Thursday, June 14, 2012

Calculating Dealer ROI


This post is co-authored with my good friend Nishit Ganatra who is currently the ASM of Punjab, J&K for CavinKare. He interned with me at L'Oreal and graduated from XIM, Bhubaneshwar. He enjoys troubling the Pakistani army by attempting to cross over the border from time to time and is giving their economists nightmares as he contemplates to sell Chik shampoo across the border owing to the kindness of his boss.You can find him here.

So probably the first thing that your distributor/dealer/stockist is going to tell you when you go to him for the first time is “Sirjee, ROI nahin baith raha hai”. What this simply means is that he is challenging you to calculate his return on investment.

This is sort of a monthly exercise – he knows that he is getting an ROI, else he would not be in the business. What he simply needs is some ego massage so that he gets an ILLUSION that he is in control of something when he is not – your rates are fixed, your schemes are fixed, and so are your claims. While ROI is something that they teach us in first day of B-School, calculating dealer ROI might be a different ball game altogether as he is a weasel who is going to try different permutations and combinations to get the better of you. Do this properly with him, and he (and you BDE/TSO who is twice your age but earns half as much) will respect you forever.

The equation is simple – Return/Investment, Return = (Earnings – Expenses).

The trick lies in realizing what earnings, expenses and investment involve & it is here where the dealer uses his tricks.

Let’s put down the formulae first:

a.       RoI or Return on Investment = Returns/ Net Investment

b.      Returns = Earnings – Expenses

c.       Earnings = Gross Margin that the dealer enjoys (Usually 6% - 8% in FMCG companies)

d.      Expenses = Direct Expenses + Indirect Expenses

1.       Here is where the first trick lies, Calculating Expenses:

This arises from the fact that the dealer in question is not dealing with just 1 company, he instead has 4-5 or even more number of companies that he is dealing with. Hence there are some resources that he is exclusively using for a particular company for eg. Sales Man and similarly many resources that he is sharing among the companies eg. His godown space, accountant, supply units etc.

Please note there is no thumb rule to it as there might be (and more often than not, will be) cases where even salesmen are being shared among 2 or more companies, and there will be one guy who would be the accountant-cum-manager-cum-supply wala etc. This is where the concept of direct and indirect expenses comes in.
Hence his expenses are split in to 2 parts i.e. Direct & Indirect Expenses

Direct Expenses are those that the dealer incurs exclusively for the company concerned.

And Indirect Expenses are those that the dealer incurs in totality for the companies for whom the resource/s is/are being shared.

The only rule in calculating expenses is that you need to take into account the part of expenses that he is incurring for your company alone. We will see how we do it below.

2.       Similarly the second trick lies in properly calculating the denominator, i.e Net Investment.

A dealer’s investment comprises of 3 parts : Average Stock that lies in his godown, Average Market Credit that he extends & Average Claims Outstanding,
Hence,
Investment = Avg Closing Stock + Avg Market Credit + Avg. Claims Outstanding

Here the usual suspect where one may go wrong in calculating Investment is the first variable i.e. Average Closing Stock of the dealer.

A layman would take the month-end closing stock as the average closing stock for the dealer, or worse if you do the mistake of asking the dealer what his closing stock is, the beast would tell you a figure which will be his all time high closing stock in a month.

The typical trend in FMCG is that majority of Pushing, also known colloquially as “thokna” (Primary) and Pulling (Secondary) happens in the last week and therefore the last week is not a true indicator of the entire month’s activity then why consider last week’s closing stock as his month’s closing stock. (To clarify, primary is what your company bills to the dealer and secondary is what your dealer bills to the retailer)

Confused?, we will deal with it with simplicity. Consider this as the trend of Primary & Secondary for a dealer in a 4-week cycle of a month

WEEK
OPENING STOCK
PRIMARY
SECONDARY
CLOSING STOCK
    1
5, 00,000
50,000
1,00,000
4,50,000
    2
4,50,000
1,00,000
2,00,000
3,50,000
    3
3,50,000
2,50,000
2,50,000
3,50,000
    4
3,50,000
5,50,000
4,00,000
5,00,000


The above table is how a dealer’s inventory in a typical FMCG set-up would behave like, i.e. majority of activity happening in the last week and hence one would be wrong in taking 5,00,000 (Week-4 Closing Stock) as the average closing stock for that dealer in that month.
The better way to do it is to take an average of all 4 weeks’ closing stocks. In this case it would come out to be as : ( 4,50,000 + 3,50,000 + 3,50,000 + 5,00,000) / 4 which equals to 4,12,500 which is lesser than the previous  result and hence his investment goes down and RoI goes up.

