Cost Increases And How You Pass Them OnWritten By Garry Bartecki
Article Date: 08-01-2004
Copyright (C) 2004 Associated Equipment Distributors. All Rights Reserved.
It’s time to put extra effort into understanding how your business operates.
While business seems to be rebounding, there is still a lot that needs your attention. One TV show I was watching interviewed a business owner asking about the economic recovery. He said, “The recovery is great and business is improving, but with all my costs increasing I’m not sure I’m any better off.”
If you find yourself in a similar situation, you have two options: Do nothing or start finding ways to pass along legitimate cost increases to your customers. It’s been a very long industry recession, but a recovery is in place, the laws of demand and supply are changing the business equation, and soon inflation (cost increases) will start to stick and prices will increase – nothing new about that.
What will increase? Maybe we should ask, what won’t. You have to assume every one of your business partners and service providers has been in the same boat as you. They have suffered and are now asking themselves, “How can I pass on these cost increases to the equipment dealer?” It only takes a few to start the ball rolling, but it’s going to happen. Are you prepared to deal with this and maintain margins in all profit centers?
Many of you have sophisticated accounting systems that help collect departmental sales along with departmental direct expenses. In addition, most of you use formulas to allocate indirect expenses to each department. Unallocated expenses are reflected as general and administrative expenses.
To get a feel for how expenses are tracking I like to compare three years of individual line items to get a feel for where we’ve been and where we’re going. Of course, you need to make sure you’re looking at apples and apples. If you think that’s a problem, have your accounting department straighten out what needs fixing before you start the comparison.
So, what do you expect to increase? What areas require more study? What areas can be fixed to minimize any negative impact? All are good questions, and all require answers, if you hope to take advantage of the business recovery.
Commodity prices have been increasing, suggesting all product costs and related parts will increase. Oil and related product prices are also increasing, which will cause product costs, freight costs and your internal transportation costs to increase.
What about personnel costs, which include pay hikes and the forever-nutty insurance markets. And let’s not forget one of your biggest line items – interest expense. Let’s see, product costs are increasing, labor costs are up, transportation costs are on the rise, and the cost to finance the entire operation is sure to climb as well.
With all that going on, it’s time to put a little extra effort into understanding how your business operates. Start by reviewing your expense lines and projecting where they may go for the balance of 2004, and take a stab at how they might look in 2005. Next, investigate any changes you don’t like or don’t understand. Get your managers and administrative staff to do some digging to find the cause of the change. Then, decide if you can eliminate the expense or mitigate the negative movement, and if you can’t, figure out a way to start adjusting prices so you can stay even on the margin side.
You have options. You can review contracts to see if you can get better terms. You can investigate ways to cut health and workmen’s comp insurance. You can review bank loans and discuss ways to protect against rate increases. You can find ways to reduce transportation costs.
Once you have identified problem areas and taken steps to reduce or control the expense, you have a pretty good idea of where you will be for the balance of the year. Now you have to pass them along. Some of the increases will take care of themselves, vendors will increase the cost of their products. Your direct and indirect expenses, however, require you to take action to resolve the issue. If you believe you are dealing with short-term pricing issues, pass them along as surcharges, thus keeping the flexibility to remove them once the markets settle down. Long-term changes, such as interest expense, have to be factored into your pricing structure. In any event, you need to make adjustments to start making up for the last four years. It’s time.
Make the adjustments necessary to produce a reasonable profit. You know why, because you earned it.
Excerpted from August 2004 Construction Equipment Distribution.
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