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| • Concepts |
| • Adequate Profit |
| • Gear Ratio |
| • Test Your Insight |
| • Glossary |
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Test Your Corporate Insight
Imagine you are running a precision machining company with annual sales of $5MM.
We are going to ask you some questions about this company and how its capacity to generate profits responds to operating decisions you make.
Compare your answers to ours and study the explanations we provide for each of our answers.
We are deliberately not giving you enough information to answer these questions quantitatively. We want you to test your "gut feel". What does your intuition tell you?
We believe you will be surprised by the "true" answers to these questions and you will gain valuable "corporate insight" from your first exposure to our philosophy, concepts and products.
Profit Model Package ®©
Our answers and analyses were derived by using our proprietary business model, the Profit Model Package ®© (PMP).
The PMP predicts profits generated under any set of operating conditions. The PMP is one of the principal tools we use in applying Light and Agile Manufacturing to our client's companies.
We have entered composite industry data from the National Tool and Machining Association, NTMA, to prepare a PMP that accurately represents the operational parameters and financial ratios for our mythical $5MM precision machining company.
Corporate Insights
The following questions are designed to test the current state of your "corporate insight".
We use a variety of common and proprietary words, phrases and acronyms to communicate our concepts. Please use our glossary to acquaint yourself with these words phrases and acronyms as you test your insight.
Our intent is to have the "true" answers to these questions surprise and compel you to find out more about how SetPoint's products and services can help you realize the maximum profit from your company's operations.
Your company policy is to have your 23 direct labor workers spend a 1/2 hour cleaning up at the end of each shift. What effect on your annual profit before interest and taxes would result if, instead, you hired the equivalent of 1.5 indirect workers to perform the cleanup duties and had your direct labor workers spend an additional 1/2 hour per shift performing job-related work?
A) Decrease $10K B) No Change C) Increase $180K D) Increase $30K E) Don’t know
Click here to see our answer.Answer
The answer is "C". Net profit before interest and taxes increases by $180,000 annualized.
Explanation
If the company has a backlog of work, then having your direct labor workers perform an extra 1/2 hour per day working on jobs produces more sales. The additional expense of 1-1/2 full-time indirect labor workers allows the direct labor workers to produce enough additional products for sale to increase NPBIT by $180,000 on an annual basis.
Your willingness to sensibly "grease" operations with indirect labor creates contribution margin until the indirect labor expense amount equals the gain in contribution margin it catalyzes.
Typically, the cost of the additional indirect labor will exceed the reduction in unapplied direct labor (UDL). But, converting UDL to ADL for the direct labor workers creates new sales. It follows that the new sales created have no associated increase in fixed cost and only modest increases in ADL and IDL. The net result is 52 cents of net profit is created for each new sales dollar generated.
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Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
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Your company typically provides the raw materials from which its products are made. What effect on your annual sales would result if your primary customer (90% of sales) began to furnish your company these raw materials instead of having your company buy them?
A) No Change B) Decreased to $3.8MM C) Decreased to $4.7MM D) Increased to $5.1MMK E) Don’t know
Click here to see our answer.Answer
The answer is "B". Annual sales decreases by $1.2MM from $5.0MM to $3.835MM.
Explanation
If no other action is taken the loss of the portion of sales previously required to reimburse the company for the costs of the materials and for procuring them will reduce sales from $5MM to $3.835MM. Unless appropriate reductions in the number of indirect laborers and administrative expenses involved are made profits will be reduced dramatically.
The engineering work statement is still the same, but a significant portion of the value added has been taken from your company.
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Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
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Your company typically provides the raw materials from which its products are made. If your primary customer (90% of sales) began to furnish your company these raw materials instead of having your company buy them you have predicted that sales will fall by about $1.2MM. You currently have 23 direct labor workers at your current sales of $5.0MM? To maintain your current $5.0MM level of sales, how does your labor force need to change?
A) Increase by 6 B) Decrease by 6 C) No Change D) Increase by 2 E) Don’t know
Click here to see our answer.Answer
The answer is "A". The number of direct labor workers must increase by 6, from 23 to 29.
Explanation
To maintain sales at $5.0MM, the loss of material and markup revenue shortfall must be made up by more direct labor hours applied to an increased work statement. The number of production workers must be increased from 23 to 29 to produce $1,165,000 worth of new sales for which the customer now supplies the material.
