Look Into the Numbers 2/7/2012 3:47:00 PM Preparation for tax season provides an excellent opportunity to look beyond the tax accounting numbers to the underlying data that are invaluable tools to better manage your business.
There are many businesses, some far larger than most would imagine, that only know at the end of the year if they made money or lost money and have no firm understanding of what drove the results.
Unless you make a single type of simple widget, you have activities and products that impact your bottom line in varying amounts. In order to make informed business decisions you need to know what the true impact of each of those items is on your costs. Too often managers tend to rely on their gut to make those decisions. In realty, many of these decisions are far too complex to rely on your gut; you need to rely on facts.
As an engineering student I studied economic lot size calculation methods. Over the years that answer has been simplified, and we now think in terms of lot size one; however, that can be an over simplification. For example, I am currently doing the cost calculations for two different processes used in door manufacturing. One process is more manual and labor intensive than the other. The more automated process requires greater set-up and clean-up time but much reduced cycle time.
The true cost per unit is based not just on labor hours but also adhesive usage and waste disposal, both of which change depending on the process used. The determination of what quantity is the “economic trigger” is not something that can dependably be pulled from one’s gut.
The need to understand material costs and the labor hours required to produce your products are obvious in making pricing decisions as well as make/buy decisions. However they alone do not tell the full story. Complete cost calculations require that you fully understand and use the true cost of your overhead applied to your labor hours. These include both fixed and variable components and those numbers should be recalculated at very least annually by your accountant. If your expended labor hours change significantly during a year, recalculate your overhead allocation based on those revised labor hours.
If you have a large shop producing a diversity of products you may have significantly different overhead costs in different areas, do not make the mistake of using a “blended” overhead allocation that could dramatically impact your business.
I recently read that the number one cause of business failures is a lack of understanding of true labor costs. If only close to being correct, that is a terribly sobering thought. If your accountant is not providing fixed and variable overhead cost information to you and counseling you in its use and application — get a new accountant.
