Value-added sales as part of performance measurement

Editor's note: This is the second in a series of articles written by a molder for molders. In it, Paul Crezee, the controller at S&W Plastics in Eden Prairie, MN, shares how his company uses value-added sales as a measurement of performance. In the first installment, (October 1997 IMM), value-added sales was described as a means of calculating profit margins without factoring in the pass-through cost of material.

Value-added sales techniques stabilize comparisons to key relationships - cost of sales, gross margin, sales, or G&A expenses - found in your financial statement summary and detail account level. This permits a focus on problem solving and avoids wasting time sorting out percent issues under the total sales method, which includes material.

VAS is helpful in establishing annual budget plans, as the data are related to a stable baseline. This makes comparison of detail account costs to prior years or to current budgets a much more usable tool. Of equal importance, VAS lets you relate to measures that are not on the financial statements but are the key control points behind the statements - those that if managed properly, will produce the performance you want. For example, since VAS relates directly to press rates, you can monitor such components as labor and press relationships to get control of direct labor costs, press uptime percents to throughput on a daily, weekly, or monthly basis, and so on.

Comparing cost increases with standard and VAS methodsStandard MethodPrior YearCurrent YearNext YearSales, in thousands28501003937001003040001008Material Costs120042361600433319004819Labor Costs50418376611831715188VAS MethodPrior YearCurrent YearNext YearSales, in thousands28503937003040008Less material120036160033190019= VAS16501004121001002721001000Labor50431376613131715348

We set our labor/press uptime relationship during the year's planning process. By tracking weekly we know how the overtime, holidays, additional operators, and automation used to increase throughput affect our VAS percent of labor. Simply, if the ratio of labor hours to "press up" hours begins to rise, something is probably out of control. In addition, the VAS per hour are monitored against plan. Use of these methods helped reduce our VAS labor ratio by 18 percent last year.

Press utilization is at the heart of measurement, because uptime controls throughput. All systems require maintenance, setup/ take-down, shift change, and break time. How these are handled can greatly affect the rates you use. When we started the new costing system, we had none of this history, so we constructed a simple collection system that complemented our automated MRP system.

Press uptime and direct labor hours (defined as press operators, material handlers, and setup people) are collected for the week and the ratio (labor to press hours) is graphed on a chart that compares actual to budget. Trends are quickly spotted. Relevant supporting data such as sales per press hour and uptime percent are also shown to assist in evaluating performance.

Once you begin to collect data, it is interesting that the "gut feel" you had - about why things happened - starts to change. But you need to use the long-term view. While it was good to start having signposts and reasons we could identify with particular results, we needed nine to 12 months to fine tune the process to today's level. Fiscal 1996 was a learning time that we successfully converted to controls in 1997. This is not "secret" data; data are posted for all to see.

The table below illustrates how the use of VAS techniques helps in planning and year-to-year comparisons. In the standard method (top portion of the table), increases in labor costs appear to be in a harmonious relationship to sales increases. However, if the VAS method is used (bottom portion), eliminating material costs, the VAS line is flat even though the material costs are up substantially. This leads to questioning why labor is up $54,000 (8 percent) on flat sales. Unless wage increases are 8 percent, the tie to total sales is distorting labor.

Overhead should be examined in the same way. But with many more fixed cost aspects to it, that analysis is more complex. If the material growth of $200,000 could be recovered in pricing, then the next year's labor would be in relationship to the new VAS figure of $2.3 million. In effect, since the $1.9 million is already the new material cost, the recovery flows to the VAS line.

If recovery is not possible, then your profits will be down, offset only by what you can save out of labor and overhead. Overhead in the broad sense includes sales/G&A expense, also. Get a leg up on cost control and make use of VAS analysis in addition to whatever else you are doing. It will pay off.

Using VAS as a loan tool

In a capital-intensive business like injection molding, loands are common. The money may come from various sources: banks, loan companies, venture capital, maybe even family or friends, but to you the borrower, that source is your banker.

As many molders know, it is difficult sometimes to educate your banker about the molding industry and to plead your case about needing the money he can give you. The banker is the person you must help to understand your business so a common ground of expectation is formed.

Since bankers bypically use ratios as one of the tools to evaluate your business, VAS can be used as a measure of how resources are employed. (A source of support for your VAS approach is the annual SPI operating ratios report, which have in recent years begun incluing value-added statistics.) But don't take our word for it. Gary Veverka, a vice president of business banking with S&W's lender, Norwest Bank of Minnesota, says, "The VAS data is a helpful supplement to the traditional financial statesments as it gives additional insight to [a molder's] opertions." The VAS approach levels the playing field by relating the costs you control to sales less material, and resulting percentages have more meaning.