Do You Have a Similar Profit Opportunity?
Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
Click here to learn more about Profit Scheduling.
Your company's quality department informs you they have to scrap parts that took 1 hour to make. If your composite wrap rate is $171 per hour, including material, plus OSP, and their appropriate mark-ups. What amount of sales is required to pay for this lapse in quality?
A) $2,531 B) $6,447 C) $0 D) $12,214 E) Don’t know
Click here to see our answer.Answer
The answer is "D". Additional sales of $12,214 are required to recapture the net profit before interest and taxes lost from scrapping these parts.
Explanation
When you scrap parts, three bad things happen. First, You lose the cost incurred in labor, material, expense and factory overhead used to make the parts. Second, you incur duplicate cost to replace the scrapped parts. Third, you squander the opportunity to make a new part that would increase sales and profits because you are forced to make replacement parts.
The dollars to reproduce the scrapped parts must come from the profit made on future parts. At the company's current rat of profit generation of 4.2%, it will take $4,071 of future sales to generate the dollars to pay for the $171 contained in the scrapped parts. Because of the requirement to replace the parts and the lost opportunity to make a new part, the actual cost is 3 times the cost of the original scrapped parts.
Do You Have a Similar Profit Opportunity?
Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations.Contact us now.
Click here to learn more about Profit Scheduling.
Your company is having difficulty meeting delivery commitments. To solve this problem production scheduling suggests adding five additional days of queue time to each job to allow manufacturing to start on each job earlier. What is the effect on your annual profit before interest and taxes of taking this action?
A) Increase $138K B) Decrease $499K C) No Change D) Decrease $55K E) Don’t know
Click here to see our answer.
Answer
The answer is "B". Net annual profit before interest and taxes decreases by $499,491.
Explanation
All other things being equal, profits decrease because the average velocity of all the jobs flowing through the shop decreases. Although, the profit potential on each job may remain the same, the pace of each job is deliberately slowed. This action spreads the application of applied direct labor and indirect labor to each job over a longer time period.
The results are dramatic! Annual profits decrease by $499,491. Sales throughput through the factory drops 20% ($1MM) from $5MM to $4MM. Labor and material expenditures are the same because the engineering work statement for each job remains the same. And, our analysis doesn't consider that you probably bought material to cover the original projected sales volume of $5MM.
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Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
Click here to learn more about Profit Scheduling.
Your company is behind in the on-time delivery of a number of jobs and is considering the authorization of overtime to counteract a projected 10% shortfall ($500K) in projected annual sales. What is the effect on your annual net profit before interest and taxes if you authorize an additional 405 hours per month of overtime which you have calculated will be just enough to get you back on schedule?
A) Increase $187K B) Decrease $169K C) No Change D) Decrease $62K E) Don’t know
Click here to see our answer.Answer
The answer is "B". Net annual profit before interest and taxes decreases by $169,300.
Explanation
The bottom line is "Overtime ain't necessarily bad."
At $5MM in annual sales, your company will make an annual profit before interest and taxes of $213K. At $5MM in annual sales direct labor is 16.9% of sales. As sales drops by 10% direct labor as a percent of sales increases to 18.8%. The 10% decrease in sales of $.5MM results in an annualized loss of $143K.
By applying 405 hours per month of overtime to prevent the decrease in sales, your annual profit crawls back to $43.7K. The inefficiency of the labor and the added expense of the overtime premium reduces annual net profit by $169.3K ($213K less $43.7K), but is still a $187K improvement over the $143K loss that would result from taking no action to counteract the projected 10% decrease in annual net sales.
There are limits to the application of overtime. You'd better know what you are doing.
Do You Have a Similar Profit Opportunity?
Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
Click here to learn more about Profit Scheduling.
Your company is reevaluating its overall company wrap rate. Some members of management want to increase the hourly company wrap rate by $2.00 per hour. Others want to decrease the company wrap rate by $2.00 per hour believing this reduction will spur a 10% increase in sales. Which strategy produces the most annual profit before taxes?
A) Increase $2.00 per hour B) Decrease $2.00 per hour C) No Change D) Don’t know
Click here to see our answer.Answer
The answer is "B". Decreasing the company wrap rate by $2.00 per hour results in a net increase in annual net profit before interest and taxes of $171,830.
