Key Concept #2 Lost Time / Opportunity Cost
In our last post we discussed a Key Concept: Throughput-margin is Additive.
We demonstrated that each job produces some amount of Throughput-margin and that we can simply add up all the Throughput-margin for the jobs we completed, shipped, and invoiced for a month and compare it to the total Operating Expense for the month to determine if the company made or lost money.
In this email, we’re going to take a deeper look at the additive concept of Throughput-margin and introduce a second Key Concept: “Lost” Time. Lost time is similar to opportunity cost.
A company loses money when Throughput-margin is less than Operating Expense for a time period.
Recall our example from Throughput-margin is Additive. Our example company had completed, shipped, and invoiced three jobs (Job 1, Job 2, and Job 3).
Now imagine that for whatever reasons, the company was unable to complete, ship, and invoice Job 3 during the time period. The reasons, while important are not where we are placing our emphasis, but rather on the bottom-line.
We refer to nonproductive time, in all its many forms, as “Lost” Time. There are numerous reasons for Lost Time, most of which are directly under your control (like set-up time). Once the time is lost, you cannot get it back. (But because Throughput Accounting does not allocate costs, there is no “cost” associated with Lost Time. Rather, there is an opportunity cost for the Throughput-margin that could have been generated with the time if it was used more effectively.)
In this example, let’s just say that there was a weather event for several days.
Now as a result, the only sources of Throughput-margin are Job 1 and Job 2. The total company Throughput-margin is less than total Operating Expense for the time period. The company loses money. In the example, $10,000 (loss).
In this case, both Jobs 1 and 2 still have the Throughput-margin that they do. Neither are “less profitable”. The reason the company lost money was that it did not ship Job 3 as originally expected.
Cost accounting would have allocated more expenses to Jobs 1 and 2, which would have meant they would have “made less” or perhaps even “lost money”. However, that is not the case. Jobs do NOT lose money.
The jobs have the same Revenue and Totally Variable Costs (TVC) as well as the same Throughput-margin.
In this example, the loss had nothing to do with labor being inefficient or ineffective. However, it very clearly illustrates the need for a company to generate Throughput-margin.
Operating Expense is going to be incurred each month, and in most cases regardless of the circumstances.
It’s your job as the owner to ensure your business generates enough Throughput-margin each month to cover the Operating Expense and generate the level of Net Profit you need or want.
To find out if lost time is costing you in your shop, sign up for a free Strategy Session. We’ll go deep and dig into YOUR financials to see if Job Shop Pricing is a good fit and how much improvement is possible for YOU.