You simply must spend more time understanding
inventory turns and cost of goods. (I don’t mean cost
of cars.) One of my good friends, Gary McKinney, a new car dealer,
taught me to focus on turns first, margins last. If you are
analyzing a return on something over a yearly basis and you
put money into materials that return a 50% margin over the year
and you compare that to inventory that turns over quickly at
20%, consider how much more you’d make if you turned the
smaller margin over six times a year as opposed to the larger
margin only once a year.
Hundreds of business owners fall into the
trap of buying the big item or the pretty item with the money
they’ve generated. Perhaps they think they look good to
have it around. But if cash flow is thin, stay away from items
that turn over slowly and favor the inventory that turns rapidly.
You’ll generate a whole lot more of that valuable revenue
from items that, though they may have a smaller profit margin,
are favorites among customers.
Now there’s a calculable point of poor
return for which you want to watch. Don’t go by a blanket
statement. Big margins are not bad and little margins that turn
rapidly are not all favorable to your business profit. Get out
your calculator and crunch some numbers.
I know this is confusing, but let me give you
an example. If you buy a car for $1,000, and it has a cost of
goods sold (COGS) percentage of 33% (meaning that it will produce
$3,000 in parts sales), and you turn it (at cost) twice during
the year, you will have $2,000 in the bank. (You double your
cost, with another thousand to go in year two.) But, if you
buy a car for $1,000 with a 33% COGS, but turn it 6 times (at
cost), it will produce the entire $3,000 in 6 months (3 turns
in the first 6 months, equating to 6 turns annually). In the
second case, you have your entire purchase price back in 60
days, ALL of the cost AND profit in 6 months, and then you are
back to the pool to buy another car. So the same $1,000 can
produce $2,000 annually, or $6,000. One is obviously better
than the other. Remember in the second example that you had
to process twice as many cars (because you are buying them faster);
so those costs increase.
At one yard, I followed a profitable numbers
trail toward acquiring more trucks for salvage because I observed
that, though the margins were not as high as some of their other
products, truck parts turned over rapidly. They could hardly
keep them in their inventory.
We’d buy them; money would flow like
the snap of a finger, sometimes almost before we could process
the parts through our system. We learned by analyzing the numbers.
We made a very progressive buying decision by comparing returns.
Next month: More good stuff from Chapter 5
of “Salvaging Millions”.
Remember, only you can make BUSINESS GREAT!
Ron Sturgeon is past owner of AAA Small Car
World. In 1999, he sold his six Texas locations, with 140 employees,
to Greenleaf. In 2001, he founded North Texas Insurance Auction,
which he sold to Copart in 2002. In 2002, his book “Salvaging
Millions” was published to help small business owners
achieve significant success, and was recently reprinted. In
June 2003, he joined the new ownership and management team of
GreenLeaf. He also manages his real estate holdings and investments.
You can learn more about him at www.autosalvageconsultant.com.
He can be reached at 5940 Eden, Haltom City, TX 76117, (best)
or 817-834-3625 ext 6#.