November 19, 2015 | Dr. Stephen Timme
Last week we introduced a new monthly series for our blog called the METRIC OF THE MONTH. Welcome to our first posting of the series. Our company is all about helping sales professionals who aren’t financial experts, but sometimes need to be able to talk like one. So it only makes sense that our blog would include a “dictionary” of sorts focused on defining and better understanding the key financial terms your clients are using to measure their results. We’ll follow this up on Thursday with The KPI Connection, connecting this month’s metric to key business processes and ultimately measurable impact on your clients’ business, so check back for that. This Month’s Metric – Cost of Goods Sold (COGS) as a Percentage of Revenue Who uses it? Primarily goods and services companies, including industrial products companies, wholesale distribution companies, retail, telecommunications and service companies, as examples. COGS is sometimes referred to as cost of products, or cost of services for industries like telecom and services. For some industries like retail you will hear reference to gross profit margin (GPM) instead of COGS. How is it measured? COGS is most commonly expressed as a percentage of revenue. Gross profit margin is simply gross profit (revenue less COGS) expressed as a percentage of revenue. What’s in it? It includes the value of costs directly related to goods and services sold – or in other words, how much it costs to buy and make whatever the company sells. For a manufacturer, it’s items like materials, labor and overhead. For a retailer, it’s merchandise costs, logistics, and it might include store costs. Why is it important? COGS is typically a significant percentage of a company’s revenues. For the S&P 500, excluding financial services companies, COGS as a percentage of revenue averages 60%. Hence a small reduction in COGS can result in significant improvement in overall financial performance. What drives it? It’s driven primarily by what a company does (its industry) and how it does it. An example -- in the pharmaceutical industry, Eli Lilly conducts R&D, manufactures, and sells its drugs. Its COGS is approximately 15% of revenue, or gross profit margin of 85%. Lilly’s very low %COGS or very high GPM reflects in part that it adds significant value to the products it makes...like saving lives. Also out of the 85% they must fund significant R&D. McKesson is a drug wholesale distributor. Its %COGS is close to 94% meaning its GPM is 6%. As a distributor, not a producer, the value McKesson adds is very different. Making it easier, for example, for healthcare providers to buy the drugs, but acting more as a middle-man than Lilly, therefore driving lower GPM (or higher %COGS). What is the Goal? Typically, the lower the COGS as a percentage of revenue is, the better. This can be through better management of procurement, quality, labor, manufacturing, logistics, or any number of other factors. It is important, however, that decisions made to lower COGS don’t ultimately adversely impact other areas like revenue growth and hurt overall financial performance. So HOW do you translate this into conversation about value with your clients? See this Thursday’s posting on The KPI Connection. For a deeper discussion on Financial Metrics, Operational KPIs and how they drive sales, see our previous blog post at http://www.finlistics.com/blog/introducing-a-new-series/
Posted in
Executive Industry Insights,
Metric Matrix
