Hands up those who can answer the following questions honestly –
What is the true cost of making your products?
Do you have an idea of your profit margin or indeed if you are even making a profit?
Which is your most profitable product?
How much wriggle room do you have should your costs increase further?
With rising costs and interest rates, now more than ever, it is vital that you are fully on top of your business costs to enable you to make informed and effective decisions and be in control of your business finances.
Outlined below are the steps you need to take to understand your current costs and a case study where Hale Portfolio helped one client to get a true comprehension of their financial position.
1. First things first, make sure your purchase ledger is up to date. Without this information, you will fail to build an accurate picture of your costs.
2. Talk to those who are making the actual product and ask the following questions –
What materials and quantities do you need to make it and who do you normally buy them from?
Checking this information against the most recent suppliers’ invoices will give you an accurate price for the raw materials involved.
How long does it take to make the product?
This will allow you to work out the labour cost of production. However, it is vital to consider not just the hourly labour cost but also include holiday pay, benefits, tax, etc to get a true cost of the labour. Also, remember that no one is 100% productive all the time so be sure to factor that in too.
3. Consider how are you selling the product – what size options are there, how does packaging vary, and do you sell individual units or multipacks?
4. Review your distribution costs and different channels. Remember to consider the delivery charges for each product offering, the postage and packaging costs, website charges such as payment platforms, Google ads that drive traffic to your site, and any marketing costs. If you sell your products in a store, what are the rent, the rates, the utility bills, etc., and what staff are needed to run the store?
5. Finally, look at the current selling price of each product. What is your margin? Are you even making a profit for every product offering?
Once you have completed these steps, what should you do with this information? Here are some considerations –
It may be that you realise you need to increase prices so look at what your competitors are doing and what is acceptable within your market.
If you sell your product via different avenues which is performing the best? Should you focus on this or spend more time and effort on the slower-performing avenues?
This information can also help with planning and staying in control of costs. I suggest you add a hypothetical percentage increase to your costs e.g., 5%, 10%, etc., and see if you would still be running a profit. What would you do if not? It is important at this point, if relevant, to consider any contracts you may have to supply large retailers – is there an agreement not to increase the price? What could you do if your costs are increasing but you are not able to increase the price agreed in the contract? Check any supply deals that you have – ensure you have a buffer in there to cover costs over the length of the deal.
Once you have carried out this costing exercise, it is important to review quarterly to check it is all still valid. Whilst you don’t need to be as thorough every time, it is vital that all purchase invoices need to be going into your system or otherwise, the rest of your information soon becomes irrelevant.
Costings case study
Hale Portfolio recently carried out a costing exercise for one of our clients, to establish which of their products was the most profitable.
The business operates two divisions, and the purpose of the exercise was to quantify the manufacturing and overhead costs attributable to one of the divisions and establish the profit margin across that division’s product range.
The division produces a single product (alcohol) which is sold to customers in three different ways:
3. Special ‘casks’ for home consumption
All products are either sold directly to the end customer or via shops and pubs.
The main question our client had was whether the margin was noticeably higher or lower in any one of the three product categories. To answer their question, we carried out the following steps -
We first quantified direct costs to produce the product in bulk including labour, ingredients, and power.
We then considered additional costs (attributable to converting the bulk product into finished goods for sale) applicable to the 3 product categories which included packaging, marketing, sales administration time, and delivery.
After we had established a finished goods cost for each product, we were able to draw comparisons between retail prices and margins achieved across the three categories and what proportion of bulk product was sold via each category in % and £.
If you would like Hale Portfolio to help you get a true understanding of your costs and profitability, then please contact me. We love to deliver financial order, efficiency, and understanding by providing flexible, part-time finance director expertise and bookkeeping services.