Industry-specific financial ratios provide benchmarks for continued success

With costs increasing and new accounts still hard to find, it behooves vending operators to bone up on financial management. Small vending operators as a whole don't give a lot of attention to financial management. Many believe that if they are covering their costs and making a decent profit, they are doing well.

Business conditions can change unexpectedly, however, and an operator who doesn't have good financial benchmarks is at risk of not grasping the impact of changing conditions. Operators need to understand that keeping a business in good financial health requires staying on top of several factors, regularly.

Most companies have a profit and loss (P & L) statement. This is a statement that measures the profitability of the company. It begins with the company's gross sales for a finite period of time, and then shows all of the operating costs, including product costs. The operating costs are subtracted from the gross sales, giving the net profit for the business.

If sales are weighted at 100 percent, and all of the operating costs and the net profit is calculated as a percentage of sales, it gives the operator a basis for measuring the operating efficiency of the business.

Because conditions change, operators need financial benchmarks
But how does the operator know if his costs are out of whack? Fortunately, there is a set of industry averages available, the National Automatic Merchandising Association's Operating Ratio Report. This report is conducted every year and is designed to provide comprehensive, yet straightforward guidelines for analyzing profitability among participating companies. The report summarizes key financial ratios in managing a vending and coffee service business.

The basic elements of financial management in any business are financial operating ratios.

The NAMA Operating Ratio Report goes beyond the profit and loss statement. It summarizes key financial ratios in a vending business. By understanding these ratios, a vending operator can monitor the financial health of his or her company.

For example, if an operator's route labor costs turned out to be 15 percent of sales, the operator would know, based on the Operating Ratio Report, that his route labor was much higher than the industry average. There might be a good reason for this; the company might have expanded into a new product category that year in which sales did not pan out as expected.

Otherwise, the operator would know that too much was being spent on route labor. He or she would then have to examine all the factors that contribute to route labor, such as salaries, sales, scheduling and productivity.

Ratios give perspective
A "bad" year might not be as bad as it seems, once the financial ratios are reviewed. At the same time, even in the best of times, operators can find themselves unable to meet their payroll if they fail to pay careful attention to these fundamentals.

The report evaluates a variety of operating ratios across the industry and then compares the typical NAMA member's figures against the industry's top performers to help pinpoint areas that could be improved to help increase profitability.

The report is particularly valuable for small companies because it provides critical insights about profitability as experienced by the industry's most successful firms. By looking at the report, for example, it's easy to see how a company compares with its competitors in terms of income, sales, inventory turns, return on investment, expenses, employee productivity and more.

Compare 'apples to apples'
In the most recent report, for example, payroll expenses for most NAMA members comprised 25.9 percent of sales, but for the high-profit firms it only comprised 23 percent. Operating profit for the typical NAMA member was 1.6 percent of sales, but at the high-profit firms, that figure jumped to 6.1 percent.

View Critical Profit Variables and Strategic Profit Model Ratios

Most operators will find everything they need on their balance sheet and income statements that they keep for day-to-day accounting purposes. Not every operator keeps financial information according to the same format, but the important elements are income, which every operator should know, along with assets and other information that is typically included on a company's profit and loss statement.

For those operators who have been struggling with the financial aspect of running the business and keeping track of figures like income, assets and expenses, there are several excellent accounting packages available. QuickBooks? is very popular for smaller operators. MAS 90 from Accounting Software Consultants is another popular software program. Other operators have reported that Peachtree software by Best Software SB Inc. is easy to use as well.

Software programs such as these can help small operators manage their accounting and will help them easily pull together the necessary information to participate in the NAMA Operating Ratio Report.

While gathering the information can be time-consuming, it pays off in a variety of ways. Small operators need to understand that in vending and coffee service, they must continuously think about their future capital needs. Vending is a very capital intensive business, and coffee service is becoming more capital intensive. The equipment is expensive and the cost of new equipment continues to rise.

Key consideration: return on assets
This is not a bad thing; new equipment usually is better. Better equipment can bring more sales. There are many instances in which vending operators have been able to win business because they offered a piece of equipment with new features. An excellent recent example of this is the guaranteed product delivery feature in many new machines.

Other costs rise as well. In order to grow the business, new personnel will be needed. Sometimes the business needs to hire someone with particular skills, such as a food director. This position will require a higher investment than a warehouse worker.

When such positions are added to the payroll, the payroll increases as a percentage of sales. Again, this does not mean that the company is headed in the wrong direction financially. In most cases, the addition of a person with special skills means the company is headed in the right direction.

Ratios track certain relationships
As the company grows, the costs increase and hopefully, the sales do as well. The financial ratios keep track of the relationship between expenditures and sales, and account for all the line items that contribute to both.

The financial ratios give management the measurement tools it needs to know how a particular investment affects the company's financial health over an extended period of time.

As a company's overhead needs increase, a business will naturally look to financing more of its expenditures. Many growing companies realize that in order to grow, they need to borrow money from conventional lending institutions. If they don't have accurate financial information and their financial ratios are not in line with industry averages, they will have a hard time securing funds to grow the business.

Preparation for business loans
Collecting the right financial information puts an operator at a distinct advantage when it comes time to apply for a loan or a line of credit. Thanks to the time spent collecting the information for the report, a company will have everything easily at hand for the meeting with the banker or loan officer.

Even more important, however, is that by comparing a company's data with that published in the NAMA report, a company can offer third-party documentation about how the company compares with others in the industry, and document such important loan considerations as projected revenue, return on investment and costs.

But perhaps the most important benefit is the insight the report can give about profitability and how to make specific operational changes that make the company more profitable.

Key variables to understand
Once an operator has evaluated the basic gross sales, net sales and overhead, the next most important ratios to evaluate are four other critical profit variables:

  • Sales per employee, an excellent measure of employee productivity;
  • Gross margin percentage, which reflects the ability to manage cost of goods sold effectively;
  • Operating expense percentage, which focuses on expense control;
  • Inventory turnover, which reflects how well inventory is managed.

It is important to keep in mind that the high-profit firm seldom performs better on all of the critical profit variables. Instead, it is the sum total of their performance on all the critical profit variables which produces higher overall results. The nature of the differences between the typical and the high-profit firm and the underlying reasons need to be understood by every operator.

Operators who participate in the NAMA survey not only receive a copy of the Operating Ratio Report, but they also have the option to purchase a Performance Analysis Report which will give even more insight about how their particular company compares with the high performers, not just financially, but across a wide array of categories.

About the author: Patrick Caffarelli is the chief financial officer and assistant secretary/treasurer of the National Automatic Merchandising Association.