Ladies Night. Nourishing Overnight Creams Page 50. PLUS Annual Home Spa Gift Guide Accessing Risk Management Top Advanced Training Courses

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1 The Premier Spa Business Resource November 2007 dayspamagazine.com $5.00 Ladies Night Nourishing Overnight Creams Page 50 FIRST IMPRESSION Redesigning Reception Areas Page 106 PLUS Annual Home Spa Gift Guide Accessing Risk Management Top Advanced Training Courses

2 By Leslie Lyon Financial Management: Part 2 Learning to calculate profit margins can significantly boost your spa s bottom line. This is the second installment in a three-part series dedicated to understanding financial statements and adding to your spa s bottom line. It focuses on profit margins for retail products and spa services. If you were able to skip some of the hard lessons and speed through a few best practices to a profitable, sustainable business, would you? As a spa owner or manager, part of your job is to continually uncover strategies for growth. Opportunities that exist throughout spas often go unnoticed and untapped. Putting even a couple of best practices in place will positively impact your bottom line. Understanding which services have high profitability and which ones don t is important to your spa s success. This information should be included when developing your revenue management system, which will reveal ways to increase profits and control. There are three ways to add to your bottom line: increase sales, cut and boost margins. Knowing how to create and decipher profit margin spreadsheets for products and services will help you analyze and monitor all three. Service Profit Margins To figure out your service profit margins, you must consider two things: 1) gross margin percentage, and 2) bottom-line impact. Gross margin (GM) is excess revenue that s generated after subtracting the cost of goods sold (COGS), or expenditures stemming solely from service sales. The simplest way to think of COGS is to evaluate the a spa incurs as a result of offering a service. The GM is then converted to a percentage. The bottom-line impact can be explained this way: Even though a service is calculated as having the highest GM percentage, it doesn t necessarily mean it s the most profitable. For example, if you have revenue of $100 and a cost of $50, it results in a GM of $50. This represents a 50% GM but only $50 in profit. On the other hand, let s say you have revenue of $1,000 and a cost of $800 for a profit of $200 and a 20% GM. It s a lower percentage, but this one sale adds more profit to the bottom line. Some spa software will greatly aid in developing this information but, in many instances, you ll istockphoto.com

3 need to formulate customized data. If you were to develop a chart in Microsoft Excel, you could input the formulas for prompt calculations and even quicker modifications. The data in the sample chart (below) are hypothetical and will vary greatly from spa to spa. Remember that the figure you end up with is the GM this means you still need to deduct operating to determine net profitability. You may also insert your payroll burden into this chart; this will be between 5 to 10% of labor, and includes taxes and insurance. To calculate your service profit margins, follow these steps: 1) Categorize and list services (facials, massages, body treatments, etc.). 2) Record the length of each service in minutes. 3) Record the price of each service. 4) Calculate the average hourly price for each service. To do this, use the formula at the bottom of the page. 5) Enter the product to administer each service. 6) Enter miscellaneous (linens, studio, etc.). 7) Calculate each service price minus the. (Consider using this figure to determine staff commissions and fees for service.) 8) Calculate average labor to conduct each service (fixed and variable). 9) Enter COGS (total of columns 5, 6 and 8). 10) Enter GM (service price minus COGS equals GM). 11) Enter GM% (service price minus COGS divided by service price equals GM%). 12) Rank the services based on GM%. Sample Service Margins Chart Service category FACIALS Ultimate facial Service time (min.) Service price Avg. hourly service price Misc. Service price minus Avg. labor COGS GM GM% Category rank 120 $175 $87.50 $17.50 $8.75 $ $36.88 $63.13 $ % 1 Basic facial 60 $85 $85 $8.50 $4.25 $72.25 $18.23 $30.98 $ % 1 Mid- to highrange facial Luxury facial Mid-range facial 90 $125 $83.33 $12.50 $6.25 $ $27.13 $45.88 $ % $150 $75 $15 $7.50 $ $34.75 $57.25 $ % 3 90 $110 $73.33 $11 $5.50 $93.50 $25.85 $42.35 $ % 3 Avg. category hourly rate $80.83 Calculating Average Hourly Service Prices Even if your spa s software is capable of calculating hourly service prices, it s important to understand how to figure out the formulas. Follow this example: Price of Length of service Desired minutes Hourly service Service (miniutes) for calculation price $ = 1.46 x 60 = $87.49

