Getting your Fixed Overhead in Order

This week’s post is the last in a series of articles focused on the Golden Ratio, a concept which has proven to be a successful way to frame and segment the operating expenses of a high-performing trucking enterprise. The Golden Ratio separates your variable expenses, your admin (non-driver) wages and benefits, and finally your fixed overhead. Re-aligning your existing P&L can be a time consuming process, but the feedback from companies who have adopted our suggested reporting model has been extremely positive to date.

For many, when you start talking about financial statements, eyes start to glaze over. However, having a set of proven and transparent (and thoroughly reconciled) financial statements each month will provide a great foundation for transforming your business. Based on my experience over the past three years with all sizes of trucking companies, I can attest that very few companies are employing a common, industry-specific, Profit and Loss statement. As a result, much of the industry isn’t getting a clear picture of the health of their operations, and as a result (in some cases) may be making improper business decisions. The added benefit of utilizing a proven, industry-specific P&L, is the ability to compare against your peers in an easier fashion. Standardization is at the core of inGauge and the Best Practice Groups. That is why we freely provide a proven P&L template for any company to download and use. To download the excel version, click here.

At the bottom of the template P&L, we break down the individual components of the last piece of the Golden Ratio: Fixed Overhead. Notably absent from Fixed Overhead in this template is Admin Wages and Benefits. Many of the existing P&Ls which I have reviewed over the years contain Admin Wages and Benefits. The common rationale provided has been that Admin Overhead is fixed and does not go up or down depending on levels of business activity. Our position is that this is incorrect and harmful thinking. Although you aren’t going to immediately layoff valuable Fleet Managers or Accounting staff when economic activity slows, breaking out this component from Fixed Overhead will provide you with a quicker route to decisions to maintain profitability while you ride out a downturn. Also, it reinforces the importance of incentive-based pay structures for your Fleet Managers, something we will talk about at a later date in a series of posts.

As a reminder, the target for inGauge users and Best Practice Group members is to achieve and maintain a Fixed Overhead level of 25% of Gross Margin. In other words, after subtracting your variable expenses from your revenue, your Fixed Overhead should be approximately 25% of this calculated value. Obviously, Fixed Overhead is going to fluctuate over time (e.g. you implement a new TMS or communications platform that includes upfront costs that you don’t want to amortize), but over a rolling six-month period, this should be a consistent goal for all. How do you get your Fixed Overhead on the right track? The three biggest opportunities for improvement based on companies we have worked with are:  1) Building Rent / Maintenance/Property Taxes , 2) IT related expenses and 3) Phone/Communications.

If you own your own property, you may be setting rent levels for your operating company for tax purposes. However, if you currently rent your facility, you may have substantial tools for improvement. This can include leveraging continued low interest rates to purchase or build your own facility. Many of our clients have done just that, and amplified the benefits by moving into a different (but close) municipality to take advantage of ongoing business incentives. Further, considering a new location allows you to better match a facility with the current attributes of your business (e.g. cross-docking capabilities etc). Finally, getting your current zoning and/or property valuation reviewed by a property tax expert can result in immediate and perhaps retroactive credits.

IT-related expenses can be a massive line item, and can vary substantially from company to company. Many companies have started to take advantage of cloud-based software solutions to drastically reduce their IT spend. Moving from locally hosted email/network configurations to cloud based services such as Google @ Work or Office 365 can immediately eliminate ongoing hardware (server) expenses, and depending on the size of the company, network admin labor. You may get resistance from your IT Team initially, but you should strongly encourage the investigation of cloud-based tools, and a thorough cost-benefit analysis. This should be done regardless of the size of your organization. Further, although many TMS providers currently focus on local installs, we suspect the trend over time will be move to the cloud – which will ultimately save money for Trucking companies and TMS providers alike.

Many of the companies we work with have reported substantial savings by routinely (every 2-3 years) shopping their communication needs with other suitable providers. Both hardware and networks costs have continued to drop over the years, and the vendor will be the last one to mention opportunities to save. Like any other expense, the key function is having a process in place to systematically review usage, costs and benefits to determine if you’re getting value for the expense.

Increase Your Gross Margin by 58% with Only an 8% Increase in Revenue

In last week’s article, we presented a way to segment your financial statistics to provide a clearer picture of your gross margin, the key functions of your success (or under performance), and ultimately your profitability (or lack thereof).

Further, we provided a ratio which will provide a quantitative target to improve your performance. As quick review, we (TCA’s Best Practice Groups) calculate Gross Margin using the following formula:

(Linehaul Revenue no FSC + Accessorials)

MINUS

(Driver Wages & Benefits + Purchased Transportation + Net Fuel Expense + Maintenance + Equipment Financing Expense + Insurance Expense + Variable Driving Expenses)

= GROSS MARGIN

*Each of the above items can contain many things, depending on your operation. If your interested in figuring out which expense and revenue items to include, please email Chris Henry ([email protected]) to get more information on our QuickStart data survey.

