Over the past few weeks we have taken an in-depth look at the Boyd Group Income Fund (Boyd) income statement, cash flow statement, and balance sheet. The purpose of this was to understand how a large MSO uses corporate finance to drive growth and to also explain how a company that reports a net loss in the millions of dollars actually generates millions of dollars of cash for shareholders (or, in Boyd’s case, the “unitholders”). We also discussed how Boyd is leveraging scale to drive increased profitability and sales growth.
This week, rather than just reviewing the financial statements as they are, we are going to complete a bit of financial analysis to derive certain KPIs that tell us more about how Boyd operates. I will keep the analysis straightforward – no derivative equations I promise! Just simple addition and subtraction with a sprinkle of division thrown in at times for good measure. We will use all of the statements to develop a high level understanding of how Boyd integrates operations and finance. We will also compare these financial KPIs to other industry KPIs so that you can compare your operations to that of a large MSO.
While I have written at length about the financial factors driving consolidation, the stark reality is that the large consolidators continue to grow because they are good operators that execute their business model effectively. The managers running these companies are professionals and generate sizeable financial returns for unitholders while also providing value to their customers. Whether you are a single-location business or a growing MSO, there is much to learn, both financially as well as operationally, from large consolidators.
The collision industry is full of metrics and KPIs. The KPIs I will discuss below are similar yet slightly different than many of the more common KPIs in the industry. They are what some equity analysts working on Wall Street would use to evaluate Boyd’s operational performance, as well as to project the future financial performance of the company. Bottom line, these are KPIs that are important for businesses of all sizes to evaluate regularly (for additional details and spreadsheets that calculate these ratios please email me on my contact page.)
When reviewing the income statement we looked at traditional operational metrics such as sales growth, gross margin, net margin, and EBITDA margin. While important, those metrics tend to focus on the financial results of operations, rather than on operations themselves. There are a number of other metrics that are useful to evaluate the performance of the company over time.
In order to draw comparisons between different-sized companies I like to normalize operational results. Two ways to do this is evaluate sales per location and sales per employee.
Sales per Location
Sales per location and sales per employee are two illustrative measurements to demonstrate the effectiveness of the consolidation model. Sales per location is calculated simply by dividing total sales by the number of locations. However, because the company acquired a number of stores throughout the year, to get a more precise sales per store number it is usually best to factor out those locations. Looking at “same store sales” or only sales at locations in operation for more than a year also factors out other ancillary businesses such as glass services thereby providing insight into collision only operations.
In 2014 Boyd acquired 64 locations from a base of 258 locations for a total of 322 locations by year end. Management provides a breakdown of same store sales on page 19 of Boyd’s 2014 Annual Report. Boyd’s average sales per location was $2.1 million in 2014 ($536 million ÷ 258 locations). While both Canadian and U.S. operations are similar in dollar size, after taking into account the exchange rate between the two countries the Canadian operations are significantly smaller on an exchange rate adjusted basis.
More telling, however, is the impact recent of acquisitions. Boyd acquired 3 major MSOs in 2014 consisting of 48 locations that contributed $89 million in sales. Over the course of the year the average contribution sales per new store was $1.8 million. Because acquisitions took place at varying times throughout the year, the $1.8 million only represents a partial financial “contribution” as of the date of acquisition. The impact of full year sales for these locations will be substantially higher. Next week we will take a closer look at specific acquisitions Boyd completed in 2014.
Sales per Employee
Sales per employee is an interesting metric to compare efficiencies across businesses. At the end of 2014 Boyd employed 5,419 people, 527 in Canada and 4,892 in the U.S. The company does not disclose employees who have worked for the company for more than 12 months. Overall annual sales per employee were about $155 thousand. However, again, of particular note is the increasing average sales per employee. Using an employee count from the end of 2013 as a proxy, 2014 same store sales per employee at the end of 2013 were only about $129 thousand.
Taking this metric a step further, at the end of 2014 Boyd employed an average of 17 employees per location. This is an approximation and actual employee count per location will be less because Boyd has significant corporate overhead in the form of regional operations managers, glass services, and executive staff, as well as support staff in functions such as finance & accounting, legal, HR, IT, and corporate development.
Payment Terms, Credit Terms and Inventory Management
Previously we dove deep into the balance sheet, and explored the importance of balance sheet management. Unfortunately, the balance sheet often is overlooked in our industry. But the balance sheet provides critical insight to both the operations and the finances of a business. There are three key metrics from an operational standpoint that are critical to measure on a regular basis: day sales outstanding, days payables outstanding, and days inventory outstanding.
Payment Terms – Day Sales Outstanding
Day Sales Outstanding (DSO), also known as A/R Days, measures how long it takes for a business to collect cash after a sale has been completed. Expressed differently, DSO is the average age of accounts receivables (AR). Knowing and actively managing DSO is critical to effective cash flow management. But more important than cash flow management, it is good business to minimize the time between the completion of a sale and the collection of revenues. The longer it takes for a business to collect revenue the more cash the business must “pay out of pocket” to cover the day-to-day expenses the business generates. Poor AR collection results in increased borrowing costs, and when taken to the extreme, potential bankruptcy due to a lack of liquidity (i.e., cash).
