Understanding your costs is complex but important. If you don’t understand your costs it is difficult or impossible to consistently make a profit. You could price your product high to insure a profit, but you will certainly miss out on sales. If you are aggressive in pricing and you don’t truly know your costs, you will certainly accept business at a loss sometimes.
It is in this environment that we created the Dynamic Cost/Price System found in eCabinet Systems. Let us start with some definitions.
Throughout the program, Cost is how much you pay for something and Price is how much you sell something for.
The most basic item is Material Cost. This is how much you pay for something. Although this seems simple enough, this, along with the rest of the financial area, is not all that straightforward. If a cabinet pull costs you five dollars the cost is five dollars, right?
Not really. The pull actually cost you more than five dollars. Five dollars is how much you paid someone for the pull. It is also likely that you paid to have the pull, along with other items, shipped to your shop. A portion of that shipping cost represents cost for the pull. The pull, then, costs somewhat over five dollars.
This is still not the cost of the pull mounted on your finished product. After you received the pull, someone had to locate it, unwrap it, figure out where it is to be used and then mount the pull on the product. All of these actions require labor, and labor is something you have to pay for. The cost of doing these tasks also needs to be added to the cost of the pull. After all, if there were no pull on the door, none of these costs would occur so it is just right that they be considered part of the cost of the pull.
Are we finally done? It depends on how accurately you want to track your costs. There are other components to cost. Each year you might lose, damage or scrap some pulls. The cost of these items must be spread over the items you actually used to get a true cost. Then, the amount of time you keep the pull on the shelf affects its cost.
If you purchased the pull a year before you used it, you tied up five dollars in inventory for a year. If you are paying 9% to borrow money, the cost of the pulls actually increased by 9% or $.45 during that year. Even if you don’t borrow money, the five dollars could be put in an interest bearing account and you could have made some interest on it for the year. Therefore, the lost interest should be added to the cost of the pull.
Although these sound like pretty small numbers on a five-dollar purchase, if you apply them to everything you buy, the number becomes significant. The cost of the five-dollar pull alone could have easily increased a dollar to a dollar and a half. This is twenty to thirty-three percent. Even for small shops, undervaluing material cost by twenty to thirty-three percent is a serious problem.
When you try to determine the cost for material such as sheet stock or wood, the problem becomes even more involved. For items such as pulls, if you need one pull, you buy one pull and use everything you bought. With wood, however, you never quite use it all. There is always cut-offs and scrap material from any process. This is the material that you discard.
When you try to determine the cost for items made from these materials, you know the amount of material in the final product. You do not necessarily know how much wood it required to make those pieces. To help properly cost these items, the accountants have come up with a term called yield. Yield is the percentage of the material that turns into the finished product. If three-fourths of a sheet of material is used in the final product and the other quarter is scrapped, the yield is 75%.
Yield is used as a kind of a backdoor way to determine the cost of the final product. For our example we will use some easy numbers. Assume a 4’ by 8’ sheet costs $32. The sheet contains 32 square feet (4 X 8). Material costs $1 per square foot ($32 divided by 32 Sq Ft).
Let’s use a 50% yield number. Half the 32 Square foot sheet or 16 square feet is used for the product and 16 square feet is scrap. The final product has 16 square ft of material in it.
If we take the final product and try to calculate cost, you would take 16 square feet times $1 per square foot for a material cost of $16. This, of course, is wrong.
It required a full sheet, which cost you $32, to make the product, but we calculated a $16 cost. To get an accurate cost we must not only calculate the cost of the material that ended up in the product but we must also add the cost of the material scrapped in making the product.
You could try to track your cost by counting the total sheets of material used for a job times the cost per sheet. We actually do just that when we calculate the cost of an entire job, however, it would be difficult to determine the cost of any particular item in the job using this method. Instead, when we deal with a single cabinet we will use the number of square feet in a finished product and then divide that by the yield, to determine the amount of material required to end up with the finished product.
Let’s look at our example. If we take the calculated cost of $16 and divide it by the yield (50% or .50) we end up with $32 which is the actual cost of the material used in the product plus the material scrapped in making the product.
Although in our simple example it is easy to calculate the cost using the starting raw material, in real life, the calculations are much more complex and using the yield figure simplifies costing.
Most of you already know this, but it is important to understand all the underlying facts so that there is no confusion as to how we present our costing numbers. We will try to explain exactly how we handle these costs so that there is no confusion that might cost you money.
So far, we have only covered Material Cost. Luckily, this is the most complex of the terms we will deal with. Selling Price is how much you change for the product you sell.
The next area is Labor Cost. As you might expect, this is the cost of labor needed to manufacture a product.
Next comes Overhead. This is all your expenses not directly tied to producing a product. It includes management salaries, travel, phone, advertising, insurance, rent, copy costs and a host of like items.
If you add the Profit you want on this job to the Material, Labor and Overhead, you get the Selling Price. This Profit number is actually more accurately, pre-tax profit. To get to the real bottom line we still have to subtract taxes.
This provides a very quick overview and some background to help determine the approach we want to use and how to determine the cost parameters we will need.
We will now go back and revisit the material area, focusing on the cost. Select the Settings/Preferences icon from the toolbar and then select Define Stock Material. This will bring up the material input sheet.
To obtain accurate cost estimates we must carefully specify the costs for various materials. It is these costs that form the basis of our cost estimates and therefore, it is quite important that they be correct when first entered and that they be adjusted whenever we learn of a change in material cost from our suppliers.
We have covered the basic input of material cost in the material area so now we will switch to the Dynamic Markup dialog where the core information is added.
From Settings/Preferences select Define Costs.
This dialog is used to specify basic information and choose the costing method you wish to use for cost estimate calculations. Once the information is entered in this area, the system automatically keeps track of Material Cost and calculates an estimate for Labor and Overhead costs for each Job. You can also determine the estimated cost of a cabinet or assembly in the Cabinet/Assembly Editor.
Cost estimate information is available from two sources, a Dynamic Cost Display along the bottom of the screen or a Cost Sheet report that can be generated from the Cabinet/Assembly Editor or from Custom Layout or Batch Cabinets. Note that a Cost Sheet for a Job includes costs for items added in both Custom Layout and Batch Cabinets.