Targeting the Bottom Line: Eliminating Financial Management Guess

• Chapter 0 - Overview
  • Learning Objectives
  • Introduction
• Chapter 1 - Role of Strategic Planning, Mission, Vision, and Goal Setting (Macro Tools in Profitability)
  • Learning Objectives
  • Introduction
  • Dreams
  • Vision
  • Business Plan
  • Strategic Plans
  • Mission
  • Goals
  • Hiring the Right Team
  • Risk Management
    • Succession Planning
    • Contingency and Disaster Planning
    • Traditional Insurance and Risk Management
  • Questions
  • Appendix – Questions for Preparing a Business Plan
• Chapter 2 - Increasing Profitability in the Revenue Cycle
  • Learning Objectives
  • Introduction
  • How the Product Is Priced
  • Customer Service
  • Follow-up Service
  • Cross Selling
  • Information Systems and Customer Profitability
  • Billing and Invoice Process
  • Accounts Receivable Management
  • Collections
  • Cash Receipts Processing
  • Questions
• Chapter 3 - Maximizing Profits through Product Mix Analysis
  • Learning Objectives
  • Profitability and Product Mix Analysis
    • Step 1: Define the Product Mix Problem
    • Step 2: Collect Data for Base-Line Product Mix Evaluation
    • Step 3: Develop New Scenarios for Additional Product Mix Analyses
    • Step 4: Select an Optimal Product Mix Profile
    • Step 5: Map Out the Actual Production Sequence to Verify the Feasibility of the Optimal Production Profile
  • Solver – A Different Type of Tool
  • Questions
• Chapter 4 - Increasing Profits in the Working Capital Cycle
  • Learning Objectives
  • Introduction
  • Cash
  • Accounts Receivable
  • Credit and Collections – Best Practices
    • Suggestions for More Effective Management of Accounts Receivable
    • A/R Best Practices to Review
  • Inventory
    • Danger Signs
    • Corrective Measures
    • Inventory Best Practices to Review
  • Short-Term Credit
  • Accruals
  • Accounts Payable
    • Suggestions for Purchasing Goods on More Favorable Terms
    • Trade Credit
    • A/P Best Practices
  • Short-Term Bank Loans
    • Criteria for Selecting a Bank Which May Best Serve Your Needs
    • Factors that Your Banker May Evaluate in Considering Your Loan Application
    • Factors that Your Banker May Look Upon Negatively in Approving Your Loan
  • Accounts Receivable Financing
    • Inventory Financing
  • Conclusion
  • Questions
• Chapter 5 - Role of Employees and Communication in Increasing Profitability
  • Learning Objectives
  • Introduction
  • Vision and Permission to Act
    • Quality Programs
    • Suggestions and Recommendations
  • Ownership
  • Reward and Incentive Programs
  • Empowerment
  • Communication
  • Organizational Complexity Predictor
    • Overall Rating
  • Questions
• Chapter 6 - Tools for Improving Profitability
  • Learning Objectives
  • Introduction
  • The Balanced Scorecard
    • Implementing the Balanced Scorecard
  • Economic Value Added
    • Current Findings on EVA Effectiveness
    • Balanced Scorecard and EVA
  • Other Tools to Consider in Profitability Management
    • Daily Key Performance Indicators
    • Weekly Profit and Loss Estimates
  • Financial Ratios
    • Liquidity Ratios
    • Asset Turnover Ratios
    • Financial Leverage Ratios
    • Profitability Ratios
    • Dividend Policy Ratios
    • Use and Limitations of Financial Ratios
    • Final Thoughts on Ratios and Indicators
    • Other Sources for Ratio Information
  • Questions
  • Appendix – Historical Basis for Incentives from Early U.S. History
• Chapter 7 - Increasing Profitability through Better Costing
  • Learning Objectives
  • Introduction
  • Trends Affecting Cost
  • Activity Based Costing
  • Activity-Based Management
  • Target Costing
  • Value Chain Analysis
  • Understanding the Impact of Allocated Costs when Business Results Change Significantly
  • Questions
• Chapter 8 - Techniques to Improve Profitability (Lean Concepts)
  • Learning Objectives
  • Introduction
  • Lean Manufacturing Overview
  • What are the Benefits of the Lean Philosophy?
  • Major Areas of Emphasis
    • 5S
    • Visual Controls
    • Kaizen
    • Value Streams
    • Pull
    • Mistake-Proofing
    • Quick Changeover
    • Six Sigma
    • Theory of Constraints
  • Major Concepts
    • Value Stream and Value Stream Mapping
    • Pull Manufacturing
    • Kanban
    • One Piece Flow Manufacturing
  • Standard Work and Takt Time
    • Standard Work
    • Takt Time
  • Production Smoothing
  • Kaizen
  • Activity Based Costing and Lean Accounting
  • Total Productive Maintenance
    • Major Pillars of TPM
    • TPM Benefits
  • Implementing a Lean Program in Your Organization
    • Applying Lean Concepts to the Office
    • Lean Office Approach
    • Lean Office Impact
  • Lean Example within the Postal Services of the World
    • Postal Service Provides Model for Lean Government
  • Appendix – Glossary of Lean Manufacturing Terms
• Chapter 9 - What Happens When There Are not Enough Profits?
  • Learning Objectives
  • Introduction
  • The Z-Score a Predictor of Bankruptcy
    • Real Life Application of the Z-Score
  • Cost Reduction
    • Raise Cash
    • Raise Prices
    • Discontinue Unprofitable Products or Product Lines
    • Reduce Expenses
    • Cost Reduction Strategies
    • Cost Reduction Categories
    • Essentials of a Cost Reduction Program
  • Financial Goals within the Planning Process
  • Improving Troubled Companies
  • Questions
  • Appendix – Thorsten Consulting Group List of Profit Enhancers
    • Macro Tools
    • Increase Revenue (or Improve the Revenue Cycle)
    • Decrease Expenses
    • The Ratio Tools
    • Benchmarking
    • Policy and Procedure
    • Other
• Chapter 10 - Latest Developments

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Chapter 3