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Using Throughput to Gain Efficiencies and Increase Profitability

08/26/2021 Kelsea Faulkner

Keeping a business moving forward, scaling up, and maintaining profitability is a recipe for success, but it’s not easy. How can a business succeed as they continue to grow or, conversely, if they hit hard economic times like a global pandemic? The answer is by managing throughput.

Throughput equals the number of units divided by time. Adding this metric to your key performance indicator toolbox can help you manage costs in times of uncertainty or increase the bottom line for future development of the business. Focus should be placed on capacity utilization, inventory turnover, and employee turnover rate to increase the throughput of your business.

Capacity Utilization – Actual Factory Utilization/ Total Productive Capacity

Capacity utilization helps determine how close (or how far) your facility is to operating at maximum output. A facility’s maximum productive output involves the utilization of every inch of a production facility and capacity of equipment.

Why it matters: Ideally, a facility should operate at 100% capacity utilization. Production inefficiencies decrease utilization driving up the overhead costs and increasing production time, resulting in decreased throughput.

Ideas for increasing capacity utilization:

  • Minimize Movement of Production Materials– If specific inventory is used for certain machines, try to place those items as close to the machine as possible to reduce the number of times inventory is touched and decrease travel time to start production.
  • Location of Equipment – Strategically position machinery and equipment to reduce the time products move between the production process.
  • Create a Workflow Chart for All Products – Do you know the lead times for each product? Where are the bottlenecks? Could bottlenecks be minimized by changing the location of inventory or equipment? Documenting the production process in a workflow chart will highlight efficiencies and inefficiencies currently impacting your capacity utilization.

Inventory Turnover – Cost of Goods Sold/Average Inventory

From juggling product prices to predicting customer demands and managing supply shortages, managing inventory likely rises to the top of a manufacturer’s list of pain points.

Why it matters: Understanding the types of inventory used in your product production, the movement of inventory through your production processes, and the historical and future purchase prices allow for effective business decisions.

Ideas for increasing inventory turnover:

  • Fixed Pricing Agreements with Suppliers – To combat large fluctuations in pricing of inventory, consider working on a fixed arrangement with your major suppliers. While it can be difficult to negotiate a fixed pricing agreement in the current market, consider short-term arrangements rather than annual or multi-year agreements. A short-term arrangement while not the most ideal would still allow for some level of stability in a market of unpredictability.
  • Preordering Arrangements with Customers – Forecasting sales and inventory becomes easier if orders are placed prior to the needs of customers. Consider a manufacturer who takes advantage of extra warehouse storage space by entering into a stocking agreement with a customer. Product is kept on hand for customer delivery at a set rate allowing the business to forecast the needs to fulfill orders. As an additional bonus, the unused storage space generates revenue for the manufacturer and offsets overhead costs creating a win-win situation.

Employee Turnover Rate – (Employees who have left * 100)/Average # of employees

Employees are a key resource to every  business. According to the Department of Labor, the annual separation rate for the manufacturing industry in 2019 was 31.6% and increased to 44.3% in 2020. The COVID-19 pandemic has created unprecedented times in the labor market. Focusing on employee retention is one-way manufacturers can remain competitive and increase the bottom line.

Why it matters: Higher employee turnover leads to slower production rates and increased overhead costs. Replacing employees requires additional training and resources from current employees.

Ideas for decreasing employee turnover:

  • Be Creative – How can you provide a better workplace than the manufacturer down the street?
    • Expense Reimbursements – A company in Indianapolis decided to provide expense reimbursements to offset the pains of physical labor. Acceptable reimbursements for employees include services like chiropractic care, massage, etc.
    • Employee Evaluation – Production goals with monetary incentives interest employees while also increasing total finished goods. It is important to note that a production quantity goal should be accompanied by a quality related goal so the overall product quality doesn’t suffer. Consider a multifaceted approach to evaluating employees placing emphasis on quality and quantity and consider making the monetary incentives more frequent than on a semi-annual or annual basis.
    • Provide Training and Growth Opportunities – Make your employees feel as if they are part of the team from day one. By implementing a training program, employees can see a clear path to success. Establish clear, defined steps in to ensure progression. In the State of Indiana, advanced manufacturers can apply for the Next Level Jobs Grant for up to $5,000 per employee retained for six months (max $50,000) for implementing a training program for trade skills (additional information can be provided upon request). A grant program like the Next Level Jobs Grant is a win-win for both the employer and employee. Other manufacturing grants available include:
      • Ohio – JobsOhio Workforce Grant
      • Kentucky – Grant-in-Aid Program
      • Be on the lookout for how your state is using the American Recovery and Reinvestment Act funding received. In the State of Indiana, information can be found through the Indiana Regional Acceleration and Development Initiative (READI).

Analyzing the key performance indicators currently in place is critical to evaluating the current  and/or future state of your business. While one performance indicator may be the driving force, such as throughput, other indicators like capacity utilization, inventory turnover, and employee turnover rate will work together to increase profit and efficiencies.

For further guidance and questions related to this topic, please contact Kelsea Faulkner at kfaulkner@vlcpa.com or 800.887.0437.

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