Pass In Training

In our last blog we discussed how you can analyse revenue for owned operations. Make sure you check this blog out before reading this blog!

Gross profit has increased each year since 2017. This upward trend (2017: £1,116k / 2018: £1,217k / 2019: £1,335k) is linked to two changes:

1) An increase in volume of trading: As revenue increases, you expect gross profit to increase.

2) Gross profit margin improving:  Since 2017, the GPM has increased from 9.8% to 10.6%. This does not sound much (less than 1%) BUT the percentage increase is around 8.2%. The gross profit margin improvement over this period accounts for around half of the overall gross profit increase.

You therefore need to be aware that a small change in the GP% between two years, does have a large impact on gross profit (£) in businesses that operate on small GP%.

So what factors impact the GP margin for Owned Operations? Firstly, remember the environment in which Scour operates:

• Competition: Highly competitive market (one of the most competitive in the UK) makes it difficult to raise prices. Costs are difficult to pass on.
• Short term contracts (less than 1 year) and ease of switching from one supplier to another.
• Growing importance of technology to drive efficiency gains

With this in mind, you need to consider these points in the exam:

1. Has the business been able to increase it's prices to customers at all? If the examiner doesn't tell you or if you have no information to work it out, you assume there has been no price increase.

Clearly a price rise, all other things being equal, would increase GP margin and no price rises should leave GP margin unchanged.

2. What has happened to the average revenue per employee? As prices increase the average revenue per employee should also increase. If it has not increased the likelihood is there is more idle time (business efficiency drops). Therefore if selling prices increase 2% and the average revenue per employee only increases by 1%, idle time has increased which reduces efficiency. The reasons why idle time could increase are:

• Additional headcount which has not been recruited in line with new business (minimum contracted hrs are 25, so there could be hours being paid where cleaners are not working and therefore not earning).
• An decrease in customer retention rates and headcount not altered quickly enough
• Technology reduces cleaning hours with no change in headcount (e.g. Tonto)

3. An increase in wages / pension etc. which you will be able to see with the average cost per employee. It isn't an official business measure, but with staff costs being such a high proportion, if this increases then gross profit margins will decrease. The only exception is if the business has managed to pass these costs onto customers (difficult in a highly competitive industry).

4. Has Thom increased its pricing? If it has this will against reduce GP margin unless costs can be passed onto the customer. The examiner may tell you Thom has increased its prices (most likely approach) but with a lack of information you could estimate it by seeing what the cleaning products and other supplies are as a percentage of revenue. If this has increased and average revenue per employee is unchanged, then prices could have increased from Thom. Don't spend long on this at all as with Revenue and Personnel costs you have covered a huge amount of GP already.

5. Transport & Distribution - linked to purchases (5% of Thom's purchases). It's a small figure so will not be important to discuss. Just remember that an increase in Thom's prices will increase transport costs. In fact we probably wouldn't even mention these costs in the exam unless there was a reason to. You can see already there are plenty of points to discuss on GP and GP%!! You don't get a bonus for getting more than four bullets (CC) in a box.

Other possible reasons for a change in GP% are:

Poor contractual arrangements e.g. miscalculating profit on contracts whilst bidding. There is currently no evidence of this occurring so UNLESS it is brought in you would not mentioned it.

An increase in training costs (none chargeable to customers) - however no evidence this will occur. You wouldn't need to discuss UNLESS the examiner brings this into the question.

Higher staff recruitment increasing recruitment costs e.g. an increase in staff turnover - again no real evidence this has occurred in the past or will in 2020 so again, do not discuss UNLESS the examiner brings it into the question.

Overall Gross Profit Margin

It is important to remember overall GP margin will change as the sales mix changes between the two streams. Don't forget to discuss sales mix! Owned Operations will have a lower GP Margin and as it's share of overall revenue decreases as franchised operations grow, then the overall GP margin should increase. 

Summary of discussion

In the exam you should cover the following:

• Overall Gross Profit & Gross Profit Margin
• Link Overall GP Margin to sales mix change (AJ)
• Comment on overall Owned Operation gross profit and GP margin
• Consider if there are any price increases which should increase GP margin
• Consider how average revenue per employee has changed and comment on likely efficiency change (idle time) - (AJ)
• Consider average cost per employee and why this has moved
• Consider if Thom has increased prices
• Comment generically whether costs are rising fast than revenue / are not being passed onto the customers.

Business Measures - Next Blog and one not to miss!

Our next blog will review the current business measures and how these may not give the board the full picture of the business performance. It will also explore some of the other potential business measures that could be introduced as the "Twist" to requirement 1.

As this is a strong possibility then check out Mock 2 (release date 1 July 2020).

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