All Sales Volume Is Not Created Equal

Is it a good sale or a bad sale?

By Albert D. Bates

Sales solve all problems. Wait, make that sales solve most problems. Actually, sales solve a lot of problems, but create a lot more. The understanding that “nothing happens until somebody sells something” causes otherwise rational individuals to undertake some bizarre sales-generating activities. It is enough to give sales a bad name. This article examines how sales volume can help or hurt financial performance for the typical GAWDA member.

Sales growth of only 5.0% has the potential to deliver 14.6% profit growth if expenses can be controlled.

Good Sales Versus Bad Sales
Just as there is both good and bad cholesterol, there are good and bad sales, depending upon the impact that the sale has on expenses. More than anything else, this expense impact is dependent upon whether the firm generates sales from existing customers and products or new ones.

Good Sales — This includes any form of sales growth that can be achieved without a commensurate increase in expenses. The most notable examples are inflation that automatically increases sales, greater penetration of existing accounts, and raising the firm's fill rate (even though carrying more inventory may be required).
Bad Sales — This includes any sales growth that requires a significant expense increase to generate the sales growth. This would include targeting new customers, expansion of the product line by adding more SKUs or product categories, and opening new branches.

The exhibit below reviews the income statement for a typical GAWDA member. It shows the firm in its current state and reviews two very different sales growth scenarios. In both scenarios, sales have increased by 5.0%. This sales growth figure could be the result of any combination of organic growth, inflation, additional products or branches, or any other activity that generates more sales volume. The exhibit says nothing about the source of the sales growth as of yet.

The Impact of a 5% Sales Increase Under Two Assumptions Regarding Payroll
Dollar Performance	Current Results		Scenario 1		Scenario 2
Net Sales	$10,000,000		$10,500,000		$10,500,000
Cost of Goods Sold	5,600,000		5,880,000		5,880,000
Gross Margin	4,400,000		4,620,000		4,620,000
Expenses
Payroll and Fringe Benefits	2,400,000		2,472,000		2,568,000
All Other Expenses	1,500,000		1,575,000		1,575,000
Total Expenses	3,900,000		4,047,000		4,143,000
Profit Before Taxes	$500,000		$573,000		$477,00

Percent of Sales Performance
Net Sales	100.0	%	100.0	%	100.0	%
Cost of Goods Sold	56.0		56.0		56.0
Gross Margin	44.0		44.0		44.0
Expenses
Payroll and Fringe Benefits	24.0		23.5		24.5
All Other Expenses	15.0		15.0		15.0
Total Expenses	39.0		38.5		39.5
Profit Before Taxes	5.0	%	5.5	%	4.5	%

In both scenarios, the gross margin percentage has held constant at 44.0% of sales. The firm continues to buy and sell items at the same relative price points as it did before. The result is that both cost of goods sold and gross margin increase at the same 5.0% rate at which sales increase.

A Checklist for
Expense Leveraging

Any action that causes sales to grow faster than expenses is normally thought of as expense leveraging. However, the concept can be expanded to include sales remaining constant while expenses decline.

There are numerous actions that assist with expense leveraging. The following are the most commonly discussed:

Sales per Order Line — If the average line value on an invoice can be increased, then for the same level of expense, the firm generates more profit.
Lines per Order — The idea of putting one more line on every order creates more sales, but only a little more expense.
Order Accuracy — Any error of any sort on an order dramatically increases the firm's costs. It also has a negative impact on customer perceptions.
Fill Rate — When the firm is out of stock, it goes to a lot of effort for no sales. A higher fill rate is always beneficial from a sales viewpoint. In most cases, the additional carrying costs of a higher fill rate are readily covered by the profit on higher sales.
Order Frequency — If firms can work with their customers to plan purchasing requirements with greater accuracy, then the same sales can be generated with less activity. This is good for the company and is also good for its customers as they spend less time receiving orders.

Further, non-payroll expenses have also increased by 5.0% in both scenarios. This is a correct assumption regarding the long-term trend in non-payroll expenses. It is tenuous in the short run, but is useful in illustrating the concept.

The real key in the exhibit is the extent to which payroll (and associated fringe benefits) has to grow to support the increase in sales. In Scenario 1, sales have increased by 5.0%, while payroll and fringe benefits have increased by an arbitrary 3.0%. There is a 2.0 percentage point positive difference between the two growth rates. The firm has engaged in what is commonly called expense leveraging, at least with regard to payroll.

The result is that pre-tax profits increase by 14.6%, from $500,000 to $573,000. It is a classic example of using sales to leverage expenses. Profits increase even while payroll is rising at a modest rate. Both the company and its employees are benefiting from the sales growth.

Sales and expenses must be planned jointly. Too often they are not.

Conversely, the second scenario in the exhibit presents the opposite situation. Sales continue to grow at the same 5.0% rate, but payroll expenses increase by an equally arbitrary 7.0%. The sad result is this increase in sales actually reduces profits.

The exhibit supports two major inferences, one of them counter-intuitive, the other intuitive to the point of being self-evident. Both of the conclusions need to be an essential part of management's thinking about profitability.

First, the counter-intuitive conclusion: Slow sales growth can be highly profitable. Sales growth of only 5.0% has the potential to deliver 14.6% profit growth if expenses can be controlled. In far too many distribution firms, though, a plan to produce both a low level of sales growth and improved profits would be met with derision. Real men and women increase their sales at double-digit rates. To achieve anything less is to admit failure.

Second, the self-evident conclusion: Sales and expenses must be planned jointly. Too often they are not. In the two scenarios, the sales manager will receive either accolades or brickbats for delivering the same 5.0% sales growth. This is because the 5.0% growth rate that was achieved either did (accolades) or did not (brickbats) meet the sales goal. The sales goal is set in isolation without concern as to the expenses required to meet the goal.

What needs to be brought into the calculation is whether the sales came from high-expense activities or low-expense activities. The sales plan must move beyond the amount of sales and also look at the source. It is the difference between profits going up and profits going down.

Targeting Good Sales
From a financial impact standpoint, the figures in the exhibit are exciting. They provide an absolute and unerring sense of direction for the firm. From a motivational perspective, though, the numbers are decidedly unexciting. In fact, bad sales growth is probably more exciting than good sales growth. Two challenges have to be dealt with in motivating employees to emphasize good sales over bad.

Selling existing products to existing customers is always the most effective way to engage in expense leveraging.

Wanting What We Don't Have — The grass is always greener on the other side of the fence. Adding customers implies the firm is moving forward. It is a natural progression in life. Penetrating existing accounts is boring. The value of customer penetration needs to be explained.

Degree of Difficulty — Generating sales from new accounts is probably more difficult than generating additional sales from existing ones. However, it is seldom viewed that way. After all, customers are already buying “everything that they want” from us. Trying to generate incremental sales from existing accounts seems somewhat self-defeating. This negative perspective must be defeated.

The reality is that selling existing products to existing customers is always the most effective way to engage in expense leveraging. It needs to be given a much greater priority in sales planning. New opportunities should not be overlooked, but they should be balanced with efforts to grow organically.

Moving Forward
In the future, sales planning must begin to incorporate the idea of driving additional sales from the base of customers and products already in place. That must be done not only from a financial perspective, but from a sales management perspective.

Meet the Author

Albert D. Bates, Ph.D. is founder and president of Profit Planning Group, a distribution research firm headquartered in Boulder, Colorado, and on the Web at www.profitplanninggroup.com.

Welding & Gases Today • Fall 2007 • Volume 6, No. 4 • Entire contents are Copyright © Data Key Communications, Inc. • All rights reserved. • Nothing may be reproduced in whole or part without written permission of the publisher.