The Following is a special guest post from Stuart Margolis CPA, MT.

The answer:  Well-managed companies can react to dips in sales appropriately and ultimately sustain profitability. Whether we have historically managed our companies well or not, all of us are looking for creative ways to stay in the black for 2011.  We watch our ratios since solutions might be found in our own strategic tactics.  Understanding the value and use of ratios enables managers to gain a better understanding of the behavior of costs.  They can be good indicators of possible manufacturing strategies that can lead to a competitive advantage and help maximize profits.

An example can be seen in the relationship between sales and profits.  Here is a scenario to demonstrate the effect of a decrease in sales, its impact on variable costs, and its impact on contributions to cover fixed overhead costs.  Let’s take a look and see why watching ratios is a common practice among well-managed companies.

A printing company’s sales went from $1,000,000 sales in year A to $800,000 in year B (a decrease of 20%).  Materials decreased proportionately so value-added decreased by the same percentage of 20% or $134,000.  The variable overhead cost also decreased by the same ratio, with fixed costs remaining the same as in the previous year.  Income decreased but did not disappear completely.

 

Year A

 

Year B

% of

Sales

Sales

$1,000,000

 

$800,000

100%

Materials

     330,000

 

  264,000

  33%

Value Added

670,000

 

536,000

67%

Less: Variable Expenses

     200,000

 

  160,000

  20%

Marginal Contribution

470,000

 

376,000

  47%

Less: Fixed Expenses

     370,000

 

  370,000

FIXED

Income Before Taxes

$   100,000

 

$    6,000

 

 

 

 

 

 

 

Here’s the danger.  Had the printer taken his eye off the ratios, results could have been  disastrous. 

If the decrease in cost of materials and other variable expenses were not proportionate to the decrease in sales (only decreasing 15% instead of 20%), income before taxes could have resulted in a loss of $20,500.  The mere 5% difference could have pushed the company into the red.

Fortunately, there’s nothing mysterious about watching ratios.  Tracking variable costs as a percentage of sales has helped some of the most successful printing companies extract more and more profits from their sales.  By keeping an eye on ratios, we can make sure variable costs are reacting appropriately.  We can then look at fixed overhead costs and either: 1. Reduce fixed costs to a lower level or 2. Get creative and find ways to convert fixed cost into a variable cost (even if only temporarily).

Want to see what ratios and margins other printers are achieving? Look no further than the Annual Printing Industries of America Ratios. The deadline to participate is quickly approaching, May 31, 2011.   Printers can download the form, fill it out, and get a copy of a resulting report for free.  Go to www.printing.org/ratios. If you’ve never filled it out before, do it this year.  During times of drastic economic swings and fluctuations, it is critical to understand your industry and your competitors.  Actually, make it a priority to fill the survey out and get a free copy of the results for the next five years.  Knowledge is power.  Keep the edge.