Specifically, DSO is calculated by dividing average receivables over a period by daily sales over the same period. In Boyd’s case, the average receivables can be determined by adding 2014 and 2013 receivables together and dividing by 2. Daily sales is calculated simply by dividing total sales by 365.
There are numerous reasons and industry dynamics as to why a company may have a quicker or slower cycle in collecting receivables; in the collision industry a well-managed DSO can range from 18 to 25 days. Boyd has a respectable DSO of just over 21 days. If you would like additional clarification on the math, email me on my contact page.
Credit Terms – Days Payable Outstanding
Days Payable Outstanding (DPO), aka A/P Days, measures how long a company takes to pay the bills it has due. It is calculated in the same manner as DSO, but instead uses accounts payable (AP) as the basis of comparison. Generally, companies strive to stretch out the days payable. DSO and DPO are opposite sides of the same coin. While companies generally want to reduce DSO, they will attempt to stretch out DPO. There is a natural push and pull between companies doing business with other companies.
In the collision industry the average length of payables outstanding tends to be about 30 to 45 days. It is common in the industry for vendors to bill monthly, i.e., to provide trade credit for at least 30 days but to demand payment promptly upon receipt of a monthly invoice. Boyd, however, does an excellent job managing trade credit and vendor management, and has an average DPO of 65 days, taking at least an additional 30 days to pay after the receipt of monthly invoices.
So, why does an astute CFO want to minimize DSO and maximize DPO? The answer is quite simple: when a company is as large as Boyd keeps a few million in the bank for an extra month, the interest it earns can really add up over a fiscal year.
Inventory Management – Days Inventory Outstanding
Days Inventory Outstanding (DIO) measures how long it takes a company to convert inventory into a sale. In the collision industry this is the rough equivalent of cycle time. While not a direct equivalent to the often measured “keys to keys” KPI, DIO is as close approximation using publicly available information. Clearly the trend in the industry is to drive down cycle time and more efficiently process workflow. Aside from outside pressures driving a focus on cycle time, the reality is the more effectively a company turns inventory into sales the more efficiently a company is able to generate cash.
DIO is calculated a bit differently from DSO and DPO, taking average inventory over a period and but dividing by the Cost of Sales rather than sales. The reason cost of goods sold is used is because inventory is a measure of costs, not sales. Inventory consists of parts and materials that have been purchased for work in process that has not yet been completed.
Keys to keys cycle time in the industry average about 12 days. Boyd reports a Days Inventory Outstanding of 11 days.
Working Capital Management
These three metrics, days sales outstanding, days payables outstanding, and days inventory outstanding, are useful metrics of themselves. However, measured together they generate even more substantial insights into a company. Together they form the basis of working capital management.
Working capital is the money that is required to fund day–to-day operations. Working capital can be thought of the money a business invests in employees, parts and materials on an ongoing basis in order to generate a final product.
Understanding working capital is important because a company can have a great gross margin but fail because of poor working capital management. Technically working capital is something that can be measured on a balance sheet (current assets – current liabilities), but it really comes down to a combination of effective operation and financial management. For example, a company can have great gross margins but poor collection policies, resulting in poor cash flow. Or similarly, a company can misinterpret low cash flow as stemming from pricing pressures from outside parties when in reality it suffers poor inventory turnover (i.e. cycle time).
There are two key metrics to manage working capital: the operating cycle and the cash conversion cycle.
The operating cycle measures the time between receiving inventory and receiving cash for the inventory. To calculate the operating cycle, simply add average receivable days to average cycle time, or DSO + DIO. The result tells you exactly how long it takes between the time a business starts on a job and when it receives cash for said job. This number is important to know because if it extends longer than 30 days, a business may demonstrate great profitability but have less than stellar cash flow. Since it is near impossible to pay bills with profit, cash becomes very important. In Boyd’s case, it has an operation cycle of 32 days.
Cash Conversion Cycle
The cash conversion cycle measures the time between paying cash out for working capital (i.e. work in process) and receiving cash back into the business. To calculate the cash conversion cycle, subtract days payables outstanding from the operating cycle (mathematically: DSO + DIO – DPO). You add DSO and DIO because these represent cash outflows while DPO represents cash received, so it is subtracted. The result is how many days it takes to convert an investment in day-to-day operations into cash. Boyd actually has a cash conversion cycle of negative 33 days, which means it receives cash on average 33 days before it is required to pay for the parts and labor necessary to complete a job. From a cash flow and working capital management position, this is a very attractive place to be.
The Boyd Group runs a very efficient business, even more so considering operations are spread out over 322+ locations. Operationally, the company continues to increase sales as well as effectively manage payables, receivables, and cycle time. Perhaps most impressive is the company’s cash conversion cycle. And while there is not room in this article to discuss different unitholder-return metrics like return on equity or return on capital employed, by every metric The Boyd Group continues to post strong performance.
How do you manage your working capital and cash conversion cycle? What challenges have you faced in maximizing your return on capital? I’m eager to hear from you. You can contact me by email via my contact page to discuss these topics at any time. I find the transformation in the industry truly fascinating and all communication is kept strictly confidential.
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