Why Take More Interest in Interest?

For your tip of the month, the next highest expense on your Profit & Loss Statement after salaries is typically your Interest and Bank Charges.  This is the one we hate the most because we feel like we have nothing to show for this expense – in other words its money down the drain.  Interest and bank charges are unavoidable but can be controlled. Read how.

Different from salaries expense, interest and bank charges are generated from two distinct sources both of which require your dedicated attention.

The first area comes from your operating line of credit or cash flow supplement.  If you are well capitalized you many not require an operating line of credit, but for most of us it is a "necessary evil" in order to run our business during periods when expense exceed sales revenues.  An over expenditure means you are relying too much on borrowed capital to operate your business based on your volume of sales.

The second area comes from your floor plan inventory finance.  Typically you will receive free floor plan (FFP) from your manufacturer for a specific length of time for your inventory purchases.  In a perfect world we would sell all of these units during the FFP period and incur no interest expense, but as we all know this rarely happens.  You are more than likely going to have carryover inventory after FFP if you are maximizing your sales potential.

So what is the magic formula?  In my opinion, based on the most profitable companies I have analyzed, your interest and bank charges expense should operate at 1% to 1.5% of your gross annual sales.  To calculate this ratio, take your interest and bank charges expense and divide it by your gross annual sales times 100.  If your percentage is higher than the target ratio of 1% to 1.5% you are over spending and losing money right off the bottom line.

How significant is this?  If you are a $5,000,000 sales operation and your interest expense percentage calculates at 3% instead of 1%, you are over target and losing $100,000 in profit.  It is time to take a serious look at your working capital ratio and inventory turns to analyze where the problem originates.  I will save these ratio calculations for another article.

Take a few minutes and try this calculation.  You may be pleasantly surprised or possibly very concerned.  Need help? contact me.

 

 

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