4 Then, plug the data into a chart, as shown on page 128. You may even choose to program a spreadsheet to automatically calculate the average service prices for each department. This will help you project revenue and payroll expenses for startup businesses and on an ongoing basis. In this example, the column numbers correspond with the numbered steps above. In this scenario, for ease of calculation, product are calculated at 10% of service price, miscellaneous are 5% of service price, and average labor is $11 per hour plus a 10% fee for service/commission. You ll need to know your own cost breakdown, which will probably be calculated individually per service, instead of a blanket percentage as shown in this example. Calculating the hourly service price for all services on your menu will provide averages for each department. The benchmark for this price ranges from $75 to $95, but it depends on the type of spa (day or resort) and its position in the marketplace. A big part of knowing your numbers is having a budget in place; in fact, it s critical. Businesses aren t controlling their cash money goes out for expenses, revenue is brought in, but there s no budget in place to indicate cash needs or when to limit spending, says Douglas Preston, president of Preston Inc., a consulting firm in Santa Cruz, California. Many owners aren t aware of the cost per treatment, let alone what it to run the business, so they re cash poor and looking for remedies. He adds that while the majority of spa owners and managers are able to provide a profit and loss (P&L) statement, many admit they don t know how to interpret it or whether it s accurate (see Financial Management: Part 1 in DAYSPA, October 2007). Spa owners aren t certain about what goes under the supplies category it could be anything from ink pens to the paper used on massage tables, says Preston. The same goes for advertising. Do they know if this information includes the ads that ran in the newspaper, as well as the spa s brochures? The bookkeeper usually just takes the owner s word for it and organizes the P&L based on that. Profit Margins Next, it s important to understand what each product provides in terms of gross margin and bottom-line impact. The standard markup on branded skin care is 100% or a 50% GM. So, if you purchase a product for $50, it sells for $100 on your shelves. Private-label products, however, have gross margins anywhere from 150% to 600%. This allows greater flexibility for spending on promotions, staff commissions and the like. Knowing what s left over once a sale is finalized can be eye opening. A big part of knowing your numbers is having a budget in place; in fact, it s critical. Although the margins may seem lower than expected, you still need to encourage employees to step up their retail sales for two reasons. First, retail sales help encourage clients to return to your spa (as results from at-home maintenance are seen). Second, they can generate a lot of money in a short amount of time. Figuring out profit margins for products calls for the same formula as services but using different istockphoto.com November 2007 dayspamagazine.com

5 types of information. To formulate your product profit margins, follow these steps: 1) List the products. 2) Record the retail (selling) price for each product. 3) Insert cost percentage for purchasing the Sample Margins Chart Item product. 4) Calculate that in dollars. 5) Insert the average commission percentage paid. 6) Calculate that in dollars. 7) Include miscellaneous (shipping, retail PRODUCT AREA Antiaging cream 1 Antiaging cream 2 Antiaging cream 3 cost % cost $ Retail cost commission % Retail cost commission $ Misc. COGS GM GM% Category rank $150 50% $75 5% $7.50 $7.50 $90 $60 40% 1 $150 50% $75 10% $15 $7.50 $97.50 $ % 2 $150 50% $75 7.5% $11.25 $30 $ $ % 3

