subject: Determining Price and Profitability Using the Balance Sheet [print this page] Determining Price and Profitability Using the Balance Sheet
Distributing tools and accessories in the construction industry can be very competitive. Companies are constantly trying to stand out from competition by offering special programs and incentives to direct business in their direction. Despite all of these incentive based programs, the most important aspect to the consumer is pricing. Before a company can come up with accurate pricing, they must first review their balance sheet.
The balance sheet is a listing of the organizations assets, liabilities, and owner's equity at a point in time. This statement of financial position easily helps you analyze the two most important sections of the balance sheet. The first are assets which are probable future economic benefits obtained as a result of past transactions. The second are liabilities which are probable future sacrifices of economic benefits from current obligations of a company to transfer assets or provide services to other entities in the future as a result of past transactions or events. The left over assets that remain after subtracting the liabilities is the Owner's Equity. The basic accounting equation is known as Assets = Liabilities + Owners Equity. After understanding these basic accounting terms we can begin to determine what price point we want to bring to the market.
When determining competitive tool pricing we first must decide what kind of margin we would like to make. Adequate tool pricing should be able to cover all costs identified in the life cycle chain which are design, production, marketing, distribution, and customer service. The market itself and competitors are going to be the best determinants of the tool pricing that you are ultimately going to bring to the market. Coming up with one set price can be done, but may not be the smartest business move. Analyzing your customer's previous buying patterns as well as the market itself has made my company come up with multiple pricing tiers. The tool distributors that do not stock our products and accessories in their stores, but will bring them in when they have an order get a lower percentage discount off of list pricing. The customer's that have made the investment in our products get an even better discounting which leaves them room to make even more profit then the non stocking distributors.
After determining a price that is competitive, we need to figure out if operating costs throughout the production cycle leave us room to produce the desired ROI. Return on Investment is a primary measure of a firm's profitability because it determines the rate of return you are able to earn on assets that are available for use during the year. The formula ROI is Return on Investment = Net Income / Average Total Assets. Many companies use ROI as a quick tool of measure to determine economic performance and if an investment can be profitable or not. ROI is expanded even further when the DuPont model is introduced.
The DuPont model is an expansion of the basic ROI calculation measuring profitability. Every company is in business to make money and the best way to measure overall profitability is to use assets to generate sales revenue. The formula for ROI is Return on Investment = Net Income / Sales X Sales / Average total assets. The Net Income / Sales portion of the equation can be defined as your margin. Margin is the amount of net income that the company brings in after all expenses have been paid. The Sales / Average Total Assets portion of the equation is going to be your turnover. Turnover is a measure of the company's efficiency and how assets are used to generate sales.
There are multiple different construction tools distributor's in the industry, but all of them do not have the same measure of liquidity. Liquidity is a firm's ability to meet its current financial obligations using current assets over current liabilities. Many firms are able to sell numerous products and services, but they must have an efficient and/or firm accounts receivable department the collects payments that are agreed to be paid within a specified period of time. If payments are not received on time, the company itself will begin to be affected financially. This is where a positive Working Capital comes into play. Working Capital = Current Assets Current Liabilities. Current assets are cash and similar assets of the company that will likely be converted into cash within a year. Current liabilities are obligations of the company that should be paid within a year.
After being introduced to the above accounting terms, you can see that selling tools or any type of products is not a simple process. Extensive research must be done to determine a price point that is competitive to the market yet also profitable for the company. Companies are in the business to make money and if they don't they will not be bringing products to the market for long periods of time.
