Masonry Magazine December 1988 Page. 9
Figure #1 Overhead/Volume Equilibrium Points Illustration Curve
Equilibrium Point A
Equilibrium Point B
Equilibrium Point C
750 1,5 2,25 3 3,750 4,500 5,250 6,000 6,750 7,250 8,000 8,750 9,250 10,000
Volume Scale
(Expressed in Units of $1,000.)
it is generating. Or, a company may find itself in a position where it has generated too much volume relative to its overhead investment.
The ability of management to identify these equilibrium points and to make the appropriate adjustments in either direct, indirect or operating overhead is essential to create the appropriate balance that sustains a profitable operation.
Price/Cost Relationships
The relationship between overhead and volume usually does not influence the demand for your company's services. That demand depends more on external forces such as interest rates or general economic conditions.
However, you can influence the overhead/volume relationships of your company through the pricing strategies which you adopt for the particular market niche in which your company may be operating. For example, no matter what your current work in process or backlog may be, if you win a new project at a given price, your overhead will fall as a percentage of sales the instant that you sign the contract.
Hence, the third step in the planning process is to determine the Markup Rates for which you will sell your work in the marketplace. Markup Rate describes the ratio of the price your company bids for a job relative to the direct costs it will incur as it does the project.
Unlike the Overhead Investment, which is totally in your control, your job price is determined partly by your competition and partly by the willingness of a customer to accept your cost markup.
You are taking a risk in submitting the price because you do not know what your true costs are going to be on a project until after the project has been completed. Thus, you must set the price based upon what you believe your costs will be.
Once accepted, the job is subjected to a host of variables such as weather, productivity, material deliveries, relations with other trade contractors, and completion dates. You have to do the job on time and still stay within your original cost estimate in order to make a profit.
Thus, Profit, the fourth variable of the CDS Model, is really the result of the intelligence with which you make your decisions to manage your overhead, volume and cost/price strategies.
Profit/Overhead Relationships
Once you understand these variables, the final step in the application of the CDS Model is to judge how well or poorly you are managing the resources of your company over a given planning period. Since the CDS Model starts with the overhead investment and ends up with profitability, this judgment can be made in terms of a new and powerful measure of organizational effectiveness identified as R.O.O.I-the Return on Overhead Investment.
R.O.O.I is defined by:
R.O.O.1 =
Pretax Net Income
Overhead Investment
For example, a construction firm generating $500,000 in Pretax Net Income with an Overhead Investment of $1,000,000 has an R.O.O.I of 50% ($500,000 divided by $1,000,000).
Is a 50% R.O.O.I. too low? Too high? Or, is it right on target? While most construction executives tend to have a natural and intuitive "feel" for how well or poorly they may be doing, very few know what the expected R.O.O.I. should be for their company.
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MASONRY-NOVEMBER/DECEMBER, 1988 9