P&L Key Ratio Guidelines Controlling Costs in a Difficult Economy

by Stephen Lett

I have always believed that you put dollars in the bank, not percentages. For example, it is not so much the percent of net income that’s important but rather the total dollars of profit achieved. However, in order to maximize profit dollars, it is important to manage the income statement by the ratios as a percentage of net sales. The dollars will take care of themselves. This month, I want to review the key ratios of a typical income statement for a B-to-B and a B-to-C catalog company.  I also want to discuss how these ratios have shifted and what is different today vs. a few short years ago.

If your company’s experience is similar to other firms, sales are probably flat (or down), expenses are up and your bottom line is getting squeezed. It is no secret that catalogers are feeling the pinch. It will pass but in the meantime, managing the key ratios on your P&L is even more critical when it comes to protecting net income. Consumer catalog companies have traditionally been able to post an EBIT (Earnings Before Interest and Taxes) of around 5%.  An EBIT of 10% to 14% has been more common for business-to-business mailers.  But today, these profit margins are difficult to achieve. The combination of increased costs, economic conditions and lower response rates are forcing catalogers to decrease circulation and make other cuts in order to maintain profitability.

Let’s take a look at common key ratios on a typical income statement. Please keep in mind that these ratios vary by company/market. The ratios I have compiled are for example only. How you organize your income statement is very important. Often, selling expenses are shown as part of operating expenses. When this approach is taken, the overall selling expense to sales ratio is not obvious. These expenses become much more difficult to manage. I prefer to see the direct selling expense broken out on the income statement so that the overall ratio can be managed. It is just as important to manage your selling expense to sales ratio as it is to track your gross profit margin on a monthly basis. Again, direct selling expenses can easily get out of hand if they are not managed as a percentage of sales. The consumer ratios are based on a hard goods (non-apparel) gift catalog company. Customer refunds often amount to 6.0% of sales; 2.5% for a b-to-ber.  Net sales represent 100%.

CONFIDENTIAL B-TO-B CONSUMER *
Total Gross Merchandise Sales 102.50% 106.00%
Less:  Returns & Allowances 2.50% 6.00%
Net Sales 100.00% 100.00%
Less:  Cost-of-Goods 46.00% 40.00%
Gross Margin 54.00% 60.00%
Direct Selling Expenses:    
   Creative/Preparation 1.50% 3.06%
   Print and Paper; Ink-Jet Address 6.00% 8.30%
   Postage 8.00% 11.60%
   List Rental 1.50% 2.71%
   Merge/Purges 0.75% 0.30%
   Internet Marketing 3.00% 3.50%
   Miscellaneous Mkting Expenses 0.25% 1.53%
Total - Direct Selling 21.00% 31.00%
Operating Expenses:    
   Packing Materials 0.65% 1.50%
   Outbound Freight 7.00% 9.60%
   Shipping & Handling Revenue -7.50% -14.85%
   Telephone Expense 1.75% 2.10%
   Salaries and Wages 8.25% 10.60%
   Total Payroll Taxes 1.00% 1.00%
   Total Employee Benefits 1.50% 1.60%
   Credit Card Fees 0.75% 3.00%
   Rent 2.00% 2.40%
   Depreciation 0.50% 0.80%
   Utilities 0.60% 0.60%
   Insurance 0.65% 0.30%
   Equipment Rentals 0.75% 0.50%
   Maintenance & Repairs 0.60% 0.35%
   Dues, Fees and Subs 0.15% 0.04%
   Professional Fees 2.00% 2.50%
   Office Postage 0.80% 0.19%
   Supplies 0.80% 0.40%
   Travel and Entertainment 0.50% 0.30%
   Other G&A Expenses 1.00% 1.10%
   Interest Expenses 0.50% 1.80%
Total - G&A Expenses 24.25% 25.83%
Total S.G.& A. Expenses 45.25% 56.83%
Operating Income (loss) 8.75% 3.17%
Net List Rental Income 0.75% 1.00%
Income (loss) – EBIT 9.50% 4.17%

Gross margin ratios have been increasing the past few years. Not too many years ago, catalog companies operated on a 50% gross margin ratio (100% mark-up). Gross margin ratios today are in the range of 60%. With the pressure to offer free shipping coupled with cost increases, i.e., paper and postage, catalogers have had to increase their gross margin in order to remain profitable. While margins have been increasing, so have direct selling expenses. Often the increase in margin is offset by the increase in selling expenses. Paper prices have increased over 30% the past 18 months. There were significant increases in postage costs too. As a result, direct selling expenses have increased from 25% of net sales a few years ago to approximately 30% today (consumer). Business mailers enjoy a lower selling expense to sales ratio but they too have seen an increase. Total operating expenses are in the range of 20% to 25%.

It is difficult to slash your way into profitability and the long-term effect of this type of quick-fix can be hard on your business. Here are a few ideas to help you generate additional revenue without increasing your costs that will leverage your existing overhead expenses:

  1. Use a Bounce-Back Offer – This is something you can do immediately with very little lead time required. Place a coupon for “$5.00 off (or $10.00 off) your next offer” in all outgoing packages. A dollar amount off offer will work better than a percentage off.
  2. Promote to Catalog Requestors – Make a “strong” offer to catalog requestors which will increase their conversion rate. Run re-activation models on older requestors. You should be able to mail these prospective at least three or more times.
  3. Promote to Prospects – Offer prospects a dollar amount off their first order (or flat or free shipping). This does not create expectations that another offer is coming. In test after test, we have determined that a strong offer to prospects will increase the revenue per catalog by 20% or more.
  4. Use Your Call Center – Empower your telephone sales representative to make offers to customers. Having a customer on the phone is a perfect opportunity to sell additional merchandise, i.e., cross-sell, up-sell, etc. Give your telephone sales reps the authority to make special offers (within guidelines, of course).
  5. E-mail Your Best Customers – Make them a strong offer. It is difficult to over e-mail your “best” customers. Hit them often and hit them hard with merchandise and promotional offers.
  6. Add a Mailing to your “Best Buyers” – If you need to generate additional demand revenue, consider adding another mailing to your “better” customers. Like e-mails, it is unlikely that you can over mail your “best” customers.
  7. Develop an Outbound Telemarketing Program (B-to-B) – For you catalogers who sell business-to-business or business-to-institutional, consider testing an outbound telemarketing program. This cannot be done by your existing telephone sales or customer service representatives. It takes someone specialized in outbound calling. You might want to consider outsourcing.
  8. Mail the Gift Recipients – Make a special offer to the recipients of gifts, a group called “Giftees”. People who have received a gift from one of your customers are excellent prospects.
  9. Use Title Slugs – This is another business-to-business mailing technique where you use your own customer list as a prospect file. Simply remove the customer’s name on your housefile and insert a functional title such as Purchasing Manager, Chief Engineer, etc.
  10. Post Card Mailings – A tool used to react quickly to lagging sales is a post card mailing with a quick expiration date offering a discount, i.e., dollar off or percentage off. Post card mailings should be mailed to current customers (not to prospects). Make a strong offer and drive traffic to the Web.

Catalog companies have continued to experience higher costs and lower response rates. Keep an eye on your key ratios. Compare them against industry benchmarks. Leverage your overhead expenses by identifying other programs that can generate incremental revenue cost effectively.