Meridian’s long-time readers already realize the value of analyzing sales, cost of goods sold and expenses on a cents-per-gallon basis in both wholesale and retail operations from prior MFA articles or Meridian seminars. With enormous fluctuations in fuel prices lately, cents-per-gallon data is critical management information. (New readers — cents-per-gallon data is one of the most valuable management tools you can utilize. Percent of sales data can’t work when fuel prices fluctuate.)
While we’ve noticed many long-time readers getting adept at identifying and correcting escalating operational and overhead costs, very few have taken the next critical step — segregating fixed and variable costs on their financial statements. Without this segregation, it’s likely you will fool yourself when it comes to analyzing trends in profitability. Here’s why.
Let’s say, for instance, that you’ve successfully grown your business by 50% from just 34 million gallons last year to 50 million gallons this year. You’ve managed to contain costs and maintain an admirable 4.75- cent bottom line before depreciation and officer’s compensation. You should be pleased with yourself, right? Wrong!
If your bottom-line cents-per-gallon profit did not increase with growth, it means expenses have escalated! Why? Because you have certain costs that no matter what your volume, stay the same from month to month and year to year. These are called fixed expenses and they should be segregated on your P&L if you really want to keep tight tabs on your business.
For those non-accountant types who may be unfamiliar with the term, fixed costs is used to describe costs like home office rent, property taxes, headquarters utilities, etc. where no matter what a company’s volume, the dollar amount of those expenses is constant. A company can double or triple their annual gallons and the dollar amount of the fixed costs would still be exactly the same.
Variable costs, on the other hand, vary directly with volume. When volume goes up, these costs go up. A clear example of a variable cost is sales commissions.
So why is it important to segregate fixed and variable costs? Because when volume increases, fixed expenses should decrease on a cents-per-gallon basis. For instance, let’s say you pay $9,000 per month or $108,000 annually in home office lease expense. Last year, when you were doing 34 million gallons, the cost of your lease ($108,000) when divided by your 34 million gallons was 0.32 cents per gallon. That same lease this year, with your 50 million gallon volume, is only 0.22 cents per gallon. What this means is that your bottom line profit should have increased by the difference (0.10 cents) to 4.85 cents per gallon. That’s why you shouldn’t be so pleased to maintain your 4.75 cent profit.
Further, using this example, by you knowing the 0.10 cents cost savings your company should have captured, and knowing you sold 50 million gallons, simple multiplication lets you discover you squandered away $50,000.
This $50,000 lost is just from the analysis of one expense item! When this marketer separates fixed costs on his profit statement, he will likely have numerous fixed expenses, and find that his growth in gallons should have produced much more than 0.10 cents in increased profits!
Segregating fixed and variable costs on your monthly profit and loss statements allows you to immediately pinpoint cost escalations, and know the cost savings you should be achieving from growth. Ideally, having subtotals for each category of cost will give you that “at-a-glance,” “easy-to-tell-how-we-are-doing-on-cost-control” look at your business.
There is another big side benefit to segregating fixed and variable costs. That segregation is a valuable first step towards benchmarking controllable costs for pay-for-performance bonus programs. Marketers who segregate fixed and variable costs usually find that variable costs are employee generated and controlled costs. Since most good profit-indexed pay-for-performance programs have cost control as one of the key critical numbers, by segregating costs now, you’ll have a head start on any performance pay program. Your employees will be able to view and analyze the specific portion of the profit and loss statement they directly control, and you can link their pay and/or bonuses to how effectively they control those costs. In essence, you will get a double punch from taking the time and necessary effort to segregate fixed from variable costs – management control and employee cost reduction.
If you are now convinced that this is a project you must tackle, start by placing a call to your GL vendor. Most petroleum software programs already have the ability to segregate these costs, even though most marketers aren’t using that portion of the program. If your vendor does not have a pre-programmed way to segregate these expenses, you can still get it done by renumbering your accounts. This may sound onerous at first, but if implemented on the very first day of a new fiscal year, will be less of a chore than you think. Like anything else, do a cost-benefit analysis. There is tremendous benefit to isolating fixed costs for tighter control of variable costs.