6 Resolve to follow a budget. Accept limits on spending, and stick to them no matter what. receiving, merchandising, etc.). 8) Total the COGS (add columns 4, 6 and 7). 9) Calculate the GM (product retail price minus COGS equals GM). 10) Convert the GM to GM% (product retail price minus COGS divided by product retail price equals GM%). 11) Rank the products based on GM%. Next, organize the data into a chart, as shown in the example on page 130. It will look much like the service profit margins chart. This chart shows the hit your spa takes when you discount retail items in this case, an antiaging cream or when you pay varying commissions to your staff based on sales of those products. Here s a breakdown: Antiaging cream 1 Staff commission is 5% ($7.50). Miscellaneous are at 10% ($7.50) of product. This allows for a 40% GM. Antiaging cream 2 Staff commission is increased to 10% ($15); miscellaneous remain at 10% ($7.50). Here, the GM drops by 5% in tandem with the commission increase. Antiaging cream 3 Staff commission is decreased to 7.5% ($11.25). Miscellaneous are the same (10% of product or $7.50), but a 15% spring discount ($22.50) is factored in. This brings total miscellaneous to $30. Thus, the GM drops to $33.75 (23%) on a $150 sale. Thinking Profitably If you re serious about finding more profitable ways to run your spa, Preston says you must commit to doing three things: 1) Embrace the idea and reality. Spa owners are hands-on and intuitive, so numbers can make them nervous. It s their responsibility to do the math. 2) Find a resource that presents numbers in an understandable way. Accountants who speak matter-offactly can cause business owners to pretend they understand what s being communicated when they don t. Find someone who talks November 2007 dayspamagazine.com

7 Knowing how much money is coming into your business is as important as understanding how much is going out. numbers in layman s terms. 3) Discipline yourself to remain on track. You have the information and you understand it, but what are you going to do with it? Resolve to follow a budget. Accept limits on spending, and stick to them no matter what. Once you ve determined your most profitable services and products, this information should be utilized on a day-to-day basis to assist in making decisions regarding: Marketing. Spend cash only on your moneymakers, unless the immediate need is to increase your spa s market share, significantly improve its image or generate awareness. Promotions. Don t over-promote the loss leaders on your menu. Booking. Train front desk employees to suggest more profitable treatments based on clients needs. To boost revenues, know what you need to sell each day (services and products) and which ones you need to cap. Floor plan. Prime space should be reserved for your spa s most profitable offerings. Staffing. Consider assigning high-priced and high-margin services to employees who have the most expertise and are highest paid. Compensation. Profitably align staff incentive pay, including fees for service, retail commissions and fixed wage scales, with service and product margins. Discounting. The best bet is to discount only your retail-driven services. If product margins are low, be careful where you mark down. Know at what point you start to lose money. When you discount products and services, you should also mark down incentive pay. Menu. Design your menu to produce maximum profits, not just higher sales. Knowing how much money is coming into your business is as important as understanding how much is going out. Most spa

8 Developing those strategies depends on having an understanding of the different market segments that are available to the spa. directors concentrate on controlling, says Jeremy McCarthy, director of spa development, operations and marketing for Starwood Hotels & Resorts Worldwide. This leads to limited improvements in financial performance and could adversely affect the quality of the guest experience. Shifting your focus to a strategy for growing revenues will continue to drive improved performance, McCarthy continues. If revenues are good, there s no need to cut. McCarthy says there are three ways to grow spa revenues: 1) Attract new customers, 2) Get existing ones to visit more frequently, and 3) Get your regulars to spend more money on services and products. Developing those strategies depends on having an understanding of the different market segments that are available to the spa, and crafting different offers and messages to incentivize those three goals for revenue growth, he says. Leslie Lyon is president of Spas2b Inc. (spas2b.com), a full-service spa development, consulting and training company in Waterloo, Ontario, Canada. Today, she enjoys her profession as a consultant, educator, speaker and freelance writer. her at llyon@spas2b.com. NEXT MONTH Next month in part three, Leslie Lyon will wrap up her series on financial management with a discussion on cash projections for your day spa. The article will address: Determining the profits of a promotion. Setting annual revenue projections. Categorizing inventory for optimum retail success. Incorporating the concept of yield management. For more on the finances of running your spa, visit the DAYSPA archives at dayspamagazine.com.