Big Business Thinking

A Critical Tool of ‘Big Business Thinking’

In last month’s inaugural column, I posited that you must incorporate what I have coined “Big Business Thinking” (BBT) to manage the business side of your laundry operation and to strategically price your store to maximize profit.

Your first BBT tool is called “Return on Investment,” known simply as ROI. ROI enables you to understand how much money you expect to earn versus how much you were required to invest to do so. You can earn money by generating cash, achieving direct cost savings, receiving tax credits, and so on. Cash-on-cash ROI measures the component of return that is actual cash that your capital investment is expected to earn.

ROI is the bedrock of my BBT theory. I use ROI in various forms nearly every day in approaching business decisions for my laundry and other investments. After this month, I hope it will become a critical part of your approach to your own laundry.

ROI is not equivalent to profit. Rather, ROI is a measurement of how productive our capital is in generating profit. Earning $20 on a $100 investment translates to a 20 percent ROI. Comparatively, earning $25 on a $150 investment means you have generated a higher profit, but a lower ROI, of 17 percent.

ROI is about money, so let’s discuss spending. Most of your daily expenditures are so small individually that you likely don’t think twice about making any single one. They are driven by desire (fast-food) or necessity (supermarket). Some purchases rise to a level of prior contemplation (expensive restaurant dinner, family vacation). What they all have in common is that they are not considered investments. This money is spent without analysis or perhaps even without thought. Your “return” is the consumption of the goods and services you purchased.

There are some purchases significant enough that you may start to talk and think about them as “investments,” the most common example being home ownership. Yet what monetary return does it provide? It may appreciate in value, especially if you live there a long while. It may provide a good tax deduction and itmight one day be tapped for home equity, which in turn can be invested (in a laundry!) to generate positive ROI. But, unless you try to rent the apartment over your garage, your home provides no positive cash flow.

Let’s assume you bought your house five years ago for $200,000 and sold it today for $300,000. Let’s also assume no pesky commissions, closing costs, taxes and such; this example might be called your “pre-tax gross ROI.” Your total return on your investment is a $100,000 profit against a $200,000 cost (also called your basis), for a 50 percent ROI.

While your ROI is 50 percent in this simple example, your annualized ROI is much lower. Your “Internal Rate of Return” (IRR) is actually under 9 percent. IRR is a component of ROI, but takes into account the component of the passing of time, and the length of time it takes to earn your return is highly significant. Let’s take the prior home sale example, changing only one data point, by extending the duration from five years to 10. Now your ROI remains the same, at 50 percent, but your IRR declines by over half, from 9 percent to about 4 percent.

This IRR of 4 percent is less than my savings account earns today.Thus, economists preach that you treat your home as a place to live and to earn great long-term equity appreciation, instead of depending on it as a short term vehicle from which to make a return on an investment. For that, you’ll need a business.

“Wait!” you shriek. “You forgot that I didn’t put down $200,000. My mortgage was for 80 percent [or, if you bought in California two years ago, for 105 percent, but that’s a topic for a different trade journal], so I only invested $40,000.”

You are correct, and you have discovered an exciting way to dramatically improve your ROI - leverage. Leverage is a fancy word for debt, or even more plainly, investing with other people’s money, like a bank’s. Your ROI on your home now looks like this: Bought for $200,000, with $160,000 borrowed, and sold for $300,000, leaving a profit after repaying the debt of $140,000, all against an initial $40,000 down payment, producing a 350 percent ROI. Now that sounds better! “You still forgot something!” my toddler yells (all too frequently). “I’ve been paying down principal on my mortgage every month.” You are correct again, and you will need to adjust your net after-tax ROI accordingly. Congratulations on your wise investment.

So now, I ask, if you’re such a darn expert on understanding and utilizing ROI as a tool for your home, a highly passive investment, which produces no positive cash flow, why don’t you, even more so, use ROI as a critical tool in your daily business? There are dozens upon dozens of daily monetary decisions available to you, each of which has the potential to provide you a great ROI. For example, buying your store’s supplies cheaply is great, but spending money that produces a higher ROI is even better.To name just one, fluorescent bulbs are ROI-positive.While you spend more on them now, you will make (save)more later on, and for much longer, and you will get a write-off this year and perhaps even earn a cash rebate.

Too many laundry owners spend the bare minimum required to keep the doors open, unwisely foregoing a myriad of ROI opportunities.Then these same owners spend a bundle in an instant, without regard to the ROI possibilities offered by different approaches.When you placed your equipment order at your distributor’s last open house, did you spend more time negotiating the straight cost of each piece of new equipment, or on asking for help in calculating the ROI each machine might bring in the first year? Why do you think it’s a “limited time offer?” Of course a new 60-pound front-load washer costs more than a gaggle of top-loaders, but you must consider your projected ROI from each, including such variables as future utility costs and turns, not to mention vend price. ROI, specifically cash-on-cash after-tax ROI, should be the mantra of your laundry business. Detailed analysis should be performed before every significant investment, decision and strategic action for your business. It is important enough that this month’s column spent more time on your home than on your laundry, because you must understand the concept fully to move to the next step. Incidentally, I rent. Next month we will meld ROI with a highly misunderstood tool—turns - and discuss why you must use a turns analysis to strategically price your store to achieve the highest possible cash-on-cash ROI.

© 2007 Jeffrey Barman, all rights reserved. VEND PRICING THE JOURNAL • NOVEMBER 2007