Profit Center Planning & Analysis

Transcription

1 Profit Center Planning & Analysis Theory of constraints, maximizing profitability, and capacity utilization Hierarchy of Resource Consumption Unit-level resources resources consumed on activities proportionally related to each unit of product or service output Variable costs Batch-level resources resources consumed on process activities related to a group of products or services leading to short-run fixed costs Semi-variable costs Segment-level sustaining resources resources consumed on capacity to support a profit segment (line of business, product-line, customer group) mid-run fixed costs Business-level sustaining resources committed resources consumed on activities related to the entity as a whole long-run fixed costs Resource Consumption Accounting Hierarchy of Resources Consumed Unit-level resources Definition resources consumed on activities proportionally related to each unit of product or service output Example Activities direct materials billable hours sales commissions Batch-level resources Segment-level sustaining resources Business-level sustaining resources resources consumed on process setup activities related to a group of products purchase ordering or services leading to short-run fixed material handling costs shipping resources consumed on capacity to support a profit segment (line of business, product-line, customer group) leading to mid-run fixed costs committed resources consumed on activities related to the entity as a whole leading to long-run fixed costs product/service design process design specialized training hiring of personnel customer service information systems management finance and accounting activities legal support activities maintenance of PP&E

2 Airline P&L Example Flight level throughput Revenues and costs specifically traced to individual flights (i.e. fuel, food) Route level contribution Additional resources consumed at the route level (i.e. destination personnel, lounge) Regional level gross profit Additional resources at the regional level (i.e. aircraft, booking, marketing, regional personnel) Airline operating income Additional long-run fixed costs at the entity level (i.e. corporate resources) Cost Behavior Mixed-Cost Behavior Unit Variable Cost Total Cost $ Total Variable Cost Mixed Cost Fixed Costs Volume Units Produced Contribution I/S Black & Blue Company Variable-Costing Income Statement For the Month Ended August 31, 2001 Total Per unit % Sales revenue (1,000 skateboards) $20,000 $20 100% Less variable expenses 12, % Contribution margin $ 8,000 $ 8 40% Less fixed expenses 5,000 Net income $ 3,000 CM/unit CM ratio

3 CVP Analysis Important Concepts: p(x) - v(x) FC = Profit Revenue vc%(revenue) FC = Profit Pre-tax income = after-tax income / (1 - TR) contribution margin (CM) = sales total variable costs unit (CM) = price/unit - variable cost/unit CM ratio = CM/sales, where p = price/unit VC = total variable costs v = variable cost/unit FC = total fixed costs x = volume I = total income S = sales TR = income tax rate vc% = variable cost ratio CVP Graph $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 Break-even Point Profit Revenue Costs $5,000 $0 Loss Units Theory of Constraints A set of techniques developed by Eli Goldratt and his associates and popularized in his novel, The Goal. The Theory of Constraints approach is iterative and continuous - a process of ongoing improvement. In TOC, a constraint limits a system from achieving higher performance relative to its goal. A constraint can be external such as market demand or vendor quality, or internal, such as labor or machine capacity,behavior of managers or workers, logistics, or policy.

4 The Lean Model Identify supply chain constraints Decide how to exploit the constraint(s) Subordinate all other decisions Elevate the constraint Repeat from step 1 Advantages of the Lean Model Decreased production lead times Improved quality of products and services Reduced inventory levels Reduced bottlenecks Increased profitability Curbing of statistical fluctuations Improved competitive position Facilitate strategic marketing and operational decisions Use of marginal pricing Continuous improvement Short-run Planning Because committed costs can not be altered in the short run, short-run planning attempts to utilize capacity in the most efficient and effective manner possible. Goal seeking and the theory of constraints (TOC) can be used to model the entity and how various short-run plans effect the financial outcomes for a period.

5 Eliminating Capacity Constraints Eliminating capacity constraints requires a continuous process of evaluating and reducing bottlenecks, reengineering, and implementing process improvements. Uses and Benefits of the TOC Lean Model Reduced inventory levels The cost accounting methods applied in TOC create a disincentive to carry inventory, particularly, finished goods inventory. Consistent with JIT systems. Reduced bottlenecks Focus on identifying and reducing or eliminating bottlenecks to improve throughput actual sellable product or services with a given set of resources. Uses and Benefits of the TOC Lean Model Increased profitability With the focus on reducing inventories and increasing throughput, profitability will improve as well.

