National Clothesline

here has been a tremendous response to last month’s article on how to calculate your break even point. Of the many readers who have contacted me, several requested that I write an article on the subject of how to calculate “cost per piece.”

Developing a formula for this calculation is fairly basic. Determining the optimum way to allocate line item costs is more complex and somewhat subjective.

Drycleaning is a service business where we process other people’s garments. The “processing” part of drycleaning is very similar to manufacturing with a few twists.

The most obvious differences between processing (what drycleaners do) and manufacturing are:

• Drycleaners do not own the garments.

• Every garment is different (no standard parts as in manufacturing).

• The time required to process a garment can be different every time it comes in (see example below).

• You cannot schedule or predict how many pieces will come in to be processed.

• You cannot schedule your product mix (the number of laundry pieces, pants, blouses, dresses, etc.).

Example: A dress — the same dress — comes into your plant five times.

1. No stains, no extra work.

2. Mustard and ketchup stains, requires spotting.

3. Hem is partially loose, a minor repair that you do not charge for but requires extra time.

4. No stains, no problems, no extra work.

5. Your drycleaner misses a stain, your finisher misses the stain, your inspector sends it back to be redone – lots of extra time spent (wasted).

Points to remember

To accurately project future cost per piece, we must analyze historical data.

When analyzing historical data, we should use a 12-month period.

When projecting future cost per piece, we should use a one month period or a three month period.

By projecting next month’s cost per piece and comparing the projection to actual results at the end of the month, you will be able to identify problems in a timely manner.

Calculating your cost per piece will show you how much you must charge for your services in order to make a profit.

When calculating unit costs (or cost per piece) we must assign all our expenses to one of the following three categories:

• Direct labor.

• Direct supplies.

• Processing overhead.

Some may disagree with the way I assign each line item to the three categories. I will try to explain my thinking in this regard.

Direct labor costs

Direct labor is the labor that goes up and down with sales. Your drycleaning finishers should process an average of 30 pieces per hour for each operator. Your finishers press 420 pieces on day one. They should get paid for 14 hours. You press 300 pieces the next day and the finishers should be paid for 10 hours. All productive labor should be considered “direct labor.”

Note: Some owners pay their production employees for 40 hours a week or a guaranteed weekly “salary” regardless of how many pieces are processed in a week. For these cleaners, production labor costs must go into “processing” overhead because this cost is fixed. Also, the production manager’s salary belongs in “processing” overhead because it is a fixed cost. This is true even though the manager may be engaged in production work.

Counter labor costs

Counter labor is essentially an overhead cost because it does not go up and down as sales go up and down. Whether sales average $20,000 a month ($240,000 a year) or $20,000 a week ($1,000,000 a year) they will not be the same every month. On the other hand, counter labor costs normally stay the same every month. This is why I consider counter labor an overhead cost.

Supplies

Some supplies are a direct cost and some supplies are considered an overhead cost.

Direct supplies. Supplies such as hangers, poly, tickets, and marking tags are all direct because their consumption varies with your volume.

Overhead supplies. Supplies such as soap, perc, paper towels, etc., are considered fixed because they do not vary with volume.

To avoid creating an accounting nightmare, I would advise you to put all supplies under “Direct” supplies. Do this because 65 percent to 75 percent of all supplies are, in fact, variable.

Utilities vary slightly with sales volume so they are considered an overhead cost.

Depreciation

The most ambiguous line item is depreciation. First, you never write a check for depreciation. Second, with the new federal law, you can deduct up to $100,000 in the first year of owning a piece of new equipment.

Example: You purchase a new shirt unit for $25,000. You depreciate the total amount the first year. You process 1,000 shirts per week (50,000 per year). If you use the $25,000 depreciation figure, you will be adding a 50 cents cost to each shirt the first year. After that you will be charging absolutely nothing — zero — for depreciation in all the remaining years that the shirt unit is in service.

A better approach for allocating the cost of new equipment is to divide the cost by 60 months, which represents five years of service. Direct and overhead cost allocations are shown in Exhibit 1.

Allocating direct costs to drycleaning and shirt pieces is, once again, fairly basic. Please see Exhibit 2.

Overhead allocation

To properly allocate overhead costs, we must determine the “overhead allocation rate” (also known as overhead burden). This is done by dividing Total Overhead Costs by Total Direct Costs. In the drycleaning industry, Total Direct Costs should not include Outside Services.

Overhead costs are indirect and cannot be conveniently traced to unit or piece costs. When we divide our overhead costs in this example by our direct costs, we arrive at an overhead burden rate of 1.94 ($150, 150 divided by $77,625 = 1.94). This is an overhead allocation rate equal to 1.94 times direct costs. See Exhibit 3.

In Exhibit #2, we have determined that the direct cost per drycleaning piece is $1.54. We have also determined that the direct cost per shirt is $.68. To determine the overhead allocation amount for drycleaning we must multiply $1.54 times 1.94 which equals $2.99.

To calculate our cost per piece, we must add direct costs per piece to the overhead cost per piece. For drycleaning pieces, that is $1.54 plus $2.99 = $4.53. The cost per drycleaning piece is $4.53. In this example, the profit per drycleaning piece is $.97.

For shirts, the overhead burden is 1.94 x $.68, or $1.31. Adding our direct costs to our overhead burden, we have a total shirt cost of $1.99. In this example, shirts cost $1.99 each and the selling price is $2. This company processes 1,000 shirts per week for a total profit of $10 per week.

Question: Why do shirts? This one is a no-brainer for many reasons, but I’ll stick with finance today because this article is about the “numbers.”

What is important here is that the shirts are contributing $1,310 per week to overhead costs. That means that shirts contribute $65,500 a year toward your salary, rent, advertising, counter labor, utilities, etc. Those costs (salary, rent, etc) will not change (diminish) if you eliminate your shirt business entirely.

Cleaners sitting around complaining about losing money on shirts are obviously clueless about business finance. They fail to understand that their shirt business is making a major contribution to the fixed costs of their business (duh!).

Plug your numbers into these three exhibits and you will be able to determine your cost per piece. Next, adjust your prices to ensure that you are going to generate a profit on all of your services.

In the game of business the more you know the better you can play the game.

Alan Robson is a private consultant dealing with the specialized needs of the drycleaning industry. Contact him by telephone at (941) 408-8819 or send e-mail to him at: alan@bizbuilderonline.com or visit the Biz Builder web site: www.bizbuilderonline.com.