{"id":1554,"date":"2021-09-04T05:58:54","date_gmt":"2021-09-04T09:58:54","guid":{"rendered":"https:\/\/www.saudercpa.com\/blog\/?p=1554"},"modified":"2021-09-03T09:00:44","modified_gmt":"2021-09-03T13:00:44","slug":"catapulting-costs","status":"publish","type":"post","link":"https:\/\/www.saudercpa.com\/blog\/2021\/09\/04\/catapulting-costs\/","title":{"rendered":"Catapulting Costs"},"content":{"rendered":"

Preface: When inventory costs catapult, a business owner may find himself in the strange position of making higher profits but having less cash.<\/em><\/p>\n

Catapulting Costs<\/strong><\/p>\n

Credit: Jacob M. Dietz, CPA<\/p>\n

Catapult on the Job Site<\/strong><\/p>\n

Imagine Abner\u2019s hammer crash into another nail as he fastens another 2X4 to connect another truss on another building.\u00a0 Abner is simply doing his honest work. He has done this for years.\u00a0 His father started the business, and he has been building even longer than Abner.\u00a0 The gentle breeze blows across his sweated face and tugs at his hat.<\/p>\n

Now, imagine someone installing a small catapult in the middle of the building that is being constructed.\u00a0 \u00a0Abner and his dad stare in disbelief at the catapult.\u00a0 Neither of them has ever seen a catapult come to a job site before.\u00a0 The catapult flings a stone up through the trusses.\u00a0 The stone sails mere inches away from Abner\u2019s hat on the way up, and it almost hits Abner\u2019s dad as it descends. The stone could hurt Abner on the way up as the catapult propels it away from the earth, and it could hurt Abner or his dad on the way down as gravity hurls it towards the ground.<\/p>\n

Business owners might stress if catapults started flinging stones at their builders, but fortunately I have not heard of any construction companies coming under catapult attack.\u00a0 Some companies, however, have been threatened by catapulting costs.\u00a0 Some fluctuations in costs may be a normal part of business, but unfortunately some costs have fluctuated in recent times in ways that current business owners, and perhaps their fathers too, have never experienced.\u00a0 Although the business owners might desire to be able to simply work a normal day without catapulting costs, unfortunately the catapult has come to the industry.\u00a0 How do catapulting costs threaten businesses?<\/p>\n

Increasing Costs<\/strong><\/p>\n

First, catapulting costs could hammer a company\u2019s bottom line if the company cannot raise prices enough to compensate for their increased costs.\u00a0 Imagine Abner\u2019s building company normally pays $35 in lumber for every $100 of sales.\u00a0 That left them with $65 for every $100 in sales to pay labor, subcontractors, and other expenditures and still have some left over for a profit.\u00a0 Net profits vary from business to business and industry to industry, although for this example we will assume that the company normally kept $15 of profit for every $100 of sales.\u00a0 If the cost of lumber suddenly doubles on the company, and they failed to raise their prices or make any other adjustments, then lumber would cost them $70 for every $100 in sales.\u00a0 Instead of making $15 on every $100 of sales, they would lose $20 on every $100 of sales.\u00a0 The catapulting prices hit this hypothetical company on the way up.<\/p>\n

Now suppose the company realized that lumber was shooting up, and they adjusted their prices to make the same profit.\u00a0 Now they should not lose money for each $100 of sales.\u00a0 There could still be other challenges, however.<\/p>\n

Increasing Prices<\/strong><\/p>\n

One challenge is figuring out how much to raise prices.\u00a0 First, let\u2019s assume that lumber doubled, so Abner reacted by doubling his prices.\u00a0 If Abner still sold the same number of jobs, his profits likely will more than double, since his sales price doubled, and his lumber doubled, but his other costs did not double.\u00a0 Depending on the market, doubling prices when one cost doubles might price yourself out of the market.<\/p>\n