Using the above formula, and two separate components of your fixed expenses (Admin or ‘Non-Driver’ Expense, and Fixed Overhead), we have developed the ratio, which we call the Golden Ratio:

The Golden Ratio

25% Gross Margin :

25% Admin as a Percentage of Gross Margin :

25% Fixed Overhead as a Percentage of Gross Margin

If you do the math, reaching these targets equates to a very healthy Operating Ratio (compared to historical industry results), and also provides a great rule of thumb for evaluating existing customers and new opportunities. For this week, and subsequent weeks, we will be focusing on ways to improve on each of the components described above.

For this week, we will be enlightening some readers on a way to increase Gross Margin by 58% with only an 8% growth in Revenue.

To start off, let’s look at the following revenue and variable statistics for a sample load:

BEFORE
1. Rate/Mile                  $1.66
2. Miles                           1,000
3. Loaded Revenue      $1,660
4. Avg. Op Cost/Mile   $1.43
5. Load Cost                   $1,430
6. Gross Profit $            $230
7. Gross Profit %           13.86%
8. Paid Deadhead          $0
9. Total Gross Profit     $230 (13.86%)

Now, the above is a pretty simplistic example of a ‘sample load’, however the purpose of this exercise is to reinforce the power of small changes. These small changes should be within the control of your Fleet Managers, and these valuable people should be incentivized to make (and test) these changes routinely with the loads they are responsible for, and within the confines of the contractual shipper terms.

In keeping with the purpose of this exercise, look how simple it is to grow your Gross Margin by 58%, with only an 8% increase in Revenue:

BEFORE                                                                 CHANGE                                      AFTER
1. Rate/Mile                   $1.66                                +8%                                                $1.79
2. Miles                            1,000                                                                                        1000
3. Loaded Revenue       $1,660                                                                                       $1,790
4. Avg. Op Cost/Mile    $1.43                                                                                         $1.43
5. Load Cost                    $1,430                                                                                      $1,430
6. Gross Profit $             $230                                                                                         $363 (+58%)
7. Gross Profit %             13.86%                                                                                     20.28%
8. Paid Deadhead           $0                                                                                              $50
9. Total Gross Profit      $230 (13.86%)                                                                       $413 (23.07%)

In review, the only differences between the first and second scenarios was: 1) A 8% increase in rate per mile, and 2) $50 of paid deadhead. All other items remained unchanged, your variable operating expense did not change (it’s the same load), but your total Gross Profit improved from 13.86% to 23.07%. On the revenue side, these are just two examples on maximizing revenue per load. There are undoubtedly additional accessorial charges that are typically not tracked or properly applied to many of your loads, which is effectively an opportunity cost you want to eliminate (or greatly reduce).

The above reinforces the value of a quality and detail-oriented Fleet Manager to maximize your revenue per load. From a strategic point of view, taking care of the pennies will result in more dollars flowing to your bottom line.

Next week, we will focus on implementing the proper processes to maximize revenue capture per load. The following week, we will discussing ways to incentivize your Fleet Managers to improve Gross Margin.

The Golden Ratio: Succeeding with Gross Margin

In my previous life as a Truck Dealer, I habitually tracked our Gross Margin on both the Sales as well as the Parts/Service side (it was our lifeblood). Further, through my participation in benchmarking within the Dealer market, it reinforced the value of:

  • Identifying and measuring your fixed and variable expenses relative to each other
  • Always striving to increase Gross Margin (Revenue minus Variable Expenses)

When I entered the trucking industry via my role as Lead Facilitator with TCA’s Best Practice Groups, one of the biggest surprises early on was the number of trucking companies tracking their gross margin (it was almost zero). For many years, I heard many reasons why gross margin had no place in the trucking industry. It’s too complicated! Too difficult to isolate variable expenses! Seasonality!

However, using the aggregated financial data from Best Practice Group members, I was able to isolate the continuously high performing fleets from the rest of pack. When I dove deeper, low and behold, my good friend Gross Margin emerged as one of the key determinants of long term success in a trucking operation. The next step was introducing the concept to those Best Practice Group participants who were unfamiliar with the concept. Over the course of years, we’ve been able to provide a simplified formula for calculating Gross Margin, and as a result a key ratio emerged, which I will talk about down the page.

The first step in any benchmarking program is developing consensus and standardizing the data and metrics. Using this process, we were able to utilize existing data points to arrive at a formula for determining Gross Margin:

(Linehaul Revenue no FSC + Accessorials)

MINUS

(Driver Wages & Benefits + Purchased Transportation + Net Fuel Expense + Maintenance + Equipment Financing Expense + Insurance Expense + Variable Driving Expenses)

= GROSS MARGIN

*Each of the above items can contain many things, depending on your operation. If your interested in figuring out which expense and revenue items to include, please email Chris Henry ([email protected]) to get more information on our QuickStart data survey.

After we were able to calculate Gross Margin for all group members, it was determined (no surprise) that Gross Margin had the highest correlation to profitability than any other metric we were calculating. Further, once we were able to separate Variable versus Fixed expenses for all group members, two further relationships emerged. Those with higher continuous profitability also maintained consistent Admin and Fixed Overhead values relative to their gross margin results. Because of this new information, we have developed something I like to call the Golden Ratio (25/25/25):

The Golden Ratio

25% Gross Margin :

25% Admin as a Percentage of Gross Margin :

25% Fixed Overhead as a Percentage of Gross Margin

We’ll let this concept percolate for a week. Next week, we’ll start talking about ways to hit these targets!