Explanation
At $5MM in annual net sales ($384,615 in each 4 week month), annual net profit before interest and taxes (NPBIT) is $213,000. Material cost is $110,384, or 28.7% of sales. Material mark up is $36,795 based on a true 25% markup. The direct labor rate is $18.00 per hour. The direct labor rate, plus factory overhead rate and G&A overhead rate represent $72.97 of the $107.41 per hour total company wrap rate. Stating the material cost, plus associated material markup as an hourly rate equals $30.57 of the $107.41 per hour company wrap rate. Profit stated as an hourly rate equals $3.87 of the $107.41 per hour company wrap rate.
If you raise the company wrap rate by 2.00 per hour, net profit before interest and taxes (NPBIT) increases from $213K to $313.9K. Annual sales increases to $5,099,520. Material is still $110,384, but now represents only 28.1% of sales. Direct labor hours are the same. hourly rate is still $18.00 per hour, but now represents only 16.6% of sales. Monthly sales has now increased by $7,656 to $392,271. The direct labor rate, plus factory overhead is still $72.97. Profit now represents $6.02 per direct labor hour. Material now represents $30.57 per direct labor hour. The company wrap rate is $109.51 per direct labor hour.
If you lower the company wrap rate $2.00 per hour and realize the expected 10% increase in annual net sales to $5,500,000 ($423,076 per 4 week month), then net profit before interest and taxes (NPBIT) increases to $384,830 for a gain of $171,830, or a 170% gain over raising the company wrap rate by $2.00 per hour. Material is still 28.7% or $121,423 per month because we increased sales so material will still have the same % of sales. The true 25% markup on material is $40,474 per month. Direct labor hours per month increase to 3,972 per month. It requires an additional 3 direct labor workers (23 to 26 workers) to create the 10% increase in sales. NPBIT is $384,830. Monthly sales is now $423,076. The company wrap rate is now $107.48, but NPBIT goes to $6.85 per direct labor hour. Material stated as a component of the company wrap rate is now $30.57 per direct labor hour. Total company wrap rate is actually now only $.07 more than that for the original $5MM company
Reducing the company wrap rate by $2.00 per hour, combined with a modest 10% increase in sales, changes the total of factory and G&A burden rates because factory overhead expenses and G&A expenses are spread across more sales. material markup is more. This mitigates the actual decrease in company wrap rate is not $2.00 per hour to only $.07 per hour.
Do You Have a Similar Profit Opportunity?
Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
Click here to learn more about Profit Scheduling.
You want to decrease your cost of goods sold by a net 5%. To do this you decide to empower your shop employees by offering them a cash incentive, equal to 1/2 of the demonstrated reduction in cost of goods sold. What increase in annual net profit before interest and taxes will you gain if your shop employees achieve the desired reduction in cost of goods sold.
A) Increase $251K B) Decrease $15K C) Increase $126K D) Decrease $121K E) Don’t know
Click here to see our answer.Answer
The answer is "C". Net annual profit before interest and taxes increases by $126K.
Explanation
Our $5mm company's annual cost of goods sold is $3.76MM, or 75.2% of sales. Contribution margin is $1.24MM or 24.8% of sales. Net profit before interest and taxes (NPBIT) is $213K.
With a Profit Share ®© fueled reduction of 5%, cost of good sold drops to $3.51MM or 70.2%of sales. Contribution margin is now $1.49MM or 29.8%. Net profit before interest and taxes (NPBIT) is now $464.6K.
Contribution margin increased by $251K. With Profit Share ®© 1/2 of the 5% reduction in cost of goods sold goes to the company and 1/2, $125.5K, goes to the shop employees. . Each employee earns $3,492 per year or $291.02 per month.
Although the Profit Share ®© incentive payments of $125.7K reduce NPBIT from $464.6K to $338.9K, a net gain in annual NPBIT of $125.9K (338.9K less $213K) is realized.
We believe significant, persistent reductions in cost of goods sold can only be achieved when direct labor and factory overhead workers are encouraged and empowered to engage in activities that reduce cost of goods sold. Furthermore, direct labor and factory overhead workers should be periodically rewarded by receiving a share in documented reductions in cost of goods sold.
Do You Have a Similar Profit Opportunity?
Time is money! Don't lose another day's potential profits! Gain corporate insight by applying our philosophy, concepts, products and services to your company's operations. Contact us now.
Click here to learn how we can translate theory to real results in your plant with Profit Scheduling.
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