Presentation on theme: "Throughput Profit Multiplier Based on the books: Building Lean Supply Chains with the Theory of Constraints Managing Business Process Flow."— Presentation transcript:
1 Throughput Profit Multiplier Based on the books: Building Lean Supply Chains with the Theory of Constraints Managing Business Process Flow
2 Throughput Profit Multiplier (TPM) A large fraction of the operating costs are fixed small changes in throughput could be translated into large changes in profits.Throughput profit multiplier (TPM) =TPM = % Changes in Profit/ % Changes in Throughput% Changes in Profit = (Profit2-Profit1)/Profit1% Changes in Throughput = (Throughput2-Throoughput1)/Throughput1TPM = (Prof2-Prof1)/Prof1]/[ (Q2-Q1)/Q1]Suppose fixed cost F = $180,000 per month. Sales price per unit P = 22, and variable cost per unit V = 2. In July, the process throughput was 10,000 units. A process improvement increased throughput in August by 2% to 10,200 units without any increase in the fixed cost. Compute throughput profit multiplier.
3 Financial Throughput and Fixed Operating Costs We define financial throughput as the rate at which the enterprise generates money. By selling one unit of product we generate P dollars, at the same time we incur V dollars pure variable cost. Pure variable cost is the cost directly related to the production of one additional unit - such as raw material. It does not include sunk costs such as salary, rent, and depreciation. Since we produce and sell Q units per unit of time. The financial throughput is Q(P-V).Fixed Operating Expenses (F) include all costs not directly related to production of one additional unit. That includes costs such as human and capital resources.In our example, F = $180,000 per month, P = 22, and V = 2. In July, financial throughput was 10,000(22-2) = 200,000. In August R increased by 2%.
4 Another Look at Throughput Profit Multiplier Financial throughput is (22-2)10000 =Fixed Operating Expense =In this example, Fixed Operating Expense is 90% of Financial Throughput.F= 0.9(P-V)QProfit = 10% of financial throughput. Profit = 0.1(P-V)QIf Q increases by 1% Financial throughput increases by 1% too, and it is all profit because we have already covered all fixed operating expenses.Therefore increase in profit = 0.01(P-V)Q, and % change in profit = 0.01(P-V)Q/0.1(P-V)Q =0.1 = 10%.1% change in Throughput, 10% change in profit.2% increase in throughput 20% increase in profit.
5 Throughput Profit Multiplier Let us summarize our notations (these notations benefit from E. Goldratt and M. M. Srinivasan)Throughput: QFixed Operating Expenses; cost of human resources and depreciation of capital resources plus all other indirect costs: FTotal Revenue: PQTotal Cost: VQ+FProfit Margin; the money generated by producing (and selling) additional unit : P-VFinancial throughput. The rate at which the enterprise generates money: (P-V)QProfit = (P-V)Q-F
6 Relationship Between Financial Throughput and Fixed Operation Expenses Suppose F/Financial-Throughput = y = F/(P-V)Q = y; 1>y >0Therefore, F = y(P-V)QProfit = (P-V)Q-F = (P-V)Q - y(P-V)Q = (1-y)(P-V)QIf % increase in throughput is x%.Then the increase in profit is x(P-V)Q.% change in profit = [x(P-V)Q]/[(1-y)(P-V)Q]% change in profit = x/(1-y)TPM = % change in profit /% changes in throughputTPM = [x/(1-y)]/xTPM = 1/(1-y)
7 Problem 5.6A company's average costs and revenues for a typical month are $15 million and $18 respectively. It is estimated that 1/3 of the costs are variable and the rest are fixed. What is the throughput profit multiplier?Total Variable Cost =VQ = 5,000,000Fixed Operating Expenses =F = $10,000,000Total Revenue = PQ = $18,000,000Financial Throughput = (P-V)Q = PQ-VQ = $18,000,000-5,000,000 = 13,000,000F/(P-V)Q = $10,000,000/ 13,000,000 = 10/13TPM = 1/(1-y) = 1/(1-10/13) = 13/3If throughput increases by 1% profit will increase by 4.33%.
8 A Viable VisionA Viable Vision (Goldratt): What if we decide to have todays total revenue as tomorrows total profit.In our example, Financial Throughput in July was Q1(P-V) = 10,000(22-2). In order to have your profit equal this amount we need to produce Q2 units such that:Q2(P-V) – F = Q1(P-V)Q2(20) -180,000 = 10,000(20)Q2(20) = 380,000Q2 = 19,000In order to have your todays total revenue as tomorrows total profit. We should increase our sales by (19,000-10,000)/10,000 = 90%. If we almost double our sales, our current revenue becomes our tomorrows profit.
9 A Viable Vision- Goldratt Decide to have your todays total revenue as your tomorrows total profit. What should your sales be equal to?Todays Throughput =R, Today’s Revenue = PRTarget Profit = (P-V}R2-F, Target Throughput =R2 = (1+x)RF= y(P-V)R PR2-F = (P-V) (1+x) R-y(P-V)R(P –V)(1+x)R-y(P-V)R= (P –V)R[1+x-y)=PR1+x-y = P/(P-V) x = P/(P-V)-1 +yx = V/(P-V) +yIf V= zP then, x = zP/(P-zP) +y = z/(1-z)+yIn our example, P=22, V=2 z =1/11, z/(1-z) = 0.1, F = 180,000, R =10,000, F = 0.9(P-V) y=0.9 x = = 1.If R is doubled, todays revenue becomes tomorrows profit.
10 A Viable VisionIf Variable cost is less than 60% of the sales prose, the viable vision is achievable by incensing the throughput by less than 2.5x.