Every manufacturing business owner is concerned with profitability, yet few use the single most powerful metric for analyzing the relative profitability of their product mix.
A metric that can inform the business owner hourly, daily, weekly, or over any time period, whether the business is currently profitable. A metric that, when combined with the production schedule, can accurately predict your future profitability. No more waiting for the financials at the end of the Month/Quarter/Year to find out how you did.
The most difficult part of creating this metric for your business? You need to simplify how you look at your business and think differently.
Grab you P&L and calculate this metric for yourself:
- Go through all your expense categories and separate into two piles:
- Pile One: Truly variable expenses that you incur ONLY if you produce a unit. Typically this is limited to just a few items: materials; sales commissions; shipping costs and contracted out services. It DOES NOT include any allocated costs such as direct labor.
- Pile Two: Everything else.
- Take Pile Two, add it up, and determine how big this pile is for a typical month. This number is your OE.
- Take Pile One and recalculate C.O.G.S. using ONLY these expenses for each of your products.
- For each product, subtract C.O.G.S. from Revenue to arrive at T$ for each product
- Carefully examine your production process and identify the ONE (or perhaps two) processes/resources that would limit your ability to produce more product if you were at capacity. If you are currently NOT at capacity, decide which process to manage AS IF it were limiting your ability to make money. This process is your CONSTRAINT.
- Calculate how many CONSTRAINT hours are used in your factory to produce your product mix to get your Current Constraint Hours used.
- Calculate how many TOTAL Constraint Hours are available in your factory to get your Total Available Constraint Hours.
- Divide OE by Current Constraint Hours to get your Break Even Rate, the rate at which your production process must generate T$ to just break even.
- Calculate T$/Constraint Hour for each of your products and sort the list from largest to smallest. This is an accurate depiction of the relative profitability of your current product mix. Any surprises? Most manufacturing business owners, when answering the simple question, ‘Which of your products is most profitable?’, will get it wrong. Did you?
- Take your Daily/Weekly production schedule and total up the T$ represented by the schedule. Does it exceed the average OE per day/week you need to break even? Any surprises here?
Here is the cool part. You now have the ability to make a clear road map for where you have the greatest opportunities to improve your business. Improve the RATE at which your CONSTRAINT processes your products, starting with the smallest T$/Hour products, and you will dramatically improve your bottom line!
Here is the corollary to that statement – improve any of your OTHER processes and chances are you will NOT see an improvement in your bottom line.