As a company owner, you probably spend a lot of time managing the various risks within your company. You do it by looking at price levels, reviewing fixed costs, and understanding current market changes. But, by focusing on the methods you’ve always followed, you might not get a true picture of your current level of risk and how you need to adjust it to stay competitive.
Have you ever considered managing risk by managing your margins?
The world of manufacturing accounting is full of volatility. Margin management is one way to manage that uncertainty, by looking at costs and revenues together, instead of seeing them in independent silos. This review places more emphasis on managing a company based on the profit margins they want to achieve, instead of on a product’s individual price.
A product’s price is driven by many variables, and hence, greater risk. This includes the ever-changing costs for raw materials, overhead, and labor, as well as the ending sale price in the market.
While you still consider the individual costs of materials, overhead, and labor with margin management, you also incorporate the revenue associated with each. Margin management also requires an understanding of your entire product mix and the overall margins you are trying to obtain, not just the margins of an individual product. The variables (more on them below) should be reviewed together to see how each affects the overall profit of the company and determine what level of profit is acceptable for your company.
Of course, there will be times when the cost of your materials will be greater than anticipated, or the market might be undersaturated with your product, both of which drive up sale prices. If you are effectively managing your individual margins, you will be able to weather these fluctuations and achieve a more consistent overall margin for your company.
There are numerous benefits to maintaining consistent margins, including:
• Planning better for capital improvement projects,
• Having a more accurate cash flow projection, and
• Improved planning for material and/or labor shortages.
With less risk to focus on, you can focus more on building a better business, growing and expanding to meet the needs of your customers.
To start managing your margins
You need to first gather the data that affects the product(s) you sell. This includes more than just the current cost of the raw material and the current sales prices. You should consider some of the following (Keep in mind that this isn’t a complete list.):
• Historically, how often has the commodity price changed?
• Will I need to hire more skilled labor in the future to manufacture my product?
• What additional capital assets will I need to purchase to keep my plant in business?
• What selling price will the market accept?
• What margins do I need to stay competitive?
• What types of margins are realistic?
• What are my fixed overhead costs, and what is the likelihood they will vary from year to year?
Armed with all of this information, you can explore how each affects your margins, both separately and then as a whole. When you look at the items as a whole, you will begin to see trends and, as a result, be able to manage your margins with what you learn.
You may be able to accept a much lower profit margin for product A, once you see that products B and C are currently being underleveraged and can be altered to yield a greater margin. You could adjust B and Cs selling prices, change the goods you are purchasing to produce them, or even change the production times of one or both.
As a company executive, you are tasked daily to manage your firm’s level of risk. Managing your margins is one way to do this effectively. Managing by the margins gives you a more holistic approach to viewing your business and allows you to set prices and make decision that make the most sense for the entire company.
Managing by margins may, or may not be, an acceptable method for your company. If you would like to know more about managing by the margins and see if it is an option for your business, please contact our manufacturing accounting experts.