Change In Product Volume & How to Handle the Situation

Feb 17, 2014

decision-makingRecently I was talking to a client concerning some dramatic changes in their volume and how product costing might affect which jobs they take in the future. In this case, the client had been operating at a comfortable volume and was profitable every month with more than enough activity to keep his entire operation busy. Due to some changes with one customer, a substantial portion of his volume was lost and now he is left with activity levels well below his break-even point. His first thought was  to reduce his overhead as much as possible in order to reduce his break-even point. Of course this is always a good idea, but in his case, not nearly enough overhead could be removed to make operations profitable or even break-even at the volumes he was anticipating.

Shortly after all these changes in his volume, he received an opportunity to take on another job. This new job was the topic of our conversation. The new job was offered at a target price with the commitment that if he could meet the target price, he could have the job. The problem, however, was that the gross margin on this job would be in the neighborhood of 15%. That means that the direct cost of producing the job would leave a margin that contributed only 15 cents on each dollar of sales to overhead and profits. The question before us was, should he take the job.

I am sure most cost managers at some time in their career are faced with a similar question. Should the company accept a job with margins that are substantially below historical margins? And, what would be needed to cover general and administrative cost, as well as, profitability?

My typical answer in circumstances like this is: it depends. It depends on the overall profitability of the company, it depends on other activity related to current sales volume that’s happening in the company, it depends on the duration of the job as well as the technical complexity of the job and the likelihood that the quoted costs to get the job will really be how those costs play out in actual production.

In this case, I would recommend that the president take this job and contribute that very small amount of profit to overhead rather than continuing to struggle with no activity and no contribution to his overhead which would likely be the case without taking this job. That advice would be predicated on the fact that we have history with the customer and they have been reliable as far as paying within terms, and in overall business. I think it may be able to get him close to break-even, or at least improve cash flows.

Categories: Cost Accounting