How Risky is your Hardware Store?
Do you lay awake at night worrying about your corporate opposition cutting prices and taking your customers? Do you have trouble sleeping, wondering if your hardware store will survive? Do you stare at the ceiling concerned at how you will appease your bankers? Not really knowing how risky your hardware store is?
These are common concerns of any hardware or trade retailer. One key performance indicator can tell you the answer I am asked constantly by hardware retailers: “Will I survive?” The calculation is called the margin of safety and, given the recent development of new entrants into the marketplace in Australia, this ratio is the most important key performance indicator you can calculate. The margin of safety is a financial ratio that will tell you the percentage of sales you can afford to lose before you cannot cover your overheads. It can be calculated on a yearly basis by reviewing your financial statements from you accountants, or monthly if you generate your own monthly profit and loss statement.
$ Net Profit (Before owners salary) / $ Gross Profit x 100
To illustrate how the margin of safety is calculated and interpreted, let’s use a case study of a retailer’s yearly result.
Cost of sales $1,400,000
Gross profit $ 600,000
Expenses not including owner’s salary $ 400,000
Net profit (B.O.S) $ 200,000
(B.O.S) = Before owners salary
In this case study the margin of safety is:
$200,000 divided by $600,000 x 100 = 33.33%
This means that this hardware store can afford to lose 33.33% of its sales before it cannot cover its expenses before owner’s salary and is therefore not making a profit nor providing a return on effort to the owner through payment of a salary. Obviously, the higher the percentage, the better. The industry average is 30% plus. The margin of safety is of crucial importance to you in the actions you undertake to the entry of new competition to your area and the pricing policies of your competition. By calculating your margin of safety you will know quickly what you can afford to lose in sales to them. If the result is low (say anything less than 15%) you are at high risk to increased price competition or the new player if they build in your marketplace. If price is being used to compete and you are cutting the gross profit margin, your margin of safety will fall. It is therefore important that whilst competing on price, you also ensure that your margin is improved in other areas such as
- Minimising damages.
- Checking in all stock correctly.
- Ensure all sales are rung up or booked out.
- Check your freight charges.
- Minimise theft.
- Negotiate early settlement discounts with suppliers. This is not the complete list there are another 15 factors that affect your gross profit result and none of them relate to neither your pricing policies nor your competitors. Put simply, it is a fact that the hardware stores with the lowest margin of safety in your suburb, town or district will probably be the first to close their doors due to increased competition in the retail marketplace.How well are you performing now but, more importantly, in the future?
Peter Cox has nearly 20 years in financial management and consulting to the Australian hardware industry. He not only works in Australia but also in several other countries. He conducts key note addresses and management and sales workshops which are aimed at improving the profitability and liquidity in one of Australia’s most competitive retail environments. His website www.petermcox.com.au has a host of free financial management tools you can use in your business. Peter can be contacted on 0438712200.