6 Example ITT Night Vision ITT s Night Vision Division Applied TQM and TOC Yield increased 200% Throughput increased 300% Backshop cycle time reduced by 50% Example Ketema A&E Ketema A & E Process engineering changes implemented in order to evaluate incoming requests Now evaluate effect on factory s constraints of taking on additional business Improved profitability Increased cash flow Example - Seagate Seagate implemented TOC for their 15k RPM disc drive Cheetah X15 beat external production release by 5 weeks First 15k drive to market All competitors behind due to technological challenges

7 Essential Elements of the TOC Lean Model Essential elements of the TOC model Logistics and scheduling Market segmentation Performance measurement Wikipedia.com Essential Elements of the TOC Lean Model Emphasizes the role of constraints in limiting the performance of an organization Represents a fundamental shift away from product/service costing and focuses on optimizing the utilization of limited resources Relies on incremental analysis Most appropriate for assessing the short-run impact of operational alternatives Consistent with other managerial tools including JIT and TQM Logistics and Scheduling Logistics and scheduling elements of TOC emphasize synchronization of flow of materials and services Five-step focusing process V-A-T logical structure analysis Buffer management (Drum-Buffer- Rope) Supply chain management

8 Five-Step Focusing Process Identify the systems constraints May be behavioral, management policy, capacity, market, vendor, logistical constraints that limit the system s throughput Decide how to exploit the constraint(s) Focus on improving productivity of constrained resource(s) Evaluate product/service mix Evaluate scheduling policies and procedures Five-step Focusing Process Subordinate everything else to the above decisions Alter management policies, processes and other resources to support above decisions Alter performance evaluation metrics to support above decisions Five-step Focusing Process Elevate the constraints Expand capacity through Additional labor Additional fixed assets New technology Repeat from step one Improvement through continuous identification of constraints.

9 Supply Chain Management TOC can be applied outside the boundaries of the enterprise, reaching backward and forward through the supply chain Improve responsiveness to customers Formal cross-organizational alliances become a point of major improvements in value creation As organizational boundaries become more transparent for physical flow of products and services, the need for increased linkage of policy/management approaches becomes critical Example DaimlerChrysler Pulled suppliers into the design process by implementing design-collaboration and life-cycle-management software cut 60% to 90% off the time needed to communicate design changes to suppliers and get back required changes Using tools for all 2004 models Product Pricing Decisions Product pricing is a key in the strategic positioning of any organization Market pricing Cost plus pricing Apply marginal revenue vs. marginal cost analysis for incremental markets

10 Example Product LYS Current Market Traditional CM Analysis Incremental Market #1 Throughput Analysis Incremental Market #2 Throughput Analysis New Market Requirements Selling Price $300 $200 $100 Material No constraints Labor Variable overhead 120 Additional labor only if 1 and 2 accepted No additional overhead Total VC $260 $80 $140 CM $40 $120 -$40 Performance Measurement Proof of effectiveness is the degree to which performance improves ROIC often used as a generic measure ROIC does not provide a direct link to TOC initiatives ROIC does not provide insight as to where to focus further improvements Performance Measurement TOC measures are based on relationships between three primary elements Throughput per unit of critical resource Throughput (T) Inventory (I) Operating expenses (OE)

11 Throughput (T) Throughput is measured as sales less purchased material costs and other external costs such as Subcontracting costs Commissions Customs duties Transportation paid to external vendors Throughput per unit of Constrained Resource Throughput (or contribution margin) per unit of constrained resource factor a measure of efficiency (productivity) i.e. Throughput/minute of machine time for the bottleneck machine Inventory (I) Inventory is defined as all of the funds invested in things the organization intends to sell Cost of RM purchased and currently in RM inventory, WIP, or finished goods Excludes direct manufacturing labor and manufacturing overhead Some practitioners include the investment in tools, buildings, and capital equipment in inventory or investment

