The single best way to increase profits and put more cash in your bank account is to focus on improving your gross profit. Increasing sales may require adding personnel, trucks and warehouse space. Increasing gross profit requires only your time, attention, and a better process.
In this article I will outline the process we used to improve gross profit and introduce you to a software solution called Salient Margin Minder. As the name implies, Margin Minder is a tool that will help you mind your margins so that you can supercharge your gross profit dollars.
Real Money at Stake: The Importance of GP
If you are not focused on gross profit, you are leaving real money on the table. A small fraction of a percentage increase in GP can have a massive impact on your profitability. Many beer distributors focus entirely on sales growth, but I recommend you turn your attention to gross profit. A few examples:
On $25million of beer sales, a small 1/2 % margin improvement equals $125,000 right to the bottom line.
On $50million of sales this 1/2 % increase equals $250,000.
That is some big time scratch. Best of all you don’t need to add personnel or equipment; you just need to have a better process and better technology to funnel these gross profit dollars back into your pocket.
Our Gross Profit Improvement Story
Sales were growing, but gross profit was shrinking. Something was going wrong with our pricing, discounting, or product costing. We needed to figure out where the problem was, and fast. The bottom line depended on it.
Unfortunately, the term gross profit was a mystery to most of our sales people. They had heard about it, but didn’t know exactly what it was or why it was important.
Few people understood the gross profit calculation let alone how to improve it. The sales team was focused only on increasing sales. The inventory team was focused on making sure we had enough inventory (but not too much). The two teams would talk to each other, but not really. Their agendas were different and their incentives were different.
The first step was to show our team on how gross profit worked and how to increase it. The process was an eye opener for everyone involved. We started by teaching them the Gross Profit Basics.
Gross Profit Basics
Before you can improve gross profit, you need to know how it is calculated. The math isn’t hard, but it’s important that everyone involved with improving gross profit understands how it works.
Sales minus the Cost of Sales = Gross Profit
Gross profit is the difference between sales and cost of goods sold. These items show up at the top of the income statement. The cost of goods sold typically includes freight, taxes and the beer itself. If you sell a case of beer for $32 and the cost of the beer is $22, you have a $10 gross profit.
Next, you can turn that $10 gross profit into a GP percentage. This makes the number easy to compare to a planned outcome. For example, if the budget calls for a blended 25% gross profit on all sales.
Gross profit $ divided by Sales = Gross Profit %
Continuing the example above, $10 gross profit divided by $32 sale equals a 31.25% GP percentage. Share these simple calculations with your team.
To avoid confusion, be consistent with the expenses included in your gross profit calculation. For example, some distributors include handling fees for bottle deposits in their product costs. Other distributors include mandatory marketing expenses.
Regardless of what costs you include or exclude, the most important thing is to be consistent. Otherwise, your gross profit will fluctuate and make it difficult to compare current results to past performance.
When you understand the different pieces of the gross profit puzzle and how they work, you can improve the number.
For a look at how we set up the sales, cost of goods and gross profit on our income statement click here.
Our Process: A Singular Focus on Increasing Gross Profit
Once our team knew why gross profit was vital to company success, and understood how it worked, the next step was to put this knowledge into action.
We set up regular gross profit meetings with our GM, sales manager and inventory manager. The purpose was to get everyone working towards the same goal: to improve gross profit.
The meeting agenda was the same each week:
- Review the actual gross profit compared to the plan – what was the income statement telling us?
- Run profit analysis reports by supplier to identify underperforming brands
- Isolate the components of gross profit (sales and cost of sales) and determine where we could improve
What we found during the first meetings was that the sales and inventory teams were not communicating at all. The two were operating separately from one another, and were focused only on their individual agenda.
The sales manager would meet with the supplier, negotiate pricing and a discounting schedule. The inventory manager would place product orders according to expected market demand. No one, however, was looking at the gross profit calculation.
In many cases, it turned out that the pricing during discount periods was so low that it killed the gross profit for the whole year. After this was discovered, the sales and inventory manager worked with the suppliers and negotiated better depletion allowance support.
In other cases, an average freight cost was used to compute the product costs. Upon closer inspection, the sales and inventory manager determined that the actual freight cost was significantly higher than the estimated freight charge given by the supplier.
The process of getting sales and inventory on the same page, working towards the same agenda helped us significantly increase our gross profit.
Use Technology to Supercharge your Process
During the course of our meetings we were able to identify and correct the big problems that were dragging down our gross profit. Our issues were related to a lack of understanding of how gross profit worked and poor communication between our sales and inventory teams. We fixed these problems and our gross profits increased.
Our next move was to drill down deeper on gross profit, and find more ways to improve the number.
We ran multiple profit analysis reports through Encompass, our route accounting system. We looked at GP by brand and by SKU, by class of trade (chain grocery, convenience, etc.) and by individual customer. The goal was to identify areas where gross profit was low and figure out ways to increase it.
This approach was not rocket science, but it worked to improve our gross profit and our bottom line.
Recently, we have begun to look at Salient Margin Minder to improve our ability to monitor, manage and increase our gross profits. The information we get from our route accounting system is helpful, but Margin Minder brings a new level of sophistication and in-depth GP analysis to improve results.
For example, Margin Minder allows you to drill down on promotion effectiveness, showing you how profits and sales are affected by discounting, deal duration and frequency. The tool also allows you to “rationalize new product SKUs and product mix” by quantifying which products can support their sales, distribution and marketing costs. That alone is worth its weight in gold.
Good process + Good technology = Superior results
Bill Gates said that “automation applied to an efficient operation will magnify the efficiency”. Likewise, automating your gross profit process by using a tool like Margin Minder will magnify your GP improvement.
Wrap up + Action Items
Beer distributors love sales growth. However, the most efficient way to increase profits and put more cash in your bank account is to focus on improving your gross profit.
A small improvement in the gross profit percentage can add up to big money fast.
- Teach your employees the gross profit basics
- Set up regular GP review meetings with a singular focus on improving gross profit
- Use technology, like Salient Margin Minder, to supercharge your process. Check out the short overview guide here.
Your Action Item, should you choose to accept it, is to implement the steps above.The results will surprise you and delight your income statement.