Imagine Abner realized that his market would not allow him to double his prices, so he only increased his sales price by the same amount that this lumber increased.\u00a0 Abner might find that he is less profitable.\u00a0 One reason is if Abner gives discounts off the total sales price to some customers.\u00a0 For example, if Abner gives a 2% discount for timely payment, and if he increases his sales price, then 2% of the new sales price is more dollars and cents than 2% of the old sales price.\u00a0 What if Abner gives discounts to certain other businesses that are even more than 2%? \u00a0Those discounts could be even more dollars and cents after Abner increased his prices.\u00a0 Also, even if Abner were able to maintain the same profit in dollars after increasing prices only enough to offset the increase in lumber, his net profit percentage would decrease, because as a percentage his profits would be lower. \u00a0It would be the same profits (numerator), but a higher sales number (denominator).<\/p>\n

Increasing Inventory<\/strong><\/p>\n

Another way the cost catapult could hurt Abner\u2019s business is by increasing inventory costs.\u00a0 Assume that Abner has X quantity of inventory in stock.\u00a0 Now, assume that the cost of that inventory doubles.\u00a0 If Abner counts the quantity of inventory, it is the same as it always was.\u00a0 The money that Abner has tied up in inventory, however, may have doubled along with the cost.\u00a0 Abner therefore needs more capital to simply sustain his normal inventory.<\/p>\n

When inventory costs catapult, a business owner may find himself in the strange position of making higher profits but having less cash.\u00a0 How is this possible?\u00a0 If the business owner increases prices enough, there might be more profits.\u00a0 The profits might need to go to fund the higher cost of inventory.<\/p>\n

Increasing Lead Times<\/strong><\/p>\n

Abner may need more capital to sustain his inventory with normal lead times if costs rise. It is even possible that Abner might increase his inventory quantity if he is having trouble getting product in time.\u00a0 Increasing the quantity of inventory that has already increased in price can be quite capital intensive.\u00a0 Abner may want to consider these capital needs when he considers how much to charge his customers.\u00a0 He might also want to consider negotiating with vendors for payment terms, and he might consider talking with his banker.<\/p>\n

Gravity<\/strong><\/p>\n

Catapulting a stone causes danger on the way up.\u00a0 Gravity also poses a risk as the stone hurls earthwards.\u00a0 What would happen to Abner\u2019s company if suddenly the cost of his inventory fell drastically, after he stocked up on inventory at a high price?\u00a0 Would the market force him to sell some of the inventory at a loss?\u00a0 Abner may want to ask himself if he has enough financial margin to sustain the business if his costs of materials drop significantly, potentially forcing him to cut his prices.<\/p>\n

Pay Attention<\/strong><\/p>\n

If a real catapult suddenly showed up at work and started flinging stones, it would get the attention of the business.\u00a0 Action might be taken to mitigate the risk.<\/p>\n

Fortunately, real catapults don\u2019t normally show up at jobsites.\u00a0 However, catapulting prices have affected the economic landscape recently.\u00a0 Are you paying attention to your costs and your prices?\u00a0 Are they healthy?<\/p>\n

Proverbs 27:23 Be thou diligent to know the state of thy flocks,\u00a0and\u00a0look well to thy herds.<\/p>\n

This article is general in nature, and it does not contain legal advice. \u00a0Contact your advisors to discuss your specific situation.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

Preface: When inventory costs catapult, a business owner may find himself in the strange position of making higher profits but having less cash. Catapulting Costs Credit: Jacob M. Dietz, CPA Catapult on the Job Site Imagine Abner\u2019s hammer crash into another nail as he fastens another 2X4 to connect another truss on another building.\u00a0 Abner … Continue reading “Catapulting Costs”<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/posts\/1554"}],"collection":[{"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/comments?post=1554"}],"version-history":[{"count":1,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/posts\/1554\/revisions"}],"predecessor-version":[{"id":1555,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/posts\/1554\/revisions\/1555"}],"wp:attachment":[{"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/media?parent=1554"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/categories?post=1554"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.saudercpa.com\/blog\/wp-json\/wp\/v2\/tags?post=1554"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}