Understanding Your Numbers Nicely Done!
Aug 05, 2021 by Roger Scherping
I share a lot of stories from my experiences of companies that do not understand their numbers and the price they pay for that in terms of poor decision making or missed opportunities. Well, today I get to share an example of the opposite: A company that is adamant about understanding their numbers!
I have a manufacturing client that prepares quotes for prospects that might want to have them manufacture a part for them. To prepare a quote, my client wants to include all of the costs that will go into producing that product. To that they add a markup, and that gets them a price to quote to the prospect. This is probably no different than what you do in your business.
In manufacturing, however, it can sometimes be very difficult to determine your true costs. You have material costs and the direct cost of the employees who work on the job. But what about all of the other costs? You have fringe benefits on labor, and you also have all of the other costs of running the shop. The latter are costs that cannot be tied directly to any job but instead apply to all of the jobs. How do you account for them to ensure that you get all of your costs included in your quote?
My client wanted to know their shop rate. That is, they wanted to know what their total cost is of one hour of activity in their shop. They needed that to be sure they are covering all of their costs. Then they would just add material costs to determine their final cost in doing a quote.
They had previously been using a shop rate of $55 per hour, but it had been a while since they had recalculated that.
We started with what their average hourly rate is for the shop workers. We call this the direct labor rate, and it became the baseline. For them that was around $30 per hour.
Then we looked at all of the additional labor costs (what we call labor burden), things like unproductive time, payroll taxes, health insurance, and 401k costs. These costs added another $35 per hour. It is not unusual that the labor burden is actually higher than the direct labor rate. This was the second layer of their shop rate.
Finally we looked at everything that it took to run the shop, things like maintenance, supplies, and utilities. My client does not allocate those costs to the jobs. Those costs have to be paid for by all of the jobs, so we need to include them in the shop rate. We simply added up all of those costs and divided them by the actual number of direct labor hours, and we came up with $25 per hour for all of the other manufacturing costs.
Understand Your Numbers
Adding these three numbers together, we determined that it costs them $90 for one hour of activity in their shop. This knowledge is powerful! Now they can confidently use that number in their quotes and be certain that they are adequately capturing all of their costs.
Their new shop rate is almost twice their prior one! If they hadn’t taken the time to understand their numbers, they would have continued to quote jobs and understate their costs. This would have meant that they would be making less on every job than they thought they were. I can just see them reviewing their financial statements every month and just scratching their heads wondering why their gross margin is so low and why they are not making as much money as they thought they should!
That’s why we talk about how important it is to understand the numbers of your business. It is really not that difficult. It may take time, but it pays back in better decisions, less stress, and more profit. For you, understanding your numbers may mean knowing your profit by job, your average product cost, or your anticipated cash flow. Take the time to understand your numbers!
ProjectionSmart will not help you with your shop rate, but we will help you look forward to see your financial future. With a better view of where you are headed, you can make better decisions and capitalize on more opportunities. You will not be scratching your head trying to understand what is going on with your business.