Enough of this gyaan now, let us get straight down to calculating a sample ROI

Premise:
Mr. Atul Mittal is the proud owner of his distribution firm M/S Bhagat Ram Jwala Prasad. His firm deals with distributing 4 companies in total of which ABC Pvt. Ltd. Is one for which we need to calculate the RoI. The firm has 1 dedicated (exclusive) salesmen working for ABC Pvt. LTd. with a monthly salary of INR 6,000/- per month per salesman. Apart from this, the firm also has an accountant-cum-manager with a monthly salary of INR 5,000/- per month, pays a monthly rent for the godown which comes to INR 5,000/- per month, incurs electricity & miscellaneous costs (supply units, chai-paani etc.) to the tune of INR 5,000/- per month. Other expenses such as his son’s education and his daughters marriage which your dealer would want to include are not to be included.

All figures are assumptions
Monthly Business (Turnover) inclusive of all 4 companies: 20,00,000/-;
Monthly Business (Turnover) of ABC Pvt. Ltd. : 8,00,000/-
ABC Pvt. Ltd.’s Company Margin: 8%
Average Market Credit for ABC Pvt Ltd. Is 10,000/- INR
Average Closing Stock for ABC Pvt. Ltd is worth 2,50,000/- INR
Average Claims Outstanding in ABC Pvt. Ltd. Is worth 10,000/- INR.

Hence going by the formula:

RoI or Return on Investment = Returns/ Net Investment

Returns = Earnings – Expenses

Earnings = Gross Margin that the dealer enjoys (Usually 6% - 8% in FMCG companies)

Expenses = Direct Expenses + Indirect Expenses

Let’s calculate each element one by one:
Earnings = Gross Margin = 8% of monthly turnover of ABC Pvt. Ltd. which is = 64,000/-
Expenses = Direct Expenses + Indirect Expenses
Direct Expenses = Salary of Exclusive Salesmen = 1*6000 = 6000 per month
Indirect Expenses  for ABC Pvt. Ltd.=( Contribution of ABC Pvt. Ltd’s Turnover to Total Turnover) * Total Indirect Expenses
Total Indirect Expenses = Godown Rent + Manager’s Salary + Miscellaneous Expenses = 5,000 + 5,000 + 5,000 = 15,000/-
Contribution of ABC Pvt. Ltd’s Turnover to Total Turnover = 8,00,000/20,00,000=40%
Hence, Indirect Expenses for ABC Pvt. Ltd. = 40% of 15,000/- = 6,000/-
Therefore Total Expenses = 6,000 + 6,000 = 12,000
Hence Returns = Earnings – Expenses = 64,000 – 12,000 = 52,000
Net Investment = Avg. Closing Stock + Avg. Market Credit + Avg. Claims Outstanding = 2,50,000 + 10,000 + 10,000 = 2,70,000
Therefore RoI = Returns/Net Investment = 52,000/2,70,000  = .1925 or 19.25%



50 comments:

  1. Just a point here....when you look at his investment in stock - one should always check whether he has taken bank loan. if he has then his actual capital investment is actually only to the extent of his own money. rest is interest which is part of expenses. a lot of dsitributors conveniently miss out this part of the equation. and for big distributors this makes a big difference in ROI.

    Similarly, if the distributor has a good overdraft facility then he actually pays for the stocks to the company from that and not his actual investment. here again interest should be added into his expenses and the investment reduced by the overdraft amount.

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    Replies
    1. That's a very important point...

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    2. Anu that's very rightly pointed for bank finance. But do you mean should we not take bank funding as investment.? Pl share as formula as sited above

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    3. Normally your Distributor shouldn't have more then 30% of his finances driven from an overdraft facility. In case of an overdraft, reduce the overdraft amount from the Investment and place the interest in the expense.

