Profitability – Identifying Real Cost Problem

Author: Larry Chester, President

Product pricing is often based on understanding cost of goods sold (COGS). The cost problem arises when the actual costs are different from the estimates used. This CFO Simplified customer watched profitability slowly disappear — till they incurred a 125,000 loss. Understanding the cause was the first step to returning to profitability.

• Business – Printer
• Location – North Central Illinois
• Sales – $19,200,000
• Ownership – Single owner – second generation

Solution

To identify where the losses were occurring, job estimates were first compared to the final production cost. Manufacturing variances were caused by a variety of factors, but the summary GL postings didn’t provide an answer. Pulling raw data from the company’s production system allowed a comparison between the estimate and the actual cost of production of each item shipped in the prior week. This information was available from their ERP System.

Initial variances were calculated at between 15% and 35% for each production run, which in most cases exceeded the planned margin. Each production run was scrutinized to determine the specific cause(s) of the variance.

Digging into each of these production orders showed a variety of issues, including – Third shift production; excessive set-up time; slow press run rate; broken printing plates; slow response time from QC to verify pre-press samples. Each one was discussed individually with the Operations VP and Production Manager.

Responsibility for production improvement was then assigned to the Production Manager. The weekly production variance report was reviewed by the Production Manager with the Team Leads.

Result

The reports identified that production problems weren’t unique. They were nearly epidemic. Greater scrutiny of the causes, with variances being reported daily, brought the issues of cost over-runs to prominence. With everyone keeping their eye on the ball, the number of production problems dropped. This resulted in cost variances being reduced to less than 5% in 90 days. That reduction drove a dramatic change in profitability, since removing wasted materials and wasted time turned each printing press into a profit generator. Monthly results showed an immediate turnaround, with Net Income moving from a loss of 125,000 to a profit of $490,000 in the first year, an increase of nearly half a million dollars.