing the wedge – A discus- sion of the specific management actions that are required to generate a sales-to-payroll wedge. The Economics of a Sales-to- Payroll Wedge One of the oldest management bromides in distribution is "Sales are vanity, profits are sanity." Bromide or not, the statement continues to be true. Sales growth almost always helps, but what is needed is sales growth that does not require a commensurate increase in payroll expenses. e economics of sales and payroll growth can be seen in Exhibit 1. It reflects the results for a typical AED member based upon the latest CODB Report. e Current Results column indicates that the typical firm gener- ates $50 million in sales and operates on a gross margin percentage of 21.5 percent of sales. It produces a pre-tax profit of 3.5 percent of sales, or $1,750,000. Of particular note, total expenses are heavily weighted towards payroll, which represents 11.0 percent of sales, or 61.1 percent of total expenses. is is why payroll control is so critical. e last two columns examine the impact of a sales-to-payroll wedge. Again, this means that sales growth outpaces payroll growth. Two sales growth scenarios are used to examine the sales to payroll wedge – 5.0 and 15.0 percent. Slow Growth – e 5.0 percent growth column reflects operations in a mature market. is growth rate was achieved with no change in the gross margin percentage. As a result, both cost of goods sold and gross margin also increase by 5.0 percent. e real key to this column is that payroll expense only increases by 3.0 The Sales-to-Payroll Wedge: A Profit Necessity Three strategies to up the sales volume without adding personnel. 42 | www.cedmag.com | Construction Equipment Distribution | April 2015 What is needed is sales growth that does not require a commensurate increase in payroll expenses. Exhibit 1 - The Impact of a 2% Sales to Payroll Wedge For a Typical AED Member 2.0% Sales to Payroll Wedge Income Statement ($) Current Results 5.0% Sales Growth 15%Sales Growth Net Sales $50,000,000 $52,500,000 $57,500,000 Cost of Goods Sold 39,250,000 41,212,500 45,137,500 Gross Margin 10,750,000 11,287,500 12,362,500 Expenses Payroll and Fringe Benefits 5,500,000 5,665,000 6,215,000 All Other Expenses 3,500,000 3,675,000 4,025,000 Total Expenses 9,000,000 9,340,000 10,240,000 Profit Before Taxes $1,750,000 $1,947,500 $2,122,500 Income Statement (%) Net Sales 100.0 100.0 100.0 Cost of Goods Sold 78.5 78.5 78.5 Gross Margin 21.5 21.5 21.5 Expenses Payroll and Fringe Benefits 11.0 10.8 10.8 All Other Expenses 7.0 7.0 7.0 Total Expenses 18.0 17.8 17.8 Profit Before Taxes 3.5 3.7 3.7

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