Many companies can improve pricing/gross profit margins by identifying overlooked cost factors and implementing strategic actions based on more reliable cost information and industry benchmark data.
Does your business require fixed price job estimates? Do you have reliable industry benchmark data to validate your perception of competitor pricing/bidding? Do you get meaningful management information tracking actual job time and costs compared to original estimates?
A growing service business entrepreneur realized pricing/gross profit margins were not as strong as expected. However, existing financial information did not reveal why. Although the company did not maintain any detailed job cost information, my analysis effectively discovered that actual time and labor cost incurred was approximately 75% higher than estimated. This obviously reduced margins since the job price was fixed. The company began focusing on a cost effective approach to manage accountability for time incurred on jobs considering original estimates.
In addition, I discovered the entrepreneurs’ bidding strategy should generate a pricing/profit margin exceeding industry norms. We had an effective discussion regarding the entrepreneurs bidding strategy (target price per estimated hour), and expected labor cost based on estimated hours. I demonstrated the pricing/profit margin that should be realized if job cost matched estimates.
As a result, the entrepreneur realized an opportunity to reduce bid prices to win more jobs, and manage accountability for job time resulting in higher margins.
Tracking and measuring labor and overhead costs can be challenging. Clean audit reports, including labor and overhead in inventory and cost of goods sold can overlook a devil in the details that may impact more meaningful margin management and competitive pricing strategy.
A client was accountable to a private equity group that acquired a majority investment in the company. As a result, management became more accountable and diligent in managing profitable growth trends. The company controller maintained financial statements with clean audit reports for years. In addition, company systems maintained detailed job time and cost.
I discovered that shop employees overall failed to log about 15% of job time incurred on product manufacturing. As a result, product profitability (performance) was overstated. In addition, work in process inventory was understated; consequently gross profit was understated.
I observed that the audited calculation of labor cost per hour appropriately included all labor related costs. However, the hourly rate was based on total hours paid. As a result, essentially all paid time off was not included as labor cost in work in process inventory nor product time cost. The calculation was accepted for the GAAP audit because it resulted in conservative accounting for inventory costs and cost of goods sold. GAAP allows total labor related costs divided by actual/standard product labor hours. In other words, if one employee dedicated one year to produce one product the total labor cost for that employee is the product labor cost. On an hourly basis, the total labor cost divided by the actual manufacturing labor hours incurred for the year (not paid hours) represents the labor cost per hour. Consequently, management pricing was based on understated labor costs per hour; and work in process inventory and gross profits were understated.
As a result, management improved strategic pricing based on reliable information. In addition, financial statements provided more accurate monthly trend profit margin results enabling effective focus on profit margin accountability.