Calculating Your Real Costs
Western Pallet Association Annual Meeting
Rancho Las Palmas Resort & Spa
January 16, 2012
Why is this Topic Important?
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Measurement and management of your day-to-day business
Measuring expected costs to actual costs, understanding the reasons for any
variation
Understanding what drives costs and managing these factors down
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Product line profitability
How do my costs vary with pallet size, type, etc.
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Customer profitability
What is the cost of that demanding customer?
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Input into pricing model
How much should I bid?
Am I competitive?
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Accuracy of accounting data
Particularly regarding inventory valuation
What you measure is what you get…
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Concepts for Discussion

An overview on costing methodology that is typically used in the
pallet business
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Complexity – how far should you take your costing model?
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Allocating overhead
Products
Customers
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Activity based costing
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CEO/CFO versus CPA
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Terminology
Costs that vary directly with the number of units produced
Variable Costs
Semi-Variable Costs
(e.g. nails, direct labor, repair boards)
Costs that vary indirectly, or in steps, with the number of
units produced (e.g. forklift capacity, truck fleet, number of
maintenance or accounting personnel, utilities)
Fixed Costs
Costs that typically do not vary with the number of units
produced. Rent, leases, leadership team (e.g., President)
Direct Costs
Costs that can be directly attributed to a product (e.g.
wood, nails, assembly labor)
Indirect Costs
Costs that are incurred in the production process but are
not directly attributable to the product (e.g. materials
handling, saw and cut-up)
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Standard Cost Accounting
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While almost all differ, most pallet companies use some variation of
the Standard Cost Accounting methodology to measure and
manage their businesses
Simple Example – Company produces new pallets
To make each pallet, the company needed to purchase $2 of pre-cut
wood, $0.30 in nails and pay two workers $0.35 each to assemble the
pallets. Total variable direct cost for each pallet is $3
The fixed indirect costs are $30,000 per month for an office manager,
accountant, a forklift driver, a truck driver, insurance, utilities, fuel,
maintenance, leased equipment and rent
Any price above $3 is a contribution to cover these fixed costs. If the
market price for these pallets is $6, then each pallet sold contributes $3
to cover fixed costs. Contribution margin is 50%.
At $6, the company would need to sell 10,000 pallets per month to
breakeven and start making a profit
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Standard Cost Accounting

Simple Example (Continued)
If the company was producing and sold 30,000 pallets/month and the
fixed costs were still $30,000/month, then each pallet could be said to
incur overhead of $1 ($30,000/30,000 units)
Adding overhead to the variable costs of $3 per pallet produced a full
cost of $4 per pallet
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Beware – As volume grows, your fixed costs need to be reallocated. For example:
If the company ramped up volume to 60,000 pallets in one month, then
the overhead per pallet would decrease to $0.50 ($30,000/60,000 units)
Adding this to the variable costs of $3 per pallet produces a full cost of
$3.50 per pallet
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Economies of scale
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Standard Cost Works in the Pallet Business
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Advantages
We still pay a large percentage of our workers on a piece rate so labor is
easily calculated
Higher variable and semi variable costs as compared to overhead
Low tech equipment doesn’t call for increased sophistication
Relatively few product lines or defined production areas
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Areas to watch
Changes in the level of “full cost” of inventory can create swings in
profitability that are sometimes difficult to explain or understand
An increase in inventory can "absorb" costs of production and increase
profits, while a decrease in inventory level will decrease profits
Given the seasonality of our business, we see variation in profitability
and cash flow throughout the year
Cost models need to evolve as your business becomes more complex
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In Reality,
Your Costing Model Can Be Much More Complex

Potential cost components of a final assembled pallet to be put in
inventory
Purchased Raw Materials
• Wood (whether new or recycled)
• Plates
• Nails
Inbound Transportation (Your Fleet or 3P)
Materials Handling (Sort and Movement)
Materials Development (Saw and Dismantling Operations)
• Labor
• Saw blades and other materials
Assembly Labor
Maintenance
Plant Materials and Services (e.g., utilities, safety equipment, etc.)
Sales and office personnel?
Outbound transportation?
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Wood Costs
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Example – How much does a repair board for a GMA cost?
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Simple Method
Average price of a teardown/machine/odd size pallet is $0.50
Yield is 7 usable deck boards and 2 usable stringers per teardown pallet
Pay $0.22 in labor for tear down
Therefore my cost per board is ~$0.08 per board

More complex method
Build in a portion of inbound transportation
Build in a portion of forklift time for unloading and handling teardown
pallets
Build in a portion of maintenance time and materials for the tear down
machines
ETC.
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Allocating Overhead to Product Lines
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Allocating overhead across one product line is relatively
straightforward
The reality is that many pallet companies have several product lines
(e.g. new, remanufactured, recycled, and services) and often many
SKUs within that product line, particularly in custom or
remanufactured
Estimates need to be made to properly allocate your costs and build
them into your cost model
Maintenance – What processes/product lines consume time?
Materials handling – Where is forklift time being consumed?
Rent – How much floor space is devoted to each product line?
Utilities – Which processes and products are energy intensive?
Management time – What processes/product lines consume time?
Others…
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Activity Based Costing
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A common methodology for allocating indirect costs or overhead to
product lines is called Activity Based Costing - assigning costs to
products based on the activities they require
Activities are regular actions performed inside a company. Example
– “Maintenance Personnel repairing pallet dismantler"
100% of each employee's time can be assigned to the different
activities performed inside a company
Activity Based Analysis (ABA) - Using surveys and time logs to track
how employees spend their time
Time should be tracked according to product line and by customer
so that a percentage of the salaries and associated resources can
be assigned to each product or customer
Your company can use the resulting activity cost data to determine
where to focus their operational improvement efforts or improve their
pricing for particular customers or product lines
Do all your product lines make money?
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Allocating Overhead to Customers
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It is a simple assumption to allocate overhead to customers based
on the products and volumes which they purchase
In being responsive to customer needs, we often take extra steps
with certain customers to ensure their satisfaction
Key question – are you earning a service premium to cover the
additional steps?
Customer related cost variation
Transportation Costs
Investment/Trailer Depreciation
Management intensity
We should know the profitability of at least the top 20% of our customers
20% of our customers often give us 80% of our revenues/profits
Once you have a methodology – getting to 100% is easy
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Consider the Following Example
 Buys 5 loads of B grade pallets per week, one load a day,
M-F, in the morning same dock time
 $4.15 per pallet
CUSTOMER A
 5 miles from your plant, in a van drop and hook 1 drop
trailer
 Issues a blanket PO at the beginning of the year
 Never calls unless you miss a shipment
 You can set your watch to their payment reliability
 Buys 5 loads of B grade pallets per week, orders are
inconsistent and often last minute (2 on M, 1 Emergency
on Wed evening, 2 Friday – next week looks different)
 $4.25 per pallet
CUSTOMER B
 40 miles from your plant, flatbed, live unload with sporadic
wait times
 Issues separate POs for each load
 Pay late, constant re-faxing of invoices
Which Customer is More Profitable?
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Takeaways

One Size Does Not Fit All
The right method is one that allows you to understand your costs and
make intelligent business decisions
Cost accounting can be as simple or complex depending on your needs
and the scope of your operations
Consistency
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Always challenge your typical assumptions as your business
changes
Work with a CPA to determine compliance with GAAP
Know where you make your money Do you know?
Use data do guide decisions and improve your return on investment
What you measure is what you get
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Questions???
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