Nothing Beats Margin
by Robert V. Lally

We are often called upon in our roles as business consultants and advisors to evaluate businesses. Not necessarily a business valuation-put-a-price-tag-on-it, but more of an assessment: "How is it going?" We also get asked: “Should I invest in this?” Or for our comments on a proposed start up.

Of course, there are lot of books and tomes on this subject. There is a whole caste of business valuation experts. (By the way, are you buying or selling, because the answer may be different!) Over the years we have a simple, litmus test. This is not exact science and probably is only a starting point. Nevertheless, it is amazing how well this works.

What are the gross margins? Simple. If they are over 30%, there is hope. If they are 20% to 30%, stay tuned. If they are under 20%, stay home. Now, this doesn't work in all industries. For example, in retail, this is too tough a standard. In those cases, you have to eliminate some of the just trading dollars part which makes the percentage look low. For example, a car dealer is only going to do 2-3% because the price of the car, in cost of goods sold, is such a big dollar amount. In such a case, a car dealer has to look at other measures to evaluate margin.

But for most of America, the 30% rule holds. Funny, most people get this wrong. When asked what kind of gross margin they think they need to command to be successful, off the cuff, they will answer 10%. Wrong. Go buy a corporate bond and stay home.

Margins drive the world. Margins cover all sins and all the expenses. If you don't have it at the top line, nothing makes it to the bottom line. Sounds almost ridiculously obvious. Right up there with: "buy low; sell high." Still, we see it all the time. To make a medical analogy, the patient has no pulse, don't worry about the cholesterol. Companies are worried about market share or employee compensation, and they were virtually dead before we even got to S, G & A (selling, general and administrative costs).
Of course, a thoughtful analysis needs much more input to be comprehensive. But you have to start somewhere. It is amazing what you find if you start at the top.