Inflation is starting to be a worry again as evidenced by the Fed's interest rate increases. Yet, for some portions of your business, you have been incurring "inflation" every year. It has been a struggle, but you have learned to deal with it and move on. However, now that general inflation is creeping back into the limelight, you have other business problems to contend with.
Most contractors have experienced price swings for both direct as well as overhead costs. Fuel costs, material costs and labor costs have all increased in the prior year. If you were lucky, your costs and your competitors' costs increased in similar fashion so that your price increases were not out of line.
Overhead, on the other hand, can sneak up on you and take a bite out of your gross profit before you realize it. To me, overhead includes those costs related to your direct payroll as well as supervision costs, with health insurance and other employee benefits representing the majority of the cost categories.
The trick to managing such costs is to have a good handle on what the costs are and when they will change, then build negative swings into your overhead rate for the next selling season.
Keep overhead under control
Obviously, the best way to keep overhead in check is to closely monitor your labor pool. Excess people cost you money in terms of insurance, payroll taxes, supplies and their hourly rate. The fewer people you can get by with, the lower your overhead will be.
The overtime premium can hurt you, as well. Make sure you know what you are paying for, and that the overtime was actually necessary. If you do not review every payroll summary, you could have a problem of which you are unaware.
Is there equipment you can use to reduce the people cost? Less people hours equal less overhead hours, and thus lower overhead costs. You keep seeing how almost every labor-intensive industry is able to reduce costs by making employees more efficient. How about your industry? Is this an option?
Insurance costs depend on the market and your claims history. It pays to have an insurance agent work on your behalf to better your claims history. Training, following safety procedures and monitoring the rehab process can reduce your insurance costs. And when we talk insurance agents, we are suggesting you use one that knows your industry.
New health insurance opportunities await your review. Find out what is going on with your employees. What do they need? How much can you pay? How much do they have to pay? Can you go to one of the new high-deductible plans?
High-deductible plans make employees aware of what they are spending and, in most cases, don't require them to spend any more than they are now. In the end, high-deductible plans, if set up properly, can reduce annual increases when compared to other plans.
Compensate for cost increases
Okay, you know costs are increasing and you have to do something about it. You can either reduce your costs or increase revenues to maintain your margin.
If you can wipe out your cost increase by taking out a comparable level of operating costs, pricing can stay the same. If this is not an option, price adjustments are the only way to go to keep yourself in the same gross profit position.
Let's assume the price adjustment is the way to go. How much do you have to adjust? If you want to maintain a 30% margin, it could go something like this:
However, if your costs increase by $1, your margin in turn declines to 29%, as shown:
To get back to 30%, you will have to kick up sales by 2% in order to recoup that $1 in lost margin:
Clearly, it pays to keep track of overhead before it becomes too big a problem. Fall behind and you can never catch up with just price increases without hurting your overall business.
Garry Bartecki is director of dealer/distributor services at BDO Seidman, LLP of Chicago, as well as a consultant to the AED. He has also worked as an independent CPA and consultant to equipment dealers. He can be reached at (312) 616-4677 or firstname.lastname@example.org.