I just helped a transportation company with this problem. They increased sales by $1,000,000 in 2018, a 20% increase over 2017, but ended the year with the same net income as the prior year. This meant they worked harder and took more capital risk but didn’t get a return on their sweat or capital.
I analyzed their income statement and found that their gross margin percentage (gross profit / sales) had decreased from the prior year. This meant that their costs of providing services (Cost of Sales) had risen without corresponding increases in sales prices.
To get under the hood (shameless pun) and fix the problem, I asked for a P&L by line of business (LOB). They had their revenues by LOB but not their costs. Without their costs by LOB, I could not determine their gross margin by LOB and without gross margin by LOB, I could not zero in on which lines of business were responsible for bringing down their overall gross margin.
I asked how they determined their sales prices since they didn’t know their costs of sales by LOB and like many companies, they lacked a good pricing template. Such template would have computed sales prices by length of trip and vehicle type, factoring into such model their costs of each passenger trip, including labor, gas, insurance and vehicle depreciation.
Lacking such template, they were somewhat guessing with their pricing and the attainment of their desired gross margin was anything but assured.
Key Takeaways
Here are my key takeaways for you.
A. Capture Costs Correctly
Capture costs in the same manner as you capture revenues. In other words, if your books group revenues into product or service types or lines of business, then capture your costs into the same groupings as your revenues so you have a 1:1 relationship of sales and cost of sales.
If you’re a service company and your billable staff are devoted to individual clients, then capture your billable labor costs by client so you can measure gross margins by client. you may be losing money on some clients.
1. Product Businesses
Capture costs of goods sold including purchase price, purchase discounts, freight in, and freight out by sku (product) so you can see which products are not exceeding your desired gross margin.
2. Service Businesses
For billable staff, capture labor costs including wages, payroll taxes, workers compensation and health insurance by customer or line of business or both. You’ll then be able to adjust pricing for those customers or lines of business that aren’t eclipsing your desired gross margin.
B. Use an Accurate Pricing Template
Base your sales prices on accurate costs per sku, client, or line of business (or on whatever basis you price your goods or services) so that gross margins by such sku, client or LOB can
be computed.
I recommend you have a CFO structure your books to capture costs accurately and develop a reliable pricing template. If you need help, reach out to me at (305) 467-5909 and I’ll help you implement them.
More Knowledge
For income statement terminology you must know, check out my article, "What’s In Your Margin – Part 1?"
To master how to maintain your gross margin and price your goods or services properly, see my article, "What's In Your Margin - Part II?"
To analyze your income statement like a pro, see my article, "What's In Your Margin - Part III?"