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  2. Thanks Anupriya! Duly noted :)

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  3. Alternatively, if a distributor rotates his investment say, 10 times a year, multiply that by net profit percentage per rotation.
    For eg:

    The company gives a margin of 5% on its products to a distributor. After all his distribution expenses, the net profit % is 2.1, and his investment is 20L with an annual turnover of 200L, ROI is easily calculated as under.
    No:of rotations = annual turnover/investment = 200/20 = 10 rotations/year
    Investment = 20 Lakhs
    This means he rotates his investment of 20lakhs, 10 times a year, each time making say 2.1%. So his ROI is 10*2.1 = 21%

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  4. Thanks Kiran! Duly noted. Please feel free to contribute in the further posts also!

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  5. Very helpful. A much needed initiative. Thanks Kaushik! :)

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  6. Brilliantly explained - Subbu and Nishit! I remember looking for somebody or something to teach me this, about a year back. That my dist. ridiculed me abt not knowing my ROI calculation was the 'push comes to shove' part.

    However, lets not forget a very important parameter of credit given by the company to the distributor which can range from 0 to anything.

    So if Credit = 7 days, 7 days of closing stock is deducted from the distributor's investment. Also a distributor gives a cash discount to wholesale or even retail, so that too has to be accounted for. I would urge you to simplify this and put it up as ur article is crisp and clear and this could prove useful too.

    Recommendation:

    1) Teach them how to calculate a Super Stockist ROI as well. Far simpler than direct.

    2) Also, in your next article you could explain how to get back an uninterested distributor on track based on key parameters. (Kaushik you had aced that, Nishit you could share too... btw sup with you?)

    3)All distributors are swines with hair coming out of all their holes.. jusayin....they might not squeal but they do grunt a lot. Somebody has got to tell these kids that... Nishit you could elaborate I guess (this inference from ur fb statuses)

    And excellent explanation Kiran... was thinking abt that while reading the article.

    Cheers,
    TiTo

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  7. hey TiTo,

    hw u doing man....

    points noted dude....the upcoming posts will only highlight the point number 3 that u ve mentioned.

    may be we could come up with a post about how to tinker RoI to get back distributor's interest provided he is sitting on a lesser RoI...

    would urge you also to contribute...and about explaining credit, wholesale discount, we intentionally didn't go into the detail to avoid it from getting complicated...

    nevertheless thanks for the feedback.

    Cheers
    nishit

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  8. Sure would love to contribute... but I would rather start by trying and provide some comic relief between intense FMCG sessions :P

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  9. Realy good explained ....Thanxxxx

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  10. very helpful.....thanks....for explanation of ROI insuch a way....
    thanks.............

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  11. Can anybody exactly explain following-
    per month
    Sales: 10 Lac
    Margin: 3%
    Inventory: 2.5 lac
    Market credit: 2.5 lac

    Case 1: No credit from company to distributor
    Case 2: 7 days credit from company to distributor
    Case 3: 30 days credit from company to distributor

    Pls explain the concept also

    Thnx

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  12. GOOD explanation......... but one doubt is there in example. ROI is 19.25%, as per calculation this is monthly ROI but monthly ROI would be 1.5-2.5%

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    Replies
    1. same doubt I have also. Could you plz explain it why.

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    2. 52k profit out of 2.7L investment is only fictionally possible

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  13. avik das......
    if no expenses are there then
    case 1: roi is 6%
    case 2: roi is 7.2%
    case 3: roi can't calculate....... because there are no investment.

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    Replies
    1. please show the working for case 2 please...

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  14. hi Ankit could you please explain the second case..

    David

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  15. davidraja....

    if market credit is given for 7 days.. then average market credit would be 75% of inventory, thus total invenstment wud turn out to be 4.2lac.. hence ROI wud turn out to be 7.1% (guys plz correct if im wrong .. not from fmcg background)

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  16. This comment has been removed by the author.

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  17. aa you are very close to being right if market credit = 2.5 lac

    for 7 days market credit = 75% of inventory
    = 75/100*2,50000 = 1,87500

    total investment would be = 2,50000+1,87500 =4,37500

    margin is 3% of sale of 10,0000 = 30000

    so, Return on investment is = returns/total investment

    ie : 30000/437500 which comes out to be 6.8 % or you can say 7%

    but how come you came to conclusion that average market credit for 7 days = 75% of inventory cost ???

