The old saying goes that time is money. But is that how businesses tend to act? The common ways for businesses to asses the money piece is of course in the P&L which comes monthly, quarterly and yearly. At an aggregated level money gets reported as a function of time.
How does business do this at a product level? To this purpose, most apply cost accounting principles.
Does cost accounting have any pitfalls? To understand that, first we need to examine what cost accounting tries to accomplish. Normally, cost accounting allocates cost based on resources used to produce a unit, to come to a fair cost allocation that represents the cost of setup, labor and other. So far, so good.
A complicating factor comes in the batch-size produced. Bigger batches are perceived lower cost as the setup cost can be spread more thinly over a bigger number of units produced. Now product cost and target margins help to determine selling price. Many businesses need this as it is never easy to guess how much a customer is willing to pay. You need a starting price that you can defend when offering a product. I am assuming that a customer will always challenge a price and that the majority of business is no monopoly, to the contrary.
Once the base cost for each product is set, a next level use of cost accounting is to tune product cost to drive the most desired product mix. This of course will be the most profitable mix. Here we do run into a critical issue with cost accounting… cost calculated is two dimensional. It only links cost to volume (batch size) to drive variation. For a tool that drives critical decisions which products to promote, for which products to increase price and which products to discontinue, cost accounting lacks the critical element of time.
In Theory Of Constraints, the time element of Throughput (profit contribution) is used per so called constraint unit. Although there is more to it, a simpler version is explained here. TOC uses the concept Throughput which you determine by the subtraction : selling price – raw material cost for a product. If the selling price for a product is 90 and the raw material cost for that product is 40, the Throughput equals 50. If we have two products and product A has a Throughput of 50 and product B has a Throughput of 40, at face value you will want to promote product A, right? Higher Throughput. Well, we need some more info to make a better decision. Would it change your mind if you know product A takes 25 minutes to produce and B only 10 minutes? The Throughput per minute for A then shows as 2 where for B it is 4! Promoting product B will grow your bottom line twice as fast..? Of course, you will now need to revisit cost accounting and determine whether you need to subsidise B and put a higher cost allocation on A to not let cost accounting become a stumbling block. Bottom line: Time is money and as a third dimension view added to your existing cost accounting process helps you make the right decisions. This approach is most important if you have an internal capacity or even a cash constraint. If you want more understanding on this, please contact us for a free discussion to asses how this can help you boost your bottom line in the shortest time possible.
In this section we will frequently add short articles on different topics related to business, processes improvement, aiming to provide insights from a slightly different angle. To provoke your thoughts.