Example of a Simple Company

Example of a Simple Company

Assumptions:

Company Operating Expense = $10,500 Per Week

1. Only two operations: stamp, and assemble
2. Only 2 products: widget and gadget
3. Demand for both is predictable: 120 units/wk
4. Widgets sell for $105; gadgets for $100
5. Widgets raw material cost: $45
6. Gadgets raw material cost: $50
7. Widgets stamping time: 2 minutes, assembly is 15 minutes
8. Gadgets stamping time: 10 minutes, assembly is 10 minutes
9. Each machine has one operator working 8 hrs/5 days/ or 2400 minutes per machine, per operator per week

Each machine has one operator working 8 hrs/5 days/

or 2400 minutes per machine, per operator

WIDGET / GADGET
Weekly Demand / 120 / 120
Price / $105 / $100
Raw Material Cost / $45 / $50
Stamping Time / 2 / 10
Assembly Time / 15 / 10
Total Process Time / 17 / 20

Capacity Evaluation

STAMPING / ASSEMBLY
Minutes to Make Weekly Demand of Widgets / 240 / 1800
Minutes to Make Weekly Demand of Gadgets / 1200 / 1200
Total Minutes to Make Weekly Demand for Both / 1440 / 3000
% of Capacity to Meet Market Demand for Both / 60% / 125%

Can't Meet Total Market Demand for Both

Now What? Choose the “Best” Product

Widget / Gadget / Best Product
Price / $105 / $100 / Widget Has
Higher Price
Raw Material Cost / $45 / $50 / Widget Material
Cost Is Lowest
Process Time / 17 / 20 / Widget Requires Less Time

Obvious strategy is to make all of the most profitable item we can and use any excess time to produce the next most profitable part.

How does that work out?

Maximizing Production of Most Profitable Item

Meet Market for Widget / Produce Bal
Avail Gadget / Company
Total
Units Sold / 120 / 60 / 180
Revenue / $12,600 / $6,000 / $18,600
Raw Material Cost / $5400 / $3000 / $8400
Gross Margin / $7200 / $3000 / $10,200
Operating Expense / $10,500
Net Profit / ($300)

Reverse: Maximizing Production of Least Profitable Item

Produce Bal
Avail Widget / Meet Market for Gadget / Company
Total
Units Sold / 80 / 120 / 200
Revenue / $8,400 / $12,000 / $20,400
Raw Material Cost / $3,600 / $6,000 / $9,600
Gross Margin / $4,800 / $6,000 / $10,800
Operating Expense / $10,500
Net Profit / $300

What if we spent $1000 to decrease widget assembly by one minute, while increasing stamping time by 3 minutes?

This would increase the product cost in a conventional cost accounting system, and the idea would not see the light of day.

Each machine has one operator working 8 hrs/5days/or 2400 minutes per machine, per operator

WIDGET / GADGET
Weekly Demand / 120 / 120
Price / $105 / $100
Raw Material Cost / $45 / $50
Stamping Time / 2 / 10
Assembly Time / 15 / 10
Total process / 17 / 20

Proposed Change at an Investment of $1000

WIDGET / GADGET
Weekly Demand / 120 / 120
Price / $105 / $100
Raw Material Cost / $45 / $50
Stamping Time / 5 / 10
Assembly Time / 14 / 10
Total process / 19 / 20
Produce Bal
Avail Widget / Meet Mkt
for Gadget / Company
Total
Units Sold / 85.7 / 120 / 200
Revenue / $9000 / $12,000 / $21,000
Raw Material Cost / $3857 / $6000 / $9857
Gross Margin / $5143 / $6000 / $9857
Operating Expense / $10,500
Net Profit ------$643
Delta NP = $323 per week Delta NP as % of NP = 114%