ORLANDO, FL — The importance of sound financial practices in building a profitable coffee service operation was addressed by Randy Parks, ProStar Services (Carrollton, TX) at the National Automatic Merchandising Association National Expo here. Leading a seminar on “OCS Best Financial Practices,” Parks offered an overview of profit-and-loss statements, their components and the value of the information they can provide.
The speaker led off by emphasizing that a reliable benchmark is a key tool for assessing a company’s performance. “The NAMA operating ratio report, Key Indicators for Success, is that tool,” Parks said. This long-standing annual program is conducted by inviting operators to provide detailed financial information for analysis by an outside specialist company, Profit Planning Group (Boulder, CO). Each participant not only receives a copy of the finished study at no cost, but also a custom company-specific report. The price of the study for nonparticipating NAMA members is $200.
NAMA chief financial officer Patrick Caffarelli, who was in the audience, explained that a new policy, starting in 2007, will offer each participant a custom report each time they complete the survey, not just on the first occasion.
Parks urged everyone to take part in the study, but noted that the report is well worth the cost to nonparticipants. While a company’s own P&L tells management whether or not the company is making money, only a comparison with the averages of other similar firms can point to areas in which it’s doing better than its competitors, and those that will benefit from management attention.
A fundamental financial report for a company of any size is its income and expense statement, Parks continued. At base, this begins with income and proceeds by subtracting the cost of goods and the operating expenses from that total. The result is the operating profit or loss.
For a coffee service company, income primarily is generated by the sale of products, Parks pointed out. In nearly every coffee service, those products include not only coffee but also other hot beverages (like tea and hot chocolate), creamers and sweeteners, and often related items like water and cold drinks. Many operations offer a more or less extensive range of additional merchandise.
Beyond the sale of goods, office refreshment operations often derive income from rentals of such equipment as upscale brewers and water dispensers. Organizing all this information on the income statement can be helpful, at a minimum, in highlighting the importance of maximizing sales, especially of higher-profit items.
Among other benefits, analyzing the company’s financial performance will underscore the importance of maximizing sales, the speaker pointed out; “Products drive the top line.” Operators simply can’t afford to lose business because their customers don’t know that they offer a particular product or service, and so they go and buy it somewhere else. “It’s very important to organize your products so that your clients know what you have to offer,” he said. “We use a catalog to keep them informed.”
Parks offered examples of income statements for a traditional office coffee service, a coffee service offering more expensive single-cup brewers, and an operation providing water coolers. In each case, the revenue and the expenses are different; in all cases, it’s not difficult to calculate the average time for recovery of the investment – and to determine the amount of monthly rent that a smaller account might be charged in order to provide an acceptable return on investment.
Calculating the cost of goods involves, first and foremost, inventory management. “You have to take inventory,” the speaker emphasized. “Do it weekly or monthly or in 13 periods during the year, but do it!”
For each period, there is a beginning inventory, to which the purchases for the period are added. From that total, any damaged or expired goods, and the ending inventory for the period, are subtracted. The difference, on the bottom line, is the total cost of goods.
Salaries represent a substantial part of operating expenses. This operating expense category includes not only route and delivery salaries and commissions, the salaries and wages of maintenance and warehouse personnel and supervisory salaries and bonuses, but all other employee salaries and wages, as well as payroll taxes and fringe benefits.
Finally, other expense items characteristic of coffee service are equipment maintenance and repair and vehicle expenses, as well as costs incurred by most businesses: facilities expense/rent, depreciation, sales and use or occupational taxes, all other taxes, including property and personal, and insurance.
Once one has done the arithmetic for one’s own company, Parks said, it’s very helpful to look at the NAMA operating ratio report. In the most recent study, the typical participating operation reported that, taking income as 100%, the cost of goods was 47.9%. Thus, gross margin was 52.1%, from which expenses were subtracted.
Of those expenses, payroll averaged 24% and other expenses, 19%, so operating profit before taxes was 9.1%. “This exercise shows you the critical things you want to watch, like salaries,” the speaker observed.
An audience member asked for recommendations on compensating sales representatives, especially those responsible for bringing in new business.
