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A “Growing” Problem

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Growth Can Have Ups And Downs

Growth Can Have Ups And Downs

The second blog I ever wrote which was posted on September 15, 2009 was about the concept of operating leverage.  Today, I am going to talk about another concept that might make your eyes glaze over from boredom. The concept is taking advantage of variable costs that are fixed within a specific range of sales or production.  Some may call these costs step-fixed.  Before you reach for the aspirin bottle or click to your Facebook account, I promise I will try to keep this simple and won’t have any difficult mathematics, charts or formulas and there will not be a test either!

What am I talking about? Okay, let’s start with some basic definitions.  A fixed cost stays the same regardless of the amount of activity a business has.  Rent for example will stay the same whether you have sales of a million widgets or three million widgets.  This assumes you don’t change your agreement with your landlord and get more space.  Variable costs change or vary with the number of units sold or produced.  Raw material costs for example are a direct variable cost.  Indirect variable costs are things (or activities) like a fork lift operator, shipping or receiving person, maintenance staff, an office receptionist or even, dare i say, an accountant.

Sometimes people use a dirty word to describe these type of activities. They call activities which are not related to the revenue generating or production process “overhead”.  Most of my career I was “overhead”.  I didn’t like being called that because accountants and those who support the revenue generating/production process are people too!  Even IF we use words like widgets.

Now that we have the concept of variable, fixed, direct and indirect costs out-of-the-way let’s delve into today’s topic. This is relevant to the small business owner in many different lines of business. The idea I want to explore is getting to the edge of needing to add that incremental variable input cost.  I hope the term “incremental variable input cost” doesn’t make your head spin.  It shouldn’t once I explain what I mean.

Adding another maintenance employee to keep machinery and equipment in good working order is an example.    The decision to add is difficult since the cost of the new employee will be about the same as the first one but spread over a smaller amount of sales and profit to absorb that cost. For example, if your sales increase to the point that you need 1.28 maintenance men to keep up with maintenance, you have a problem since maintenance employees only come in increments of one.  One way to avoid the need to hire is to increase his productivity by adding to his skills through training or by providing him with better tools.   If that is not an option you can outsource, utilize a part-time employee or have the existing employee work overtime.  This can be fine as long the “limbo” period doesn’t last too long and you either increase sales to support a second full-time maintenance employee or sales or production levels go back so that one employee is adequate.

Many companies have a very hard time growing because of this.  To add to the complexity; you might have to add another person in addition to the maintenance employee at the new sales level.  The first thing I would advise is to increase sales to get to the edge of needing to add staff as fast as you can.  The reason being; until then your operations are not at its best productivity.   To put it another way you might only need .81 maintenance employees at your current sales level and the cost of one full-time employee is an unproductive use of a full-time resource.  Some may say it is a waste as harsh as that sounds.  Once at the “edge”, the safe way is to take baby steps, as stated above, by investing in training or tools for productivity gains or use part-time, overtime or outsource until you feel confident you can push through to the next level without taking a hit to the bottom line.

I hope this helps if you are nearing the next step. Have a great week.

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Written by pacelinebiz

November 2, 2015 at 8:01 am

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