Theory of Constraints POOGI Part 56: We lost money on that job!

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints. {This series was co-written with Brad Stillahn.}

Cost accounting is alive and well in American business (and around the world really), even though it is an invalid, old technology. The continued—and unquestioned—use of cost accounting has led directly to the loss of competitiveness and long-term decline of American manufacturing. Stop using it!

Brad: You give a lot of speeches to business owners. Tell me again, what drives you nuts?

Dr. Lisa: When someone says “We lost money on that job” or “We lost money on that project".

Brad: That’s cost accounting talking. It’s amazing the owner is still in business, saying something like that. If his competition didn’t all think the same way, he would be out of business.

Dr. Lisa: Truly variable costs—materials, outsourcing, freight, sales commissions—are normally just a fraction of the selling price. There are only two ways to lose money on a job: 1) charge less than your truly variable costs; or 2) re-work a job over and over again causing you to incur the truly variable costs multiple times and the total of all the truly variable costs are more than the price you charged.

Brad: The all-industry average for truly variable costs (TVCs) is 40%. And machine shops are usually much less than that, depending on the type of work they do. So why does the business owner think he “lost money on that job”?

Dr. Lisa: It’s the allocation of overhead cost, the number one conceptual mistake of cost accounting. Remember, cost accounting was invented back at the turn of the last century, when labor was paid piece rates and overhead was less than 10% of total costs.

What really happened was that the job took more time than estimated. And since cost accounting allocates “cost” to that time, the job “cost” more than expected, perhaps more than the price. But this is a mirage. The margin received — the sales price minus the truly variable costs — is the same no matter how long the job took to produce.

... to be continued.

Here's to maximizing YOUR profits!

Dr Lisa Lang

(c)Copyright 2009, Dr Lisa, Inc. All rights reserved.

Theory of Constraints POOGI - Part 48

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints. {This series was co-written with Brad Stillahn.}

Do-it- yourself 'Viable Vision'

Brad: "If a business owner wanted to grow the bottom-line of their company at the fastest rate possible, what would he or she have to do?"

Dr. Lisa: "Get operations 'perfect', and increase sales without a proportionate increase in fixed costs."

Brad: "And what kind of improvement is possible, say for a machine shop?"

Dr. Lisa: "We call what is possible 'Viable Vision'. It varies for different types of businesses, but the results that are possible are bigger than most business owners dare imagine. One definition of Viable Vision is to 'turn your sales level into your profit level in four years or less'."

Dr. Lisa: "Another definition is to increase the percent return-on-sales to a level that the owner, at the outset, would definitely agree is unrealistic. For example, a business that has hovered around breakeven can easily have a 20% return-on-sales, but the owner probably thinks this is unbelievable. And it doesn't matter how small or large the company is; it's possible. The amount of TVCs a company has, as a percent of sales, will have an impact on how long it will take. But it is possible."

Brad: "So what you're saying is a business with $2 million in sales could have $2 million profit by the middle of 2013. Or $10 million sales into $10 million profit. Have you forgotten about the recession?"

Dr. Lisa: "The recession just highlights the importance of sales. A business with an offer 'too good to refuse', what I call a 'Mafia Offer', will grow sales in any economic conditions. We have experience with companies that traditionally had a 'hit rate' of less than five percent, increasing that to well over 50%, while reducing their sales cycle time."

Brad: "What do you mean by 'perfect' operations?"

Dr. Lisa: "When we develop a Mafia Offer, there is a need for operations to be very reliable. By 'perfect', I mean it must be a rare occurrence for the company to miss a due-date commitment or whatever the offer promises. A Mafia Offer is backed up with a solid guarantee, in the form of a self-imposed penalty for non-performance of the offer, so if we're late, for example, we might be giving the customer the order for free."

Dr. Lisa: "No matter how unreliable a machine shop might be now, they can become 100% on-time in a very short period of time, like two months."

... to be continued.

Here's to maximizing YOUR profits!

Dr Lisa Lang

P.S. If you have an internal constraint (not 100% on time), check out www.VelocitySchedulingSystem.com (based on Golratt Drum Buffer Rope) Group 5 starts November 23, 2009! (for job shops only)

P.P.S. If you have an external constraint, check our our ON-LINE at www.MafiaOfferBootCamp.com ; GROUP and PRIVATE Mafia Offer Boot Camps at www.MafiaOffers.com

P.P.P.S. If you have a cash constraint ACT NOW! Free cash video, click here --> The Fastest Way to Increase Cash Flow.

(c)Copyright 2009, Dr Lisa, Inc. All rights reserved.