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Two Different Thinking Bridges Part 2

Two Different Thinking Bridges Part 2

By Bob Sproull

Review

In the last post, we presented the concept of two different thinking bridges (i.e. least cost vs. global thinking bridges) and laid out the first part of a case study about an engineer who wanted to implement an improvement. After presenting the data for the company, we used the least cost analysis to determine the impact of the proposed improvement on the first year cost savings (i.e. $17,085, a payback period of less than three months, and the internal rate of return, which was over 400%. We then ended the post by relating four questions asked by the Casparis:

  • Since the payback period is less than three months, this appears to be an excellent proposal. What do you think?
  • Is this proposal an improvement?
  • Is the example typical of how decisions are made in your organization?
  • Does your organization pursue production efficiencies with the purpose of increasing the bottom line?

In today’s post, we will use the global thinking bridge to analyze the engineer’s proposal. You can then answer the Casparis’ four questions listed above. As pointed out in the last post, in this series of posts we will present material published in a book entitled Management Dynamics—Merging Constraints Accounting to Drive Improvement written by John and Pamela Caspari[1]. I recommend this book to anyone trying to drive profitability to new levels.

Initial Data

As a review, here is the initial data we presented in the last post.

The company is currently selling 3,500 widgets per year at a price of $400 each. The widget manufacturing process uses four workstations as follows:

Work Station

Processing Time

101

15 minutes

102

25 minutes

103

10 minutes

104

5 minutes

Total Time

55 minutes

Widgets process sequentially through four workstations. When completed, the widgets transfer to a finished-goods storage area or ship to the customer.

Each widget requires raw materials costing $80. Individual employees at each workstation earn $18 per hour. Each employee works 2,080 hours per year (40 hours per week for 52 weeks per year), and the employees are not cross-trained. The plant engineer has been hard at work and has determined that, with the addition of a fixture that costs only $5,000, the processing times at each workstation can modify. We will now answer the Casparis’ questions and demonstrate how the “Global Thinking Bridge” evaluates this proposal.

Scenario 1: Using the Global Thinking Bridge

The Global Thinking Bridge (aka Throughput Accounting) uses Throughput, Investment/Inventory, and Operating Expense as its cornerstone. When using this bridge technique for financial analysis of a proposed expenditure, we ask a series of five questions about the proposal:

  1. What prevents the firm from increasing Throughput (T)?
  2. Will the total amount of Throughput change?
  3. Will the Operational Expenses (OE) of the firm change?
  4. Will the amount of Inventory/Investment (I) in the firm change?
  5. What is the real economic effect of this proposal?

Q1: What prevents the firm from increasing Throughput? It’s important to note that this question is not part of the Least Product Cost Analysis because it is not part of the Least Product Cost Thinking Bridge. The bottom line is that workstation 102 limits the number of widgets that can be produced and by adding two minutes to its processing time, we have reduced the capacity of this process. Even with the addition of two minutes, the capacity is still enough to satisfy their number of orders. The real limitation lies in the market demand for this company’s widgets. They are selling 3,500 widgets per year though their capacity is more than 4,500.

Q2: Will the total amount of Throughput (T) change? The answer is no; since the engineer’s proposal has no impact on the sales volume, neither the sales revenue nor the variable cost of sales (i.e. raw materials) changes. Remember, Throughput is defined as Revenue minus Totally Variable Costs.

Q3: Will the Operational Expenses (OE) of the firm change? If we have the same number of employees and the amount of overhead has not changed, then the answer is no. There might be a small amount of change in things like depreciation or energy usage, but for the most part, there are no changes to OE.

Q4: Will the amount of Inventory/Investment (I) change? The value of (I) will increase by $5,000, the cost of the new fixture.

Q5: What is the real economic effect of this proposal? The real economic effect is that the company spends $5,000 and has a real economic loss of $5,000 in the first year and no change in subsequent years.

So based upon this analysis, how would you answer the Casparis’ questions?

  • Since the payback period is less than three months, this appears to be an excellent proposal. What do you think?
  • Is this proposal an improvement?
  • Is the example typical of how decisions are made in your organization?
  • Does your organization pursue production efficiencies with the purpose of increasing the bottom line?

I can’t answer all of the questions, but I can answer the first two. Based upon the Global Thinking Bridge result, this proposal is not something this company should accept. Losing $5,000 should not be considered an improvement. Only you, the reader, can answer the last two questions.

Next Time

In my next post, we will present a second scenario, using much of the same data we used in scenario 1, but with a couple of modifications. We will, once again, use both thinking bridge techniques to analyze the same proposal made by the engineer. As always, if you have any questions or comments about any of the posts, leave a message and I will respond.

Until next time.

Bob Sproull

References:

[1] Management Dynamics—Merging Constraints Accounting to Drive Improvement, written by John and Pamela Caspari, published by John Wiley & Sons, Inc, 2004

Bob Sproull

About the author

Bob Sproull has helped businesses across the manufacturing spectrum improve their operations for more than 40 years.

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