Quotations and cost analysis

Knowing your costs (well) to sell better

Many business owners don’t earn enough, or can’t work out their selling prices. Almost always the problem lies upstream: they don’t know how to assign costs to the product.

The problem

Prices by gut feeling, hypothetical margins

Calculating industrial costs is a job in its own right: you have to go into production, follow the processing, measure times and consumption. It is not the task of financial accounting, nor of the external accountant, whose job is a different one: accounting records how much the company has spent in total (raw materials, wages, energy and so on) and does not say how much of that spending ends up in each single product. Price lists need to be built on objective data.

So all too often prices are set by gut feeling, with rough estimates and hypothetical margins. The result is products sold below cost, eroded earnings and decisions taken in the dark.

The wrong quotation is invisible when it is signed. It shows at the end of the year.

The limit of SMEs

Without cost accounting, there is an alternative

Most SMEs have no cost accounting system to provide reliable information on production costs and on contribution margins by job or product line.

There is, however, a simple and sustainable alternative even for small and medium-sized companies: the industrial analysis of the profit and loss account, combined with a map of the organisational and production structure. Direct costs are separated from indirect ones and the hourly rates and specific costs to be applied to the bills of materials, the “recipes” of each product, are calculated. Only then do selling prices become consistent with real costs and margin targets.

The method

Direct Costing

The most effective method for determining industrial costs is Direct Costing. It assigns to the product its direct variable costs, that is raw materials and direct labour, and also the specific production costs that are fixed or nearly so: depreciation of machinery, calculated on replacement value because sooner or later it will have to be replaced, electricity, indirect labour, consumables, maintenance and technical services.

The result is a realistic quotation model, which takes every variable into account and allows you to sell at the right price, protecting margin and competitiveness.

The step up

The MES

For those who want to go further there is the MES (Manufacturing Execution System): software that, together with production scheduling and the warehouse, records actual quantities and times and constantly compares them with the theoretical data in the bills of materials. You can see where income is generated, where it is lost and how to recover it.

For SMEs that do not want to bear the cost of a full MES there are simpler interfaces that collect times and quantities directly from the machines.

An example

Profitability by processing stage

A company working stainless steel to order wants to know the profitability of its products to set more precise prices. There are two routes: analysing revenue and costs job by job, or analysing them by processing stage.

With many jobs the second is more efficient: the analysis is set up by cost centre and processing stage, avoiding the complexity of job costing. With average hourly production costs and actual machine data (from the MES or an interface), actual times are compared with theoretical ones.

This gives the industrial cost per unit of measurement (€/m², €/kg and so on), to be compared with the sales price lists to check the profitability of each process.

From data to margin

Each process is linked to the customer it was done for, so profitability can be read by machine, by stage and by customer. It is the typical approach of companies that produce to order (Make to Order).

You know how much it costs to produce each item and how much each process really yields, and decisions are taken quickly, on the figures. Industrial controlling, after all, does not wait for the books to close: it is built day by day on actual production data, while there is still time to correct course.

Real cases

Three quotation models we have built

Three different sectors, the same principle: the price is built on the variables that really determine it.

Moulding to order

Technical plastic items

There are many variables and they are linked. On one side the raw material: type, colourant, end use, minimum batches, inserts and waste. On the other the processing: mould cleaning, set-up, type of press, automatic or manual production, rejects, oven cycles, packing and packaging.

With the option of amortising the mould directly on the product, you get a solid basis for setting the selling price correctly.

It is the model built for the company in our fractional management case.

Flour milling

Flour to order or for stock

Different types of wheat become flours for food use, each with its own “recipes” and the supplements added during processing. By-products such as bran and middlings also come out of it, used as animal feed.

Recipes, packing and transport of the finished product all go into the model: the selling price and the profitability of each line are calculated on every variable.

Trading

Petroleum products

Without a transformation process the business looks simple: buy and resell. Behind it lies complex logistics, made of loads, distances and delivery conditions, and that is exactly where an operation makes or loses money.

The model calculates these variables one by one: a precise estimate of logistics costs and therefore of the real profitability of each operation.

Mistake no. 6

The quotation based on average cost

In plastic moulding a company has automatic presses, costing €16 an hour, and manual presses, costing €24: the average is €20. Anyone who prepares quotations on €20 an hour sets prices that are too low for the manual-press parts and out of the market for the automatic ones.

The result is the worst possible: the profitable jobs go to competitors, and what stays in-house are the ones that tie up the slowest, hardest-to-manage presses.

How much does what the company sells really cost?

If the answer is “more or less”, the margin gets lost in the “more or less”. Let’s build the quotation model together.

Let’s talk