With inflation increasing at 40-year record highs, nearly every business is impacted with higher input costs.
Along with supply chain challenges and increased labor wages due to labor shortages, a company’s profitability is at risk if the impacts of these challenges are not measured and strategic actions to offset the impacts are not executed.
One of our clients was looking to purchase a company that had been significantly impacted by inflation, with its gross margin rate declining steadily since the start of the covid-19 pandemic. Schneider Downs was asked to do a profitability study on the targeted company to determine root cause(s) of the declining margin and the potential future risk to profit based on backlog orders.
The profitability study analyzed sales and margin data for all customer transactions over the previous 24-month period. Key findings include:
Each business unit within the company showed declining margin rate
Evaluating customer transactions show that items purchased this year and not last year had a lower gross margin rate (-1.1%) while sales growth of +33%
Customer products purchased in each of the last two years, which represents 80% of total sales, showed the gross margin rate declining (-3.1%) with gross profit dollars declining slightly
Further evaluation of customer products purchased in each of the last two years showed:
Cost increases of $2 million was only partially offset by price increases of $1.6 million
Year-over-year price increase of 3.7% and cost increase of 8.2%
The amount of cost increases passed through to the customer as in increase in price was only 78% for the company and only 70% for the company’s largest business unit
Backlog profitability showed an even further margin rate risk, with the average gross margin rate of 36.2%, or an additional (-2.3%) margin rate decline from the previous 12 months
After performing the profitability study, Schneider Downs recommended that after the acquisition was completed that a Strategic Profitability Plan be developed and executed quickly to target specific actions to offset the unfavorable trending from the last two year period.
Over the long run, if cost increases outpace price increases, a company will eventually go out of business. Conducting a profitability study and proactively analyzing impacts of cost, price and mix at a transaction level provides visibility of a company’s performance and assists decision-makers in addressing areas of concern to better manage profitability.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.