    ReplyDelete
    Replies
    1. I believe, he has not taken it as 75%..but..for 30 days..stock is 2.5 lacks..so for 7 days it's 2.5 lacs* 7/30~=58300....So net investment in inventory=2,50000-58300=191700.....So,
      roi comes to be 6.7%..I think so...

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    2. Hi what is the healthy ROI for FMCG Distributors(as u told margin is between 6%-8%)? Is it between 14%-24%?

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    3. 30 days inventory is 2.5 Lakhs
      so we can calculate inventory for 23 days which comes out to be (250,000/30)*23=191,667
      then final investment= 191,667+250,000= 441,667
      ROI= Earning/Net Investment
      =(30000/441,667)*100
      =6.7%

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  18. HI can any one confirm the standard norms for the ROI & Investment.

    If some one having please share @ vikasmendi@gmail.com

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  19. can anyone clear my following doubt
    Investment include Avg Closing Stock + Avg Market Credit + Avg. Claims Outstanding OK.... but what about deposit given for taking godown on rent and down payment done for purchasing vehicle do these investments are consider for calculation of net investment and if not then what would be consideration for them

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  20. This comment has been removed by the author.

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  21. Hi..Can someone help me crack this..
    Distributor does a 20Lac business per month. Earns Gross Margin of 10%, Exp per months comes to around 2%. Avg Inventory: One month, Avg Market Outstanding of 45 days. No claims outstanding. No company outstanding. Funding purely from internal resources. Doesn't have any other co's distributorship.
    I get two different ROIs with different approaches. Turnover/Inv method and Standard Method of Net Earnings/Investment.

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  22. In both case it will be 38.4 % annual Roi

    1st method 160000 *100/ 500000 = 3.2 monthly Roi or 38.4 annual Roi

    2nd method 2400000/5000000 = 4.8 rotations , Earning per rotation 8 % hence annual Roi will be (8*4.8) = 38.4% only

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    Replies
    1. Can you explain how did you get 5000000 in the 2nd method?

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  23. in first case read denominator as 50 lac and not 5 lac

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    Replies
    1. By Turnover/Investment method
      Turnover is 20 lacs
      and investment is (30/365)*100 i.e 8.219% and (45/365)*100 i.e 12.328% Total is 20.54% means investment is 20lacs*20.54%= Rs 410800
      2000000/410800= 4.868 times Rolling
      NP is 8%means ROI is 8*4.868= 38.94%

      I second method NP is 160000
      Investment is 410800
      160000/410800*100= ROI is 38.94%

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  24. in the second case shouldn't the numerator be the annual turnover ?

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  25. Can anybody explain the following

    Abc is a fmcg company

    xxx is the product name

    Margin of the product for stockist is 10%
    Margin of the product for retailer is 20%

    Mrp of the product is 25000

    cost of stockist is 19120
    Retail cost is 20830

    What is the method of calculating the margin

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    Replies
    1. Suppose ur MRP is 25,percentage of retailers margin is 20 %,distributor is 10 % then margin for retailers is 25 /1.2, it will be 20.83 which can be divided by 1.1 (10% distribution margin) .

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  26. ANYONE KNOW THE Healthy ROI for the FMCG channel partner??

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  27. In the comments above, Himanshu spoke about two methods of calculating ROI. One is the Inventory/Turnover and the other Net Earnings/Investment. Could you please elaborate a little bit more on the Inventory/Turnover method.

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  28. Thanks for sharing this Informative content. Well explained. Got to learn new things from your Blog on SAP SD

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  29. Dear friends...
    I have a question...
    Suppose im about to finalize a distributor for my company. Monthly proposed turnover is 5 lacs. What should be his minimum initial investment??how is it calculated?

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  30. a distributor take loan of rs 10 lac and he is paying rs 10000/- interest per month to bank can we take this in his investment for calculting his ROI??

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  31. Interesting Indeed ! I find this useful for Industrial Distribution too, not just FMCG.

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  32. Hi, please tell someone how to calculate Avg. Market Credit and Avg. Claims Outstanding, explain with example.

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