Money Talk: Right Sizing Your Firm for Optimal Performance

As we make it through the first quarter of 2010, some things are quite apparent: Everything is changing, and As things change we must change things. That being said, in our client companies, rightsizing seems to be an inevitable conclusion. Although sometimes misused, rightsizing is not necessarily a dirty word. In the media, rightsizing is often interchanged with “layoffs or staff reductions.” Although layoffs can be a component of rightsizing, the two words are not interchangeable.

When thinking about rightsizing, think about your company's scalability. As sales shrink or grow, what does your relevant cost structure look like? Why can't a printer earn a profit at whatever sales level they are? In many cases within a printing company, the first measurement to figure if the company is “right sized” or if its relevant cost structure is appropriate for its sales is to look at the company's “Utilization Factor”.

Utilization Factor = Chargeable Hours dived by Total Hours Paid (of direct labor)

The utilization factor is a particularly important ratio to consider in the direct labor area. The higher the utilization factor is, the more time the employee is producing value added sellable product. The lower the factor is, the more time the direct laborer is sitting, waiting for the next job. It's hard to earn a profit if your direct laborers are spending less time producing and more time waiting for work.

Typically we strive for an 80 percent Utilization Factor or higher. In the last year or two, most printers are reporting utilization rates between 60-75 percent. A healthy company in the Northeast reported that, “Efficiency has gone down because we've downsized and are asking people to do a variety of work. When you're busy and fully staffed, it's much more efficient….Nowadays, it's hand-to-mouth, waiting for the next job to come. Our Utilization Ratio dipped to 65-70 percent, and it shows (with low profits or losses).”

The effect on profitability can be disastrous. When the Utilization Factor dips below 75 percent, it becomes very difficult to make money. As an industry, we price jobs so that at normal utilization factors, we earn a profit. However, when the Utilization Factor drops and employees are standing around, we lose money. This leaves owners wondering, “Can I continue to pay these production employees? How can we rebound?”

Many printers report that the recession has caused them to take a fresh look at work coverage, shifts and job efficiencies. Creative ideas like having two-shift turnovers in a 24-hour period instead of three, or running 13-hour crews instead of eight-hour crews have proven effective for some.

If sales projections seem aggressive or even scary, it's probably time to consider scaling back on critical components to accommodate realistic sales levels. For example, let's say you ran a six-color press last year 4,000 hours, but this year it's down to 3,500. You need to figure out how you will save the payroll costs to cover the diminishment of 500 hours. One printer we spoke to eliminated a shift and built a part time shift to come in only when there was printing to be done.

Next, it is prudent to consider costs beyond production. Consider the Support Efficiency Ratio, the ratio of Management and Overhead Payroll to Direct Labor Payroll:

Support Labor Efficiency Ratio = Support Labor Cost divided by Direct Labor Cost

In other words, find out how much support labor cost you spend for every dollar of Direct Labor payroll you spend. It's critical to not over support production labor and burden your cost structure. Support labor is defined as all other labor that is not direct, which includes management and indirect factory labor, and all administrative and sales labor. Too much support labor cost will squeeze your cost structure and make it impossible for you to recover your cost in your sales price. Historically, this ratio has been 1:1 to 1, as reported in the Ratios Study published by the Printing Industries of America.

A printer in the Midwest started to experience a slide on its profit and loss statement. After calculating these ratios, he was able to communicate clearly where cost adjustments needed to be made and why. As he explained on our recent teleconference(*), “If you don't measure the right things, or you don't let your staff know their importance, nothing will improve.”

By combining these two ratios, you can right size your printing company's labor cost. To reiterate, the first ratio wants you to run your company at 80 percent or more Utilization of the direct labor. The second factor tells you to spend $1.10 on average for every dollar of the now efficient direct labor. By monitoring and striving to achieve or excel beyond these ratios, you are right sizing your company.

A final ratio to consider for measurement is as simple Cash Flow coverage ratio:

EBITDA Coverage of Debt Service Ratio = EBITDA (Earnings before Interest, Taxes and Depreciation and Amortization) divided by Debt Service

Banks use this ratio. So do creditors. This simple calculation tells you whether you have the cash flow to pay your debt service. Without the cash flow from operations, much more creative means has to occur to pay off the banks. Obviously, it's easier to earn it from operation, so rightsizing your operations, payroll and non-payroll cost is the challenge. Cash Flow Coverage should be 1.25 to 1. Remember, even if you don't have a bank covenant, it is very important to have this ratio covered. If you cannot cover debt, it becomes a steep and painful slide out of business.

Beyond all this is another hurdle for all employers: How do you adjust appropriately yet maximize productivity? First, use the measures described here. For additional guidance, make historic references. Look back five, or even 10 years, at your company's past performance ratios. Were your ratios in line then? If so, what did a healthy cost structure look like at that time? If you're at a loss for comparisons, use the Printing Industries of America Ratios Reports. The Ratios Reports are segmented in various ways including by company size. A company that was accustomed to sales levels around $10 million/year, but now needs to scale back to a $7 million level, can use these industrywide reports as a guide.

When the dust settles, will there be an upside in all of this? Industry experts say yes, so rightsizing now allows you to become smaller but mightier—and well positioned for that recovery when it comes. Indeed, scaling back to profitability has been needed for years.

Many printers report that the recession has caused them to take a fresh look at work coverage, shifts and job efficiencies. Creative ideas like having two-shift turnovers in a 24-hour period instead of three, or running 13-hour crews instead of eight-hour crews have proven effective for some. Others are creatively utilizing part timers to fill in gaps, managing labor costs like a variable cost. We all know that rightsizing in times of growth is easier than during a down economy. No one likes to make the tough decisions. In this economy, though, look at rightsizing for what it really is—a sound, business-based opportunity to become more profitable. After you calculate the pertinent ratios and do the comparisons to past years and industry averages, you will be in a prime position of strength to reboot and clean things up that you should have addressed years ago.

(*) A Cup O' Joe is a complimentary teleconference series for printers offered by MargolisBecker on timely topics for the graphic communications industry. Details and registration forms for upcoming sessions are available at www.margolisbecker.com under the “Events” tab. MargolisBecker LLC is the nationally known business and management advisory specialist in the graphic communications industry. We offer services including strategic planning, business valuations, mergers and acquisitions, turnaround management, accounting, auditing and tax compliance; and are the preparers of the PIA financial Ratios Studies. If you have any questions, contact Stuart Margolis or Joe Becker at (610) 667-4310 or e-mail to smargolis@margolisbecker.com or jbecker@margolisbecker.com.

Loading