Monday, August 03, 2015

Lies, Damned Lies & Accountants

Subtitled, “How we degrade the discussion because our minds are made up and we don’t want to be confused by any facts.”

I was involved in a discussion of raising the minimum wage to $15/hr, a proposition on which I hold no strong position one way or the other. I consider government regulation of business to be necessary generally, and as to wages, as long as everyone is playing on a level field I don’t see how it hurts business. I don’t see how proponents can claim that it isn’t inflationary, but

One person cited a study by Purdue University’s School of Hospitality and Tourism Management to say that the increase of 107% in wages would only raise fast food prices by 4.3% on average. Not quite believing that doubling labor cost, which is typically 30% or more of total cost, would have an impact that small on overall pricing, I went to the news article in question and it took less than a minute for me to see that either the study was entirely bogus or the journalist was quoting it out of context, or perhaps both.

The article states, without supporting calculation, that,
“If hourly wages were $15 (106.9% change from $7.25) food prices would rise 4.3%.”

Support was provided in the form of a table from the Deloitte & Touche accounting firm titled “Derived Sales Calculations – Increased Wages.”  The word “derived” in there was an immediate red flag, as it is a word with the same root as the financial “derivatives”  that caused the crash of 2008. It didn’t take long for my bs detector to start buzzing.

Three columns are shown, one for current wages, one for $15/hr and one for $22/hr, and all three show the same costs until you reach payroll costs. The column for current conditions shows nothing for payroll costs, which is an odd way to provide comparisons and upped the volume on my bs detector. The other two columns show wages per employee circled in red, which took my bs detector to a deafening level.

If you want to discuss the impact of a wage increase, it’s hard to do that without knowing the current payroll amount, and the cost per employee which they circled in red is meaningless. They also made the rather astonishing assumption that the average fast food restataunt has only nine employees.

They slipped up, though, and did include enough information in this table that the current payroll amount can be calculated, because while they do not show the total revenue in the first column, they do show it in the second two columns for the purpose of comparison. So if you back out the 6.3% profit margin from that $626,796 current sales figure and subtract all of the costs “Before Payroll and Benefits,”  you get a current payroll and benefits cost of $231,534.

You also get a total overall cost, then, of $591, 316 based on current wages; a figure which we will put to use just a little bit later in this discussion.

They show a payroll cost of $253,352 based on the $15/hr, supposedly representing the 107% increase over current wages. But, does that look like a 107% increase over the current $231,534 payroll cost? No it does not, which is why they did not show the current payroll costs. It is actually a 9% increase in payroll cost, which might indeed be consistent with a 4.3% price increase, but has nothing to do with the 107% wage increase from $7.25/hr to $15/hr which is the subject they are presenting.

They show “total costs and expenses”  in the last two columns, but they are based on payroll costs which are badly out of touch with reality, facilitated by not providing the starting point from which the costs are calculated. The payroll cost in the second column should actually be $479,275, and in the third column it should be $703,863.

They then show “Derived Sales”  and compare them to the current sales in the second and third columns.They apparently simply pulled those “derived sales” numbers out of their collective ass, because there is no other explanation for how they arrived at them. You may recall that the “derivitaves”  in 2008 were financial instruments which were so complex that only the sellers could understand them, but I suspected at the time that even the sellers did not understand anything about them either, other than that “If you buy these from us we will have more money and you will have less money.”

There is the business management method of calculating a price increase, which is much more simple because it involves nothing more complex than plain arithmetic. First you calculate the cost, which you can do by subrtacting the 6% profit margin from the selling price; so that $4.77 hamburger costs you $4.48 to produce. (That’s 94% of the $4.77 selling price.)

Now you need to know how much of that cost is labor. D&T accountants omitted that figure from their “Derived Sales”  chart, but we can determine it from the numbers that they did provide, and can calculate that the payroll portion of your cost is payroll cost of $231,534 divided by total cost of $591,316 which amounts to 39%.

So of that $4.48 total cost, 39% is payroll cost, which amounts to $1.75 for labor. That amount, we have been told, increased by 107% which amounts to $1.87. So the original cost of $4.48 has increased by $1.87 and is now $6.35. You want to retain the same 6% profit margin, so divide that cost by .94, for a new selling price of $6.75.

The $4.77 hamburger is now selling for $6.75 which is an increase of 42%.

That’s a long way from the 4.3% that the Deloitte & Touche accounting firm got by the “Derived Sales” method. Any company that doubles its wages and follows the accountant’s advice to raise prices by only 4% is not going to stay in business very long.

When I pointed out the flawed model in the discussion the response was “I didn’t waste my time figuring it out”  and, to paraphrase, “I don’t care because I am in favor of raising the minimum wage and am willing to cite any source that supports that position whether it is valid or not.”  That really should not have surprised me.

Progressives are critical of conservatives for making bogus arguments but are, of course, quite willing to make the same type of argument themselves.

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