The Price Is Right…Or Is It?
Sales up, profits down? It’s frustrating to work hard all year, while watching sales increase, and then at the end of the year find out you didn’t make any money!
Decreased profit can be caused by a variety of things, but more times than not the root problem is improper labor pricing …from a cash flow perspective. It’s not necessarily that management didn’t re-evaluate costs and increase pricing. The foundational problem is often overlooking significant, but forgotten about, “real” costs of doing business.
Just to be sure your pricing is correct, let’s review a few key areas that are sometimes overlooked.
Depreciation vs. Equipment Replacement Costs – Depreciation is an accounting term that takes the purchase price of a piece of equipment and allows the company to write off typically 20% of that value each year. Is that enough to replace your equipment when the time comes? Absolutely not. Equipment replacement cost needs to take the place of deprecation in your pricing model. Equipment replacement looks at how many more years a piece of equipment will last and then estimates its replacement cost at that point in time. The future cost is then divided by the remaining number of years BEFORE replacement. The resulting number takes the place of depreciation in your pricing model. Equipment replacement dollars are typically 30%-50% HIGHER than depreciation. Is that eating your profits?
Non-Billable Time – Non-billable time, is time the technician is paid for that cannot be directly charged to the customer. Non-billable time is AM/PM shop time, travel between jobs, trips to the distributor, vacation, holiday time, and sick time. It also includes callbacks, company meetings, and warranty work. For a typical service tech non-billable time is about 50% of what they are paid. Installers normally have non-billable time in the 20-35% range. This is normally the companies #1 cost of doing business. Have you included that cost in our overhead pricing model? If not, it’s eating your profits!
Loan Payments – If you have a $500 loan payment of which $400 is principle and $100 is interest, do you know what shows up as a cost on your P/L statement? Only the interest is shown as an expense. The other $400 went on to never-never land. If your company has a lot of loans this situation may help explain why sales are up but profits are down. Be sure the full amount of the loan payment (principle and interest) is in your pricing model, not just the interest. If you don’t include the principle payment in your pricing model, it too will eat up your profits!
Debt Repayment – Do you owe money on your line of credit, to a supplier or to Uncle Sam? Are you paying back borrowed money to friends, family, or an investor? If you are paying off past debt 100% of that money comes straight out of your profit…none of which is shown as an expense on the P/L statement. If you are paying back debt, be sure to include that debt repayment, dollar for dollar, in your cash flow pricing model as an expense. Failure to include debt repayment will result in paying off debt from current profits. That will also eat up your profit.
These are just a couple things to think about in your pricing model. If you include them, you will be priced to actually SEE a profit at the end of the year. Failure to include the above items will result in having a really great sales year…with little profit to show for it.
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