“There are different ways to do it,” Parks replied. “Do you give them marketing support? The more marketing support they get, the more new accounts they’ll close.” That marketing support costs money; suppliers often can be persuaded to help support it. But it makes money, too. The ability to balance the cost and the benefit is another substantial value obtained by good financial management.
“The average account may bring in, say, $150 a month,” the speaker continued. “We pay a base salary plus a rolling commission based on three months’ sales.”
All the costs must be taken into account, recognizing that many costs greatly increase the sales force’s efficiency. “Do you do ‘demos,’ and do you buy leads? Our salespeople close 12 to 15 accounts a month, on average, because we support them.”
As for route personnel, Parks added, one approach to determining salary is to take a percentage of sales.
It also is important to make sure that someone is maintaining the existing business, he emphasized. One way to do this is to pay a residual commission to the “outside” rep who sold the account; another is to pay commission to the “inside” salespeople who call on the account to take orders.
Speaking from the audience, industry pioneer Len Rashkin observed that, in his experience, a new account with new equipment costs $1,700 to sign up and install.
Caffarelli explained that, in addition to publishing the operating ratio report, NAMA prepared an annual wage rates and benefits survey that can cast considerable light on the industry’s practices.
With income and expenses written down, Parks said, one can address the “critical profit variables.” A particularly useful feature of the NAMA operating ratio report, he observed, is that it provides averages for “typical” and “high profit” member operations. The “critical profit variables” that differentiate the two groups are sales per employee, gross margin percentage, operating expense percentage and inventory turnover, expressed in the number of turns per year.
For a typical operation, sales per employee averaged $153,033; for a high-profit firm, the average was $168,160. Gross margin percentage – a measure of the ability to manage cost of goods sold – was 51.8% for the average operation and 51.6% for the high-profit one. Operating expense percentage, an index of success in controlling costs, was 47.9% for the high-profit firm and 50% for the typical one. And high-profit operations averaged 12 inventory turns per year, compared with 11 turns for typical companies.
Taken collectively, these differences result in substantially stronger performance by the average high-profit firm. While typical companies averaged $1,316,327 in assets, the high-profit ones were leaner, with an average $971,457 in assets – but their return on assets was much higher, 14.8% compared with 5.1% for the typical operation, Parks reported. Although the high-profit companies do not seem to perform spectacularly better than the typical ones in any one area, the cumulative difference is striking.
Other variables that are important to operating companies include the average accounts-payable payout period, a measure of promptness in paying suppliers. It is calculated by dividing the cost of goods sold by 365 days, then dividing accounts payable by the quotient. The ratio of accounts payable to inventory is determined by dividing accounts payable by year-end inventory; the quotient is a measure of the percentage of the inventory financed by its suppliers. And asset turnover is determined by dividing net sales by total assets; the quotient is a measure of sales generated by each dollar of assets.
Among many other useful ratios, Parks said, personnel productivity deserves particular attention. It is calculated by dividing payroll expense by gross profit, and the quotient expresses payroll expense as a percentage of gross margin.
Getting a handle on these measures of financial performance is the essential first step in building the business on a sound basis, the industry veteran reiterated. For example, every owner of a growing OCS business confronts periodic questions: When is it time to add another route? When is it time to retain a service technician? At what point should one add a supervisor or other manager? The effect of taking action or waiting can be predicted by looking at ongoing performance.
“You can’t control what you can’t measure,” Parks insisted.
The ability to organize a business for profitable operation and sustainable growth involves developing expectations that can be attained in the real world, he explained. The crucial ingredient in establishing such expectations and assigning quantities to them is a firm and detailed grasp of the business’s finances.
Not everyone takes pleasure in frequent calculation, Parks observed, but resources are available. “For example, there are ‘rent-a-chief-financial-officer’ programs; I used one,” he instanced. Once the operator understands the methodology and variables, it’s often helpful to delegate the detail work.
“There are great opportunities out there,” he said. “You need this kind of planning to go after them successfully. You need it in order to borrow money; you need it to establish a history that you can use to predict future results. Your banker wants to see it – and you want to see it!”