Driving Profitability: Understanding Your Costs & Operational Performance
This article appeared in 2024 MMA Operations Conference event program. Learn more about MMA events.
It’s happened again — another month-end, and the profits are not where you expected! Margins are still coming in lower than they should. What are you missing?
Many small and mid-size manufacturers struggle with profitability for the same reason: They haven’t fully captured their total cost of production and its impact on operating performance.
Understanding the total cost to manufacture and the ability to monitor operating performance are key to driving profitability. Having a clear picture of your company’s cost structure makes a crucial difference in your ability to manage costs, accurately evaluate and improve performance, and — most importantly — make informed business decisions that can propel your company forward. Here’s what it takes:
Step 1: Establish a solid foundation that comprises:
- Selecting a costing methodology and costing approach. Based on the nature of the item produced, select a costing methodology that aligns with your production process — job cost, work order or repetitive — and costing approach — actual, average or standard.
- Developing your total cost to produce. Your goal is to identify all costs incurred to produce the product.
- Materials Costs (aka Bill of Materials): Specify the materials and quantities required for each item and the yield or scrap inherent in the production process.
- Production Processes (aka Router): Create a production route detailing the steps to produce the item and the labor needed for each step. If applicable, include outside processing.
- Overhead: Establish cost pools that align with the production process; establish an allocation methodology.
Step 2: Identify and understand your capacity (throughput) and its impact on overhead rates. Allocate fixed costs based on the level of capacity and treat fixed costs related to unused capacity as a period expense.
Step 3: Quantify and analyze performance. You’re now ready to evaluate the actual costs to produce versus the estimate. 1) material: usage and price, 2) labor: utilization and efficiency, and 3) overhead absorption.
Ultimately, these efforts will help identify the causes driving variance to expected performance — training or equipment issues, unexpected increases in materials prices, etc. — and give you the information needed to make fact-based decisions:
- Identify corrective actions along with the associated costs to implement and the expected results.
- Evaluate operating decisions, such as investing in capacity, equipment upgrades or process improvements.
- Assess make-versus-buy opportunities; what and when to produce in-house or outsource.
- Opportunities for competitive pricing
Every one of these challenges can become an opportunity when you know your cost structure and monitor operating performance.
About the Author
Jerry Benjamin is Consultant with Rehmann focused on CFO Services, Finance and Accounting Solutions. He may be reached at 313-910-8971 or jerry.benjamin@rehmann.com.
Jerry Benjamin was a speaker at the 2024 MMA Operations Conference. Learn more about MMA events.
Rehmann is an MMA Premium Associate Member and has been an MMA member company since July 2006. Visit online: rehmann.com.