While every business or commercial venture aims to optimise productivity and profitability, success eludes some of them.
In our profession, we often come across the question, “How can I turn my company into a profitable operation?”
Experience has proved that success will not elude companies with sound administration, financial discipline and management, high employee morale and a proper understanding of the market and the evolving needs.
Some small and owner-operated enterprises are not aware of the basic terms that we use in business plans, marketing strategies and profit and loss accounts. These are Sales (Revenue received from the Customer excluding GST), Gross Margin (Margin over Materials and Packaging), Variable Costs (Costs which change with each unit of production), Contribution Margin (Margin over Variable Costs), Factory Fixed costs (Costs which do not change with each unit of production) and Operating Margin (Margin over Variable and Fixed Costs).
It is important to know that Expected Margin comprises Cost of Capital (the return required by providers of capital), Administrative Costs, Expected Profit and Breakeven Point (where Operating Margin equals the Expected Margin).
Any increase in sales above this level or any cost reduction below this level will give profit to the enterprise.
The two techniques that give an enterprise a clear picture of its Products Costs are the Boston Consulting Group (BCG) Model and Activity Based Costing (ABC).
The BCG model analyses the business potential, evaluates the environment and classifies businesses as high or low according to its growth and market share.
The ACG Model
The Activity Based Model enables an enterprise to determine the real cost of its products, establishing relationship between overhead costs and the activities.
It allocates overheads precisely to products, services or segments; factory overheads are assigned to products more logically (based on cost drivers) than the traditional approach of allocating costs based on direct labour or machine hours.
Control on manufacturing labour costs involves managing timesheets, use of appropriate manpower and computer software for consolidation. Payment of wages should be based on completed time sheets, calculation of chargeable labour hours versus non-chargeable labour hours.
Cost-Profit Analysis
An in-house financial planner or an external expert will enable a company to determine the appropriate mechanism for apportionment of variable costs, supply chain costs and manufacturing services costs. A manufacturing plant that runs on optimum capacity for each production area, utilising the full potential will invariably function at optimum productivity and profit.
Management Accountants, Business Analysts and financial professionals will advise the following:
1. Target optimum capacity utilisation, profit will follow
2. Aim for Gross Margin, Contribution Margin and Operating Margin based on industry averages and benchmark it by products
3. Any customer quote not fulfilling the criteria should undergo thorough investigation and referred to the higher level
4. Different tier pricing for peak and off season, aim to keep plant occupied throughout the year
5. Establish KPIs based on plant utilisation or excess capacity
Mukesh Arora is Director of Tally Accounting & Business Solutions Limited. He has Chartered Accountant qualifications in New Zealand and Fellow Chartered Certified Accountant (UK) and Cost Accountant (ICWA) India. He can be contacted on 0800-825599 or 021-1290810 Email: tallysolutions@xtra.co.nz
