-A personal perspective, By Rob Lehmann
Business college taught me about traditional models. I gained insight into how various businesses ran. I learned that the snapshot of success or failure is usually disclosed by examining their finances. The nuts and bolts of any business can often be dissected by disseminating a P & L statement, balance sheet and associated ledgers. I also learned that a traditional inventory-based business sells durable goods at keystone or double cost (100% mark-up) and perishable goods at double or triple keystone (200-300% mark-up). In ordinary terms, this means that a shirt that cost a retailer $10, gets sold for a minimum of $20. A piece of fruit that cost a grocer $1, gets sold for $3-$4. Let’s now apply this simplified model to my business, The Reeded Edge. By definition, I am a wholesale-retail business. Ignoring the wholesale facet for a second, this means that in a traditional retail business model, a coin that cost me $100 needs to sell for a minimum of $200, a 100% mark-up or a 50% gross profit margin (GPM = the percentage of total revenue that becomes profit). The problem arises in the word traditional. There is NOTHING traditional about the rare coin business. In fact, we defy tradition at almost every turn. Let’s go back to the example of the coin that cost me $100. On average, I sell this hypothetical coin for $115, $120-$125 if I’m lucky. This mark-up (or lack of) miffed my accountant. He told me that it was impossible for a business of my nature to sustain with this model. He and I had that conversation 31 years ago! How then, does my non-traditional business do it? To simplify the answer, I will address two extremely important concepts: inventory turns and cost of money. As we will see, this is a symbiotic relationship, meaning one factor impacts the other. First, let’s look at inventory turns. An inventory turn can be simply defined as my annual sales divided by the value of my inventory. For example, If I sell five million dollars worth of rare coins in a calendar year and my average inventory is valued at one million dollars, in this instance I would have 5 inventory turns per year. In actuality, the target number I need to hit is 6.5. Without micromanaging, this can easily be monitored by keeping a handle on my inventory levels and staying cognisant of my sales figures. Let’s look at the second factor or my cost of money. This is a bit more abstract, meaning that its harder to measure or quantify. If I maintain 6.5 inventory turns per year, then every $1.00 spent on coins, without any profit factored in, has yielded me $6.50 at the end of the year. Now let’s apply my non-traditional mark-up of 15% and see what happens. My one million dollar inventory yields me $6.5 million dollars of annual sales multiplied by 15% or an additional $975,000 of profit. In this hypothetical example, I now have profit which allows me to pay salaries, rent, insurance, travel costs, advertising etc, etc….which is known as overhead. If I turn inventory less often, this profit number would decline. If I turn it more often, obviously it increases. The direct correlation between inventory turns and profitability of my business should be readily apparent. Let’s now look at cost of money. I will apply this simple definition. Cost of money is what every dollar is worth to me at the end of a calendar year. In the previous example $1 invested in inventory at the beginning of the year, yields me an additional 97.5 cents at the end of the year. Every dollar I gain, yields me $1.97 per year in round terms, and every dollar I lose, cost me $1.97. Therefor my cost of money annually, expressed as a ratio, is approximately 2:1. Why is knowing this number so important? For one, it allows me to assess the liability of dormant inventory. Not every coin, sells 6.5 times a year. Some are still in inventory a year later. For every dollar spent on one of those coins, it has cost me almost two dollars. Awareness is very important in business. It is one of the reason I constantly monitor stock codes and how they translate to the age of a coin in inventory. When a coin gets to a certain age, it needs to go. I will discount it incrementally until I hit the sweet spot and it sells. The actual loss sometimes is the least offensive aspect of ownership. The dollars the coin has tied up by not selling, and the value of those dollars in sustaining my business, is the more integral factor. A second and equally important component of understanding cost of money, is loan value. What exactly do I mean by this? Let me use a simple example to illustrate. If a customer decides to purchase a coin but needs an extended period of time to pay for it, I have to understand what it will cost me to do this transaction. Let’s say that customer wants to buy a $1500.00 coin which originally cost me $1250.00, and needs two months to pay for it. On the front end, I am making $250.00 of profit, but in reality, I am only making $250.00 less the cost of money of providing 60 day free financing. I know that my cost of money annually is about 2:1, which on a monthly basis, would translate to about 8%. That $250.00 profit times 8% times two (the number of months that I am providing free financing) , is now reduced by approximately $20.00 per month, netting me an actual $210.00. Is it now apparent why understanding my cost of money is so important?
Contrary to popular belief, the coin business really is extremely challenging. The margins are some of the lowest for any inventory-based business on the face of the earth. Challenges such as a declining market, slow-pay accounts, economic or seasonal factors and rising overhead, just to name a few, impact my business even further. Understanding and interpreting concepts such as inventory turns and cost of money are really not electives. They are at the very foundation of my business, and what allow me to continue selling rare coins for the next 31 years.
Note: Throughout this article, I have used the first-person. It is not just I who runs this business. Robbie Jenkins is both a junior partner in The Reeded Edge and an equal partner in The Reeded Edge Reserve Equity Fund, a related but separate company. Without Robbie’s knowledge, dedication and work ethic both companies would be nothing more than namesakes. I don’t want any of my readers to think for a second that our business is a one-man operation, because that would be the furthest thing from the truth.