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Off the Cuff: How to Measure Key Barometers of Business Health

One of the main reasons Impressions asks me to write an online column is simply what I do for a living; I'm a full-time management and marketing consultant in the apparel graphics industry. I’ve been at it 30 years and still look forward every day to plying my trade.

Among the most important tools in my consulting kit is an elaborate operating ratio database that enables me to see where a company is and has been financially. I can compare it vis-à-vis the averages compiled on similar companies and quickly determine where a company is doing well or not so well in various aspects of its enterprise. It also allows me to help the owner set goals for enhancing bottom-line performance. Finally, this process gives me a handle on the company's management and production cultures. Think of this data as being akin to your physician getting a profile on you from the results of blood tests, EEG's, EKG's, and monitoring your heart rate and blood pressure, among other indicators.

A word about the database: The Apparel Graphics Institute, which I own, has maintained this operating ratio database since 1986 and updates the results every two years, based on information from a broad cross-section of the industry as to company size, decorating technologies, and types of products and services offered.

All companies included in the data:
•Operate on a year-round commercial basis
•Produce and sell custom screen-printed and/or custom embroidered apparel as its primary business, and
•Sell finished apparel (screen printed and/or embroidered) to end-user accounts.

This semi-annual report is available only on a selective basis via subscription. The next update will be published in March 2010 and will reflect the current challenges apparel decorators are experiencing this year.

Beyond merely looking at the bottom line—which is about all that bankers and accountants concern themselves with—this analysis tells you if your company is doing well in its operations and how it stacks up relative to similar-sized competitors.

Seven Key Barometers

When reviewing financial statements from clients or providing appraisals on industry firms being bought or sold, I look at traditional ratios such as debt-to-equity, price-to-earnings, and Accounts Payable vs. Accounts Receivables to get a quick financial snapshot. But where my stethoscope tells me how a company's performing internally—in its heart and in its head and in its future—are the percentages shown on its profit-and-loss statement for the cost of garments, production payroll, advertising, rent, telephone, utilities and professional development.

Standard ratios show a company in black and white. My internal examination shows me the diagnosis in full color. To get that full-color picture, I look at:

1. Cost of garments. The single largest expense in virtually every custom decorating company, this figure typically ranges (including inbound freight) from 35 percent to 65 percent, with the average firm spending between 50 percent and 60 percent of its total revenue on apparel blanks. These figures test true from companies doing low six-figure annual sales up to $2.5 million. Every point you can save here goes right to the bottom line.

2. Production payroll. Defined as shop labor excluding production prep, it's here, the second largest cost center in most companies, where the most significant barometer matters in ways that payroll for owners, office staff, salespeople, artists and digitizers don't. The average shop labor runs, including taxes and benefits, between 12 percent and 16 percent of total revenue. The most efficient companies operate at less than 9 percent. When this figure is above 16 percent, a company is headed for serious trouble if it cannot improve its production efficiency ratios.

3. Advertising. Ratios here demonstrate wildly diverse commitments to advertising by various custom apparel graphics decorators. For the record, my recommendation for advertising is in the 3 percent range, give or take a half point. Having studied this aspect for more than 20 years, I can say with authority this level of commitment is necessary to satisfy the objectives of lead generation, account retention, and market share gains. That requires, of course, that the advertising be executed effectively and intelligently. When I see a company spending less than 1 percent on advertising—which is the norm in the industry—I see a company skimping on the protein critical to sustained progress in terms of re-orders, new leads, new first orders, new accounts and referrals.

4. Rent/Mortgage. On average apparel graphics companies grossing up to $1.5 million in annual sales spend roughly 3 percent to 6 percent on rent or mortgage payments. Larger firms spend a lower percentage—2 percent to 3 percent. When rent/mortgage is more than 6 percent of revenue, that company should have a retailing operation as a key element of its revenue mix. If not, a non-retail custom shop spending 6 percent on rent is on the precipice of failure.

5. Communications. Telephone and Internet expenditures tell me about the company's marketing performance. As companies grow, this ratio tends to decline as a percentage of revenues. The norm for communications costs in our industry is in 1.5 percent zone. That ratio suggests the company has made solid commitments to good telecommunications systems (good hardware, cell phones, toll-free numbers) and maintaining a reasonable Web presence. It can, however, also suggest a lot of money is being wasted, particularly when corresponding costs per-leads and per-sale can be shown to be excessive, meaning the expense is either unnecessary or inefficient.

6. Utilities. Proper cost accounting of utilities here means tracking only energy consumption and water usage (and the latter figure is usually quite nominal). Ratios of 0.5 percent to 1.5 percent are good to tolerable; 1.4 percent is the industry average. When ratios exceed 1.5 percent of gross annual sales, a likely profit-eating pathology is festering without treatment. While screen printing companies almost always pay higher energy bills than embroidery firms, occasioned by the need to run dryers and heat more cubic feet of space (because screen printing operations require more room to operate than embroidery firms), ratios of more than 1.5 percent should warn the firm to tighten up on these costs.

7. Professional Development. This tells a great deal about a company's culture. It tracks how much a company spends for staff to attend trade shows, seminars and workshops at trade shows and supplier venues, hiring in trainers and reimbursing employee tuition for courses offered by a local college or your chamber of commerce or economic development agency. (Contrary to how your accountant keeps score here, travel costs for meals, transportation and lodging for trade show attendance and employee training are more accurately tracked as "professional development" than being lumped into the traditional "travel" category).

The percentage spent on professional development is the best barometer I have in measuring a company's commitment to keeping its people and its operations current with new technologies and trends. Qualitatively, the effects on the bottom line aren’t surprising: companies that spend more on professional development tend to be more profitable, have measurably lower production labor costs, and experience lower turnover in skilled personnel.

About 0.5 percent is the recommended level of commitment for most companies. The average industry firm spends about 0.25 percent and nearly half of all shops spend nothing at all! My admonition here is that companies that spend less than 0.5 percent on professional development are cheating themselves.

In Part Two, we'll explore specific steps and remedies for improving the ratios and generating a healthier bottom line.

Mark L. Venit, MBA, president of Apparel Graphics Institute, Ltd., provides management and marketing consulting and proprietary research to apparel graphics companies throughout the Americas and Europe. Author of several books and nearly 400 articles on management and marketing, he also serves as chairman of the board of ShopWorks Software.

Source: Impressions