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!
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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) firstname.lastname@example.org or 817-834-3625 ext 6.