Why is benchmarking so vital to the success of your dealership? Benchmarking will help you become a high performer. It gives you the ability to compare your company's financial performance against other dealers as a whole; within a region; of comparable sales volume; or those within a similar line of business. Spotting significant differences between your dealership's performance and that of comparable dealers can be the first step to improving your profitability.
A difference between your dealership’s performance and the benchmarks is not necessarily good or bad, it merely indicates that you need to do further analysis. For instance, it may be helpful to calculate the same performance over several years to identify any trends.
Additionally, benchmarks can be a tool for informed decision-making as opposed to using absolute standards. Any two companies can be successful yet have different performance measurements because of their size, location, local economy, etc.
Financial Ratios that Matter Most
While it's important to analyze financial information in dollars and cents, it’s essential that percentage in ratios for better comparisons to past performance and other metrics. Just as dollar figures are not overly meaningful by themselves, ratios can't be used in isolation. However, when ratios are combined with dollar amounts, they can provide an extremely accurate overall picture of your dealership's financial performance.
For example, while it's helpful to recognize your annual employee compensation expense, it's even more essential to compare this expenditure to the value that is producing. How much gross profit am I getting for the dollars I’m spending?
Learn more in the Rural Lifestyle Dealer podcast, “Measuring Up: The Financial Metrics Every Dealer Should Know.”
A dealer has many numbers to watch, but here are the financial ratios that matter most in determining the profitability of your dealership:
- Gross profit per employee
- Return on assets
- Return on equity
- Return on sales
- Debt-to- equity ratio
- Asset turnover
- Net working capital
- Fixed coverage or fixed absorption
Gross Profit per Employee
Gross profit per employee is one of the first measurements I look at. Like the other measurements, it’s important that you start with solid data. For instance, sometimes a dealer lists the employee size, but that number is no longer accurate. Or, they share the total of all employees, as opposed to just full-time equivalent employees. I do suggest excluding technicians from this particular ratio.
The gross profit per employee that we see on average for equipment dealers is about $207,000 per employee. Our high-performance stores are $243,000 gross profit. Putting this metric to use in the dealership could mean letting go employees that are falling well below the desired level.
The other reason I look at gross profit per employee on every store is that there are really no adjustments that need to be considered for accounting conventions specific to that dealership. Gross profit is generally calculated the same way by everyone.
Sometimes, I am asked why I use gross profit per employee vs. revenue for employee. Too many dealers have compensation plans that reward based on revenue level, so the sale team may be cutting margins to make a sale. Revenue targets are reached, but profit goals aren’t. This practice encourages employees to work the pay plan instead of working the department.
Return on Assets
Average equipment dealers achieved a return on assets (ROA) of between 4.8-5% in 2017. High performing dealers achieved an ROA of 12.6%, a big difference from their average counterparts.
The ROA metric indicates how profitable the dealership is relative to its total assets and tells us how efficiently management is using assets to generate net income.
Return on Equity
Return on equity is a measure of the dealership’s profitability in relation to the investment that the shareholders made. In essence, how well is management using the capital that’s been invested to generate net income?
The average equipment dealers run at about 16%, while our high performers are running at almost 27%. Again, a big difference there.
Return on Sales
When measuring return on sales, I'm typically looking at net income before taxes. When looking at net profit margin, our high performers are at about 8.2%. I also have dealers achieving higher than 10% return on sales of net income percentage. Typically, to achieve that type of return, you need a strong fixed operations department.
Debt-to- Equity Ratio
This is simply the net income as a percentage of each dollar of sales. Debt-to- equity is calculated by taking the total liabilities divided by the total equity. For example, our high performers are leveraged at about 1:1.
The question dealers often ask is whether they should be striving for a high or low debit-to- equity ratio. There is not really a straightforward answer on that. A high debt-to- equity ratio indicates the company may not be able to generate enough cash to pay its bills. However, a low debt-to- equity ratio (which banks prefer) indicates that the company may not be taking advantage of opportunities for profit that borrowing money may bring.
We've all heard the old adage about making money using other people's money. I like to borrow money and get a high return off of that.
Asset turnover simply measures the efficiency of a company regarding the use of its assets in generating sales. I generally prefer to look at this by category, such as new inventory turnover, used inventory turnover, parts turnover, etc. And, even within that, when I look at new inventory turnover, I may look at specific lines, such as high horsepower tractors, low horsepower tractors, etc.
High performing dealers are achieving a 1.7 total asset turnover (not inventory turns).
Net Working Capital
Net working capital is a metric that banks tend to look at. Your manufacturers are also looking at your net working capital and your total assets.
The general working capital formula is total assets minus total liability. However, manufacturers frequently make adjustments to that for dealers. They will use your working capital as your total assets minus your total liability and also minus your long-term debt. Not every manufacturer does this, but some do.
Fixed Absorption Rate
What is fixed absorption or fixed coverage? Those are interchangeable terms and refer to the ability of the parts, service and rental operations (the fixed departments) to cover overhead expenses for the entire dealership. Calculating fixed absorption is one of the most important business strength metric measurements that a serious dealership owner and manager can make. A high fixed absorption rate will “recession-proof” your dealership.
Calculate this rate by taking the profit generated by the fixed departments and dividing it by the total of the dealership’s overhead expenses.
To put this into perspective, the average dealer is hitting at about 68%, the high performers are at 82% and our excellent performers are realizing in excess of 100% and 115% actual fixed coverage. This high ratio means the super high performers can still be profitable without selling any equipment.
For example, an operation might have a 50% fixed absorption rate, leaving 50% of the dealership’s expenses to be paid by the variable departments, which are the new and used sales department.
Service, parts and rental are referred to as fixed because they're supposed be somewhat consistent, regardless of the current economic condition. On the other hand, the variable department (equipment sales) is highly affected by market conditions. So, if you have a low fixed absorption the question is whether the fixed departments are returning a lower-than- expected gross profit percentage or whether expenses are too high.
Then, we still have to dig deeper. Is my gross profit too low in parts, service or rental? Conversely, if my expenses are too high, which expenses are too high?
Improving Absorption Rate
Let’s say we have issues with the profits generated in the service department. Often, the service department’s profit is affected by process failures. I worked with a dealership that had limited shop space, so they moved equipment into the shop at night and then out in the morning. This took them about 45 minutes every evening and every morning. To solve the problem, the dealership added storage space and staged the equipment in for repairs. This helped them can gain back that lost time.
Process failures in the service department could be as simple as better organization, so technicians aren’t wasting time looking for tools, for instance.
A dealership may also have problems in its parts department by not having the requested parts on hand. This is often due to a poor information flow. By fixing that problem and having the right parts inventory, you can improve profits and increase your customers’ uptime. This can lead to repeat business and referrals.