Management Perspectives: Business Costs

Keeping tabs on the expenses that fly under the radar.
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Management Perspectives:
Business Costs

Apr 1, 2005 12:00 PM, By Mark E. Battersby

Keeping tabs on the expenses that fly under the radar.

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It is a rare contractor who doesn't know whether his or her business is profitable: Accounting statements or even the operation's tax returns often provide that information. How many integrators, however, know whether their bids, jobs, or services they perform are profitable? Few are aware whether their best customer is generating profits sufficient to warrant the degree of services provided.

Unfortunately, few integrators understand what a particular job, service, or customer actually costs. Far too many believe that if they charge one sum of money and pay a worker a slightly lesser amount, the job, contract, or service is profitable. In reality, however, nothing could be further from the truth.

MOM AND POP'S BUSINESS

Many contractors operate as a Mom-and-Pop type of business. Pop is in the field or on the job hustling up work and performing the services that generate the income for their operation. Mom does all the chores such as billing, bookkeeping, scheduling, and fielding complaints and other phone calls.

If Pop charges $200 for a job that can be completed in three hours, he might figure that he's making $50 per hour after subtracting for the costs of the supplies used. But then, reality intrudes.

Ignored in that all-too-common equation are quite a few expenses that can add substantially to costs. What about the cost of Mom and Pop's labor, setting up the job, scheduling, billing, and collecting the amounts due? What about the cost of the vehicle used to get to the site of that job, the wear and tear on any equipment needed?

The expenses of traveling between jobs warrants consideration, as does the cost of having Mom perform her services. And don't forget about overhead costs for such things as advertising and the expenses of maintaining a base of operation — even if it is only the kitchen table that Mom works from.

THE HIGH COST OF MONEY

As is the case with many business expenses, the cost of money is often overlooked or misunderstood. In our Mom-and-Pop business, for example, the couple believes that using their savings and investments to finance needed purchases, or to keep the business going, is saving them.

Unfortunately, money costs. If those funds had remained invested or kept in a savings account, they would have increased in value. Removing funds from savings incurs a “lost opportunity” cost. The business should consider that a legitimate cost of doing business.

On a similar note, a business that bills for its services is, in essence, lending its customer the amount of the bill, interest free. The business must usually pay its workers and bills before it receives payment for the services rendered. Often, this means borrowing money. It is up to Mom and Pop to decide whether it is more economical to borrow the money necessary to keep the operation going or to offer their customers an incentive for paying early. But if they decide to offer the customer a discount — say, two percent — for paying early, the business is paying the customer to avoid late payments. In other words, that discount still will cost the business something.

As an alternative, the business could increase the amount it charges to cover the amount of the discount. Thus, if not taken advantage of by the customer, that would-be discount becomes a charge for the use of the operation's money.

KEEPING TABS ON COSTS

What does it cost your business to perform its services, jobs, or contracts? Although financial statements, if available, clearly show expenses, they are rarely broken down into specific jobs or even categories of services. That's where cost accounting enters the picture.

Cost accounting is the process of allocating all of the integrator's costs, both direct and indirect, associated with the business. Direct costs include such things as the total wages paid to workers, supervisors' salaries, and supplies expended. Indirect costs are all of the other expenses associated with keeping the operation going, such as the aforementioned lost opportunity costs and equipment wear and tear.

Cost accounting can be as simple or as complex as desired. However, just as with the cost of money, it should never be ignored. How, after all, can profitable bids be prepared, discounts offered, or prices and fees decided if the operation's expenses aren't reflected accurately?

Consider the cost of adding a worker, for example. If our Mom-and-Pop business hired an employee, they would pay him a fair amount without benefits. Mom and Pop might assume, wrongly, that the cost of that employee equals the wages paid him.

They would be correct in assuming that the addition of an employee adds to the cost of doing business.

There's more to sending an employee out to do a job or perform a service than wages. The business' insurance expenses must also be considered. After all, employees increase risk, a liability that should be covered by insurance. And don't forget the cost of workers' compensation insurance, matching FICA contributions, and unemployment taxes.

There are also costs associated with supporting that employee: The cost of supervision, bookkeeping, and payroll services, etc. Add to those figures the basic support costs of sales, administration, and other necessary tasks. Not surprisingly, the cost of fielding an employee increases the amounts charged to customers.

ESTABLISH A SYSTEM, CREATE A GOAL

Naturally, before the integrator can improve the operation's efficiency, particularly in the area of its non-revenue-generating services, he or she must first be able to identify what specific support activities the operation is performing, describe in detail how it is performing those activities, and establish how much it is spending on those activities.

Conventional cost accounting, which is that employed by many software programs, usually places support costs into a pool that is distributed across the operation's cost centers or services. This can distort actual costs. For example, a job that requires 10 estimates and 10 sales calls before finally winning the job is usually assigned the same support cost as a job that didn't require any estimate or sales calls.

To set up an effective cost-accounting system, an accountant's or CPA's help might be advisable. Cost accounting, after all, can get fairly complicated. The money spent on professional guidance will be well worth it.

ACCOUNTING FOR COSTS, REDUCING COSTS

Obviously, there's more to cost accounting than determing the cost of a job or service performed. Business owners should analyze carefully their costs of doing business to locate and reduce those expenses that are out of line.

Many integrators begin by comparing this month's expense figures with those of last month or the same month last year. Eventually, year-to-date expenses are compared with last year's figures. Then an attempt is usually made to determine the reason or reasons for any discrepancies between the figures in different accounting periods and, perhaps, place the blame for costs that have increased.

If, for example, supplies expenses represented two percent of sales last year and shot up to 15 percent this year, you should want to know the reason. Equally important, you should want to know about the fiscal health of your operation. A business' financial health has a bearing on much more than the bottom line or profits. It can also affect both the cost and the availability of financing.

Taking financial control of your business means knowing and understanding the cost of money. It also means understanding what each service, contract, or job actually costs your operation. You can also use the discrepancies revealed by the costing analysis to discover why costs have been rising.

Accounting for costs means more realistically pricing your services to enable your costs to be passed on to the customer. Cost accounting can also prove invaluable when it comes to determining actual profits; finding out what a particular job actually cost; or, if the analysis is detailed enough, what your best customer actually costs you and your business.

Mark E. Battersbycan be reached atmebatt12@earthlink.net.

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