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Manufacturing Processes—Production and Business: Measurements for Effective Decision Making, Part 9

Manufacturing Processes—Production and Business: Measurements for Effective Decision Making, Part 9

By Bob Sproull

Review of Measurements for Effective Decision Making, Part 8

by discussing constraint schedule attainment, manufacturing productivity, and manufacturing effectiveness.

In Part 9, I will present the final four measurements: order cycle time, throughput shipping delay, inventory turnover and return on investment. I will refer to the highly recommended [1] Throughput Accounting—A Guide to Constraint Management, a book written by Steven M. Bragg, as I have throughout this series.

Calculate order cycle times for information that can help speed processing

The faster a company can process orders through its production system, the faster it can realize more throughput and profitability. Even though the volume of orders processed is entirely driven by the capacity of the constrained resource, other parts of the production process can be compressed to achieve even shorter cycle times. This is important to remember in instances when demonstrably shorter cycle times than your competition may result in more orders, although this will create a larger backlog in front of the constraint. The order cycle time is calculated by subtracting the order receipt date from the ship date for each order shipped. From this calculation for each order, we can calculate an average for all orders.

The calculation is:

(Ship date) – (Date of receipt of order)

Let’s look at an example from Throughput Accounting—A Guide to Constraint Management:

The Marine Granite Company, makers of fine marble tiling for oceangoing yachts, must process orders on a timely basis or they will incur the wrath of wealthy clients. Some types of granite must be flown in from remote areas of Italy, and can be delayed well beyond the norm. Its order cycle time information for the past month is seen in the table below:

Order Number Ship Date Order Date Cycle Time Days

200603

None

January 11

139

200641

None

February 06

114

200832

May 17

April 23

24

200833

May 19

April 26

23

200834

May 25

April 30

26

200835

May 25

May 03

22

200836

May 26

May 09

17

200837

May 29

May 09

20

200838

May 31

May 12

19

If Marine Granite’s cycle time calculation in only based on the final seven orders on the list, the average cycle time appears to be a reasonable 21.6 days. However, if you include the two orders for which granite has not yet been received from Italy, and has not yet shipped, then the average cycle time increases to 44.9 days, which is clearly not acceptable.

Use throughput shipping delay to identify bottlenecks late in the production process

Even though the constrained resource is the primary determinant of the amount of throughput that can be shipped, there can also be delays later in the production process that can prevent orders from being shipped. To see if this problem exists, it is useful to track the throughput shipping delay. The calculation for this is to divide the amount of throughput dollars shipped late (or not yet shipped at all) by the total throughput scheduled for shipment during the period.

The calculation is:

Throughput Shipping Delay =

Throughput $ scheduled for shipment but not shipped


Throughput $ scheduled for shipment in the period

This measurement is designed to support the customer service function, since it reveals the proportion of orders shipped late (even if the delay is only one day). Let’s look at a simple example provided by Bragg:

The Big Round Tire Company sends custom drag racing tires to clients around the world via air express because timely delivery is enormously important in this industry. The company manufactures its own tires. They have been having trouble processing sufficient quantities of green (uncured) tires through their curing station to meet scheduled shipment dates. In the most recent month, shipments representing 22 percent of all throughput dollars were sent after their scheduled dates. One third of the orders in the 22-percent measurement were not shipped as of month’s-end, which resulted in a throughput shortfall for the month of $231,000. The 22-percent throughput shipping delay is used to measure the company’s customer service performance, while the $231,000 of lost throughput is used to explain a portion of Big Round’s loss for the month.

Use inventory turnover to maximize use of the constraint

Inventory turnover is traditionally defined as the annualized cost of goods sold divided by the average level of on-hand inventory. In a throughput environment, the inventory turnover calculation changes, as does the application of overhead costs to both components of the calculation. Further, it is used in a different manner to manage the business. When measuring inventory turnover to maximize the use of the constraint, the key issue is how much inventory is needed to maximize throughput. Considering this goal, the cost of goods sold is replaced in the numerator by throughput dollars. Inventory remains in the denominator, but the amount shown is strictly the variable cost of the inventory. Overhead is not added to any part of this calculation.

The calculation for inventory turnover is:

Inventory Turnover =

Annual throughput


Acquisition cost of on-hand inventory

Let’s look at an example provided by Steven Bragg:

The J-Stroke Company builds a traditional strip-built birch bark canoe. Strips are taken from birch planks to construct each canoe in a series of lamination steps. The problem is that many birch planks contain flaws in the grain which are only discovered during the production process. A great deal of raw material must therefore be stocked to ensure sufficient inventory is available to keep production running smoothly.

J-Stroke’s current inventory investment is $620,000, and its annual throughput is $4,250,000, which represents inventory turn-over of 6.9. If J-Stroke invests an additional $100,000 in birch planks, it estimates that the constraint resource will suffer less downtime, resulting in increased throughput of $210,000. The resulting inventory turnover would be 6.2. Thus, an increase in inventory also increases throughput, which is a desirable outcome, despite the resulting decline in inventory turnover.

Calculate return on investment the throughput accounting way

In throughput accounting, there are few investments made, with the exception of inventory. The general assumption is that the system already has an excess level of capacity, except at the constraint, so capital investments are not common. The return on investment calculation is net profit divided by the acquisition cost of on-hand inventory.

This is the calculation for ROI:

Return on Investment =

Net profit


Acquisition cost of on-hand inventory

Let’s examine another example from Bragg:

The Ashley Spinning Wheel Company wants to increase sales of a specific product by stocking more finished goods for its primary summer sales season. Historically, if this company runs out of product, customers will buy from their competitors. In this case, the constraint is the market, so it can increase production levels. Ashley’s sales manager estimates that an additional 240 spinning wheels should be held in stock during their busy summer sales season. The materials cost of each spinning wheel is $315, for a total cost of $75,600. No additional labor costs are added since those costs are charged off as operating expenses incurred. Ashley then realizes sales of 195 spinning wheels with each wheel selling for $750. Its ROI is then:

Return on Investment =

($750 – materials cost) x 195 units sold


$315 materials cost x 240 units held in inventory

= 12.2% return on investment

Coming in the next post

In the next post, I will complete this series on our constraint-based performance reporting system by discussing three important reports that manufacturing companies should generate, Throughput Contribution Report, Buffer Management Report and Buffer Hole Percentage Trend Report. As always, if you have any questions or comments about any of my posts, leave a message and I will respond.

Until next time,

Bob Sproull

References:

[1] Throughput Accounting—A Guide to Constraint Management, by Steven M. Bragg, John Wiley & Sons, Inc., 2007.

Until next time,

Bob Sproull

References:

[1] Throughput Accounting—A Guide to Constraint Management, by Steven M. Bragg, John Wiley & Sons, Inc., 2007.

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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