The following article uses The Job Shop Break-Even Rate Calculator. Follow along and find your shop’s break-even rate!
One of the most important numbers a business owner needs to know is when they are breaking even (Revenue = Fixed Cost + Variable Cost). This is the line in the sand that clearly delineates between profit and loss. For job shops, this is a pretty simple task. There are two types of cost:
Fixed – A fixed cost is an expense or cost that does not change with an increase or decrease in the number of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent of any business activity.
Variable – A variable cost is a corporate expense that changes in proportion to production output. Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases.
What we want to focus on today are fixed costs only. The reason for this is that we are focused on required Contribution Margin.
The contribution margin represents the incremental money generated for each product/unit sold after deducting the variable portion of the costs. It provides one way to show the profit potential of a particular job and shows the portion of sales that helps to cover the company’s fixed costs.
This sounds complex at first, but it is actually quite simple and we are going to use our new Shop Rate Break-Even Calculator to help you figure out where your contribution margin needs to be to break-even.
First thing we are going to do is look at historical fixed yearly expenses.
Assuming nothing has changed in your business, your fixed expenses are likely going to be very similar to last year. Something that shop owners need to keep in mind here is that owning the building and all of the equipment should not be forgotten as a yearly expense. Depreciation on the building and the cost of reinvesting in new equipment or maintenance of existing tools should be considered. Your yearly expenses need to encompass the actual expense to keep your business running in the long-term.
Now that we have your total fixed cost of operating your business, we are going to take a look at your total production capacity. First we will start with a simple count of your machines (Mills, Lathes, Wire EDM, Waterjets, Laser Cutters, etc.).
This should not include secondary equipment that is not directly being billed out hourly. Clearly not all machines are created equal and shops also offer value added services like engineering and assembly that are not included in the production capacity, but we are keeping this simple for the moment.
Now that you have the total count of production machines we are going to take a look at your anticipated utilization rate for each machine.
There are a few factors that influence this number, but it is important to look at historical data to get a good sense of how long your machines ran in prior years. If you haven’t changed your technology or increased your workforce, it is unlikely that you are going to be running at a much higher capacity this year. One mistake shop owners make is calculating their utilization rate based on an 8 hour work day, 5 days a week. This is very deceiving and is not a good number to base decisions off of. When we hear shop owners say that they are running at 75% capacity, that is usually a red flag to start asking questions. Simply put, if you are running 1 shift and your machines do not run when people are not in the shop, then you are probably running close to 10% of total potential capacity if you could run 24/7 365.
Determining Your Break-Even Hourly Rate
When you plug in these three numbers we calculate the total available hours that your shop anticipates billing out for the year. We then divide your total fixed costs by the total anticipated billed machine hours to determine what your minimum hourly rate needs to be to cover your expenses for the year. When you take this rate, add in variable costs and your profit margin, you should get a good sense of where your pricing needs to be.
The key takeaway here is that shop rates cannot be aspirational – these have to be based on reality. I speak to owners weekly who tell me their shop rate is $125 an hour, but then we start calculating quotes together and they start adjusting cycle times down to hit a more realistic pricing on their total quote. The problem with this methodology is that by using runtimes as a lever to achieve your target price, you are losing full visibility of what it is actually going to take to make the part. This causes your scheduling and job costing to suffer dramatically. The mission should be to nail runtimes and adjust rates according to the type of job always keeping in mind the per hour price that we established today to cover your fixed costs.
— Jason Ray
Jason Ray is the Co-Founder & Chief Executive Officer at Paperless Parts. He drives the company’s product vision, while building relationships with manufacturers and partners. Before Paperless, he served as an officer in the US Navy and led the implementation of additive manufacturing technology. Jason holds a BA (Trinity) and MBA (Babson).