By Deborah Rechnitz CMA CMC

Seen any shrinking profits recently? Has your profit, as a percentage of sales, dropped from 10% to 9% to 8% to 7%? Is it as low as 5%? Hard to pay your bills at this rate isn't it? Have you looked back to try to explain this drop and been unsuccessful? Sometimes the causes are as big as day and yet hidden in the darkness.

Understanding the numbers. Profit is, obviously, one of the most important line items on your financial statement. Frequently it is the line item you look at first or at least second, right after your sales line. The dollar amount for profit may jump up in good sales months and drop during 5 week payroll months, but on a year to date basis, the percentage of profit to sales tells a lot about the health of your business.

Goals for profit range anywhere from 15% to 25% depending on a variety of factors. The rate of growth has a lot to do with achieving this percentage. If you are experiencing very fast growth, up front costs for new stores and additional staff to support this growth usually lowers profits in the short term. Very large operations frequently have profit results on the lower end of the scale because management rarely performs operational tasks, but 15% of $5,000,000 is still a lot more than 25% of $500,000. Regardless of your size, constantly improving this number is the challenge for all operators.

The Biggest Bang For Your Buck. With very little time to spend looking at financials statements, you have to spend your time wisely. There are items that never change from month to month like rents. There are other items that are very small. There are still others that you have no choice about, at least in the short term, like repair and maintenance, utilities, and vehicle expenses. These items may go up and down from month to month, but they rarely are the cause of shrinking profits.

There are two major items that have consistently caused shrinking profits, but the root issue is rarely obvious. Sales and labor are certainly the obvious culprits, but understanding how they cause the negative results is more important than running down to the production floor and getting frustrated at your poor productivity. That will not fix the problem.

Each sales transaction has two components -- revenue per piece and the number of pieces. Labor costs have three components -- wages per hour, productivity and the number of pieces processed. The relationship between all of these components can result is a cost, as a percentage of sales, between 32% and 50%, and that's before payroll related taxes and benefits! That will significantly impact your profitability.

Understand the Details. It's been said before that the Devil's in the details, and this business is no different. There are four variables affecting a high labor cost and contrary to popular opinion, productivity is rarely the most significant component. Volume, of course, cures most ills, but it is harder and harder to come by and without other changes, labor costs could still be increasing faster than sales. What, then, is the answer?

The third wage component, after volume and productivity, is the wage rate itself. This is calculated by dividing total wages by total hours and incorporates overtime costs as well. This rate has been increasing at nearly double digits compared to the price increases on your product. The result is shrinking profits! Evaluate your own price increases over the last two years. Perhaps you've had increases of 2%, 3% or even 5% per year. Was it $5.00 and now it's up to $5.25 two years later? That's only a 5% increase over the last two years. Now compare just the starting wages of your staff since 1998. Was it $6.00 in '98, $6.25 in '99 and $6.50 in '00 or is it up to $7.00 in 2000 in order to attract qualified staff? That amounts to a 17% increase over the last two years. The affect of these results will be a drop in profits by 4 percentage points from 10% to 6.19%.

There is an alternative scenario. The price increase needs to be in line with the wage increases, unless there are major changes in productivity results. A 5% increase in prices, each year will fully offset the necessary wage increases to meet market demands. Profit, as a percentage of sales remains nearly the same in the Current Year Adjusted example above. It is critical to maintain this relationship in order to maintain your existing profitability because without profits you can not continue to exist in the long run.

Productivity in this analysis has been held constant. Productivity improvements do impact the profitability of a company, but generally with the significant wage pressures in this strong economy, increases in productivity with existing equipment and existing processes will not, by itself, bring profits back in line with historical levels.

Today, profits don't come easily in this business. It takes time and effort and both are in short supply. You need to make the best use of your time. Spend time this month looking at your historical revenue per piece and your wage rates for the last two years. Did you stay in sync or have you fallen behind? Your time may be worth four percentage points of profit. Now that's a good use of your time!

Published in the American Drycleaner, December 2000


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