12 Operating Expenses (OE) Operating expenses are all of the funds consumed except for those costs accounted for in throughput Direct and indirect labor Supplies Interest expense Depreciation G&A TOC Metrics TOC metrics focus on increasing throughput (T) and reducing inventories (I) and operating expenses (OE) Key difference between TOC measures and typical profitability measures TOC metrics can not be improved by producing goods and storing in inventory TOC Metrics Productivi ty = throughput operating expenses throughput Velocity of materialflow = inventory throughput Efficiency= unit of constrained resource Complementary operational measures On-time delivery % Lead time Scrap rate Return rate Defect rate

13 Additional TOC Metrics Throughput dollar days = throughput x #days late Inventory dollar days = cost of inventory x # days early Ideally, throughput dollar days = 0 Can be used externally or internally Ideally, inventory dollar days = 0 Measure of the excess inventories Absorption Costing and TOC Activity-based costing theoretically treats all costs as variable in the long-run Appropriate for many decisions TOC is oriented toward short-run optimization where most costs are fixed in nature Variable Costing and Throughput Accounting Conventional variable costing Variable costing w/ labor treated as fixed Throughput accounting Simplified throughput accounting Revenue Revenue Revenue Revenue -direct materials - direct labor -variable overhead = contribution margin -direct materials -variable overhead = contribution margin - totally variable costs -direct materials = throughput = throughput - fixed expenses - fixed expenses -operating exp -operating exp = profit = profit = profit = profit

14 Variable Costing Variable costing treats fixed costs as operating expenses (noninventoriable) Still treats labor and some overhead as inventoriable Throughput Accounting Throughput accounting (TA) requires a more precise sorting of true, short-run variable costs Increased burden to ensure underlying cost structure is well documented and verified An assumption of TA is that once a certain capacity level exists, all associated operating expenses are fixed TA does not include value added in calculation of inventory Inventory only includes purchased costs of materials and components that will become throughput downstream Committed Capacity Costs Design of the process defines the committed costs of capacity Long-term cost structure of the enterprise Big six airlines vs. LCCs Converse vs. Nike Cost per available seat mile, 2002 US Airways 11.0 United 10.4 American 9.2 Delta 8.4 Northwest 8.2 Continental 7.9 America West (B) 6.7 Southwest (B) 6.3 JetBlue (B) 5.3 Source: J.P. Morgan

15 Managed Capacity Costs Costs added to activate a process People Supplies Materials Tools Utilities Purchased services Capacity Limits Theoretical capacity Operating 24/7, zero waste Committed capacity costs Practical capacity Theoretical capacity adjusted for setup, maintenance Managed capacity costs Normal capacity Average expected utilization for a defined period Budgeted capacity Planned utilization for the period Actual utilization Capacity actually used for the period CAM-I Reporting Template Rated Capacity Rated Capacity Summary Model Idle Nonproductive Productive Industry-Specific Not marketable Off limits (mgmt policy, contracts, legal) Marketable Standby (variability) Waste (scrap, rework, yield loss) Maintenance (scheduled, unscheduled) Setups (volume, changeover) Process development Product development Good products Traditional Model Theoretical Practical Scheduled

16 Capacity Utilization Metrics Percentage of theoretical capacity associated with each category Committed capacity costs associated with each category Throughput Efficiency Productive 35%, $1.4M Idle 25%, $1.0M Nonproductive 40%, $1.6M Using Excel Tools to Evaluate TOC Using excel tools to evaluate TOC Create TOC compatible P&L worksheet Define objective functions Define and configure constraints Evaluate the incremental financial impact of alternative scenarios Create a TOC Compatible P&L To capitalize on the benefits of Excel s Solver tool, a throughput or variable costing based P&L statement is necessary. Additionally, some basic computations for capacity utilization measures are beneficial in evaluating alternative scenarios.

17 Define the Objective Function The objective function can take one of three forms Maximize a P&L element, such as revenue, throughput, contribution margin, or income Minimize a P&L element, such as unused capacity Set an P&L element to a target value, such as % of available capacity utilized. Changing Cells Once the objective function is defined, it is necessary to identify the objective element is determined i.e., in a P&L, income is generated by selling volume of product Define and Configure Constraints Constraints may take the form of <= constrains the element to less than or equal a specific value >= constrains the element to greater than or equal to a specific value = constrains the element to be equal to a specific value Integer constrains the element to a whole number