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Begin with the End in Mind, Part One October 11, 2017 (0 comments)

Omaha, NE—Is your retail business helping you with your future wealth and retirement requirements or is it just providing you with a job?

"Beginning with the end in mind" means demanding more from your business and for yourself.  It requires an understanding of the ‘gap’ between required/desired performance and current performance: something we refer to as the ‘GAP Analysis.’

Your retail business is simply a ‘tool’ to help you achieve your living and wealth needs both now and in the future. It’s important to remember that the return on your business investment comes over and above your ‘market’ income each year. Your market income reflects your daily activity and is therefore excluded from any return on investment. So a business has to generate not just each person’s living wage (more on that later), but also a surplus to build wealth. If a business cannot post a surplus after the owners’ salaries, it might also be hard to substantiate goodwill to a potential purchaser.

Understanding the ‘GAP’ Process. Otherwise referred to as the ‘Bottom Up’ budget, there are four steps to the ‘Gap’ process. These are:

1. The ‘GAP Analysis’
2. The Gross Profit ‘GAP’
3. The Sales ‘GAP’
4. The Inventory ‘GAP’

Because we are committed to you actually using this powerful process, we will only cover one step at a time, then have you complete some action steps of your own.

Step 1 – The ‘GAP Analysis.’ The ‘GAP’ analysis also consists of four steps:

1. Retirement / Exit Planning (including succession planning)
2. Personal Exertion
3. Return on Investment (this is different from GROI)
4. Overheads (operating expenses)

Let’s take a closer look at these.

Retirement / Exit Planning. Do you work to live or live to work?  For those people who work to live, this topic is for you.   If you live to work, we recommend staying healthy to enable you to work a long time, as retirement is not something you would seriously contemplate right now.

Setting a retirement / exit target date is not something to be taken lightly or done quickly. The date becomes a stake in the ground that allows further calculations to be completed. This can also be looked on as a timeframe to be able to retire rather than an end date--so going to work then becomes a choice, rather than a necessity.

When determining your personal wealth goals, you need to make assumptions about your future lifestyle needs and life expectancy. We urge clients to take specialist financial planning advice in this area. It is widely considered that you need a minimum of $700,000 of investment capital (over and above your house, art collection, boat, etc.) to retire modestly. 

Example: Let’s say you want to retire with $700,000 of investment capital in 2027 (i.e. 10 years from now) and you currently have $400,000. That means you need to generate a further $300,000 of investment capital over 10 years, which is $30,000 per year after tax. We will talk more about actual exit / succession strategies at another time.

So the first figure to go into your ‘GAP Analysis’ is this: Retirement / Exit Planning - $30,000.

Action Steps:

1. Determine required retirement wealth
2. Set retirement / exit date
3. Calculate the extra annual gross profit required

Personal Exertion. Your personal work effort each week (exertion) reflects your market salary. This is normally consumed and does not form part of your wealth calculation. However, any superannuation plan arising from savings (after living costs) are included in your wealth calculation.

A good way of looking at this is to ask yourself what you would pay someone else (a manager) to do what you do or what you would expect someone else to pay you if you worked for them. We are trying to establish what you would earn with your skills and experience when running another person’s store, to ensure your salary is based on strictly commercial terms.

If you have to work 50 – 60 hours per week to complete your role, please add the kind of premium over and above your salary that you’d expect if you were an employee of another store. The business must pay for the hours worked to create the result.

Example: If the market salary for your role is $50,000 for a 40-hour week and your work a total of 60 hours, your adjusted market salary would be $75,000, because you are essentially doing the work of one and a half people.

The second figure to go into your ‘GAP Analysis’ is:

1. Retirement / Exit Planning - $30,000
2. Personal Exertion - $75,000

Action Steps:

1. Complete your Personal Exertion calculation
2. Add it to the ‘GAP Analysis’

Return on Investment. Putting a figure on a ‘required return’ is as much an art as a science. We recommend you seek help from your professional advisers (accountant) in this area as each jeweler’s return will be unique to their specific financial circumstances.

Action Steps:

1.  Determine the investment you have made in your business or what your business owes you; i.e. $400,000. Some of this may be reflected in your business balance sheet and will include your capital and current account; however, let’s say in the Personal Exertion step you calculated your market salary at $75,000, but your business has only been paying you $50,000 for the last five years. Your business has been short paying you $25,000 for five years, which is $125,000--and you won’t find that on your balance sheet. This is payback time. If you have trouble with this, please seek advice from your accountant.

2.  Ascribe a financial return that warrants your business risk. As a rule of thumb, we use a figure of 27%, which is approximately half way between what a willing buyer will offer you for your profit (they normally want a 33% return) and what you think is fair (normally 20%). In other words, if your business is making an annual net profit of $100,000, a buyer would offer you $330,000 for your business (a 33% return) and you would want $500,000 (a 20% return). So, a 27% return is roughly where a willing buyer and a willing seller would settle.

This return of 27% is made up of two parts:

1. The ‘risk free’ return; i.e. the rate any bank would pay you for having your funds on deposit with them.
2. The ‘risk premium’. Consider general small business risk, the fact your funds cannot easily be withdrawn and specific industry risk such as a competitor opening next door to you.

Example: If your business owes you, say, $400,000, at a 27% return you should expect to generate $108,000 of extra gross profit from your capital investment. 

The third figure to go into your ‘GAP Analysis’ is:

1. Retirement / Exit Planning - $30,000
2. Personal Exertion - $75,000
3. Return on Investment - $108,000

Overheads.  In this context, overheads are all other costs below your gross margin line. As your gross margin (profit) is profit after the cost of the item only, overheads are simply everything else. The list would include wages (excluding your own because this has been allowed for in your personal exertion calculation), rent, power, bank fees, etc. Basically, everything in your Profit & Loss list, excluding product.

Example: If your other business costs are $350,000, this figure needs to be added to the ‘GAP Analysis’ as shown:

1. Retirement / Exit Planning - $30,000
2. Personal Exertion - $75,000
3. Return on Investment - $108,000
4. Overheads - $350,000

Total Gross Profit required: $563,000

Action Steps:

1. Complete your Overhead calculation
2. Add it to the ‘GAP Analysis’
3. Add a), b), c) and d) together. This is the amount of gross profit your business needs to generate to fulfill your ‘GAP Analysis’.

Congratulations on successfully completing Step One! In the next article, we will calculate your Gross Profit ‘GAP’.  Stay tuned!

The Edge Retail Academy is a highly effective jewelry industry consulting company that provides customized strategies for retailers and vendors to increase profits, optimize growth, reduce debt, create profitable inventory solutions, build effective teams and enhance brand loyalty and profitability. The Academy is committed to helping jewelry businesses improve their bottom line while reducing uncertainty and stress. Edge Retail Academy software and the unique talent pool of their business advisors provide real world knowledge and advice for guaranteed results, all on a “no-contract” basis. www.edgeretailacademy.com.