Don't get caught off guard by unexpected cost hikes. Learn how to carefully track your direct and indirect costs and then adjust your pricing so that your business remains profitable and healthy.
By Mike Ukena
A customer who will not accept reality by allowing you to make enough money to keep doing his orders is not a customer at all, he is a leech. That customer is only sucking the life out of your business to the benefit of his business.
Some accounting terminology
First, let’s define a couple of things. In this discussion, direct costs are those that contribute to the direct production of the product and therefore directly impact the gross margin. For a garment printer these items would be the ink, labor, shirt (if included), and the coating, exposure, and setup of the screens. If those items work out to 60% of what you can charge for a product, then the gross margin would be 40%.
Indirect costs are also known as overhead. These costs include rent, clerical and management salaries, utilities, and those supplies that do not directly help produce a product. These products might include cleaning solvents, reclaim labor and materials, mesh, frames, maintenance, and insurance.
Now let’s look at an example of that upside down situation I mentioned earlier. You’ll see why it is better to live without the type of customer who wants to be the only winner.
Imagine you have an agreed-to price with a major customer for $0.80/print for prints on their garments. This is a situation in the industry often referred to as contract printing (whether or not a contract actually exists). Six months ago, your gross margin on this work was a satisfactory 40%. Since then, your ink has gone up 12% and your emulsion has risen 10%. On the surface, this may be cutting your margin a few points. Unfortunately, there are other factors that are very much in play in the current economy. The rapid rise in the cost of fuel, solvents, power, and many other intangibles is hitting the indirect side of the profit equation.
Last year, a 40% gross margin may have carried forward to a 10% gross profit. But now, it may actually be a lot less than that. It is easy to see the way to proper pricing when just the direct factors are changing. It is much more difficult when the indirect factors are changing rapidly too.
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