By: Ray Lampner, CPA, ABV, CVA, CFF
The opportunities to work with a new customer can often be a complicated process. Frequently the opportunity is viewed as opening a door to even more business with that customer. So in turn, the manufacturer is interested in discounting the initial order to help open that door. The manufacturer is often faced with the question of “what are the actual costs of this order?”
When determining the actual cost associated with a sale, it is important to just look at the associated variable costs. Examples of these are as follows:
- Materials
- Subcontract expenses
- Labor – including overtime and related payroll taxes
- Machine setup expenses
- Freight
- Sales commissions
A common mistake for manufacturers is to include fixed expenses in this analysis. We recently worked with a client that was in an industry that had a competitive bidding environment. The company had a very low success rate when bidding new work. The company had significant fixed expenses, some of which were as follows:
- Lease expense for the building
- Lease expense for equipment
- Wages and benefits for non-direct labor
- Depreciation
Every quote the company compiled included a fee for a portion of the fixed expenses. So the company assumed that they would be losing money on each order if they became more competitive on price. Fixed expenses have this name for a reason. The cost is fixed every month, with no change based upon the level of business. So, when the company does take on these additional orders, they do not have additional expenses other than the variable expenses listed above. Once the company adopted this philosophy of pricing, they lowered their price for only the competitively bid items and the bottom line of the company began to grow.
I am not suggesting decreasing overall prices, but companies should know the ‘true’ cost of production to properly price each item and help maximize the bottom line of the company.
