We need to get a better idea of what it costs to produce what we sell. We don’t do enough to manage those costs. What can you suggest?
Thoughts of the Day: Managing cost to produce is one of the most important activities any organization can decide to tackle. Establish measures to analyze. Assign someone to do the tracking. Figure out industry standards.
Your company exists to produce and deliver goods and services that your customers purchase. The goal is to understand and find ways to control and reduce costs while focusing on optimally profitable customers and goods to sell. A good understanding of components can also help the company manage as inflation creeps into an economy recovering from recession.
Industry standard measures to track and analyze:
• COGS % = Cost of Goods Sold / Revenue; include all costs to produce and deliver, including shipping, labor and materials. I recommend also analyzing sales commissions as a variable cost, but not sales salaries which is fixed and have no direct relationship to whether the product or service is sold.
• Cost of Labor / Revenue and Cost of Materials / Revenue help identify which sub-component is going up or down.
• Inventory Turns improves cash flow and reduces risk of obsolete and lost parts. The simplest formula = (COGS total for a year) / (Average Inventory for a year). Establish that formula for a given period and watch how it moves as you add and drop months.
• Days to Clear Inventory = Turns / 365 days, gives you an idea of how many days inventory sits before being used.
Per unit analysis will help on a more granular level:
• Cost / unit produced helps evaluate pricing and production = (COGS, including commissions) / (units produced)
• Contribution / unit tells about selling margin = (selling price – variable cost to produce) / (units produced).
• Transportation / unit, Fuel / unit, Labor / unit, Material / unit, etc. reveal trends that impact overall profit.
• Breakeven output = company’s fixed costs (overhead) / cost per unit produced, tells you how many components you have to produce to cover your costs.
Profit / customer by product and overall will help direct future sales efforts.
Accurate data is key. Tracking data is usually assigned to finance even though the data are coming from operations. Two groups within the organization, looking at the same data from different points of view, can lead to productive debate, ability to spot more trends and more ideas about what to do when a concern arises.
Controlling inventory is challenging for most companies. Inventory is constantly on the move from supplier to storage to installation before being charged to customers. Most accounting systems have modules that allow bar code readers to scan inventory in and out. A policy that suppliers will not be paid without a purchase order and scan provides control over parts. Audit of POs vs. customer invoices reduces missed items.
Analyze costs as trends over time to identify when changes are happening. Graph out the data to make trends easier to see. Meet regularly to review and discuss what the graphs are saying and compare that to issues and obstacles in operations and sales.
Look for seasonal variations, as well as overall economic changes. For example, if gas spikes, overall Cost of Goods Sold might not go up a lot because fuel is such a small part of the total. But transportation/unit and fuel/unit would spike indicating that a fuel surcharge is in order.
Every industry has benchmarks for standard measures, for example: COGS% total, material, labor; Turns; and Days to Clear Inventory. Get the benchmarks and compare how your company is doing. Once you know your numbers set goals to improve results that will contribute to increased profitability.
Looking for a good book? Try “Company P&L Economics: Economic Measures for Managing Revenue, Costs and Profitability” by William F. Christopher.
Andi Gray is president of Strategy Leaders Inc., strategyleaders.com, a business consulting firm that specializes in helping entrepreneurial firms grow. She can be reached by phone at (877) 238-3535. Do you have a question for Andi? Please email it to AskAndi@StrategyLeaders.com or mail to Andi Gray, Strategy Leaders Inc., 5 Crossways, Chappaqua, N.Y. 10514. Visit AskAndi.com for an entire library of Ask Andi articles.
A version of this article appeared in the print edition of the Business Journal for the week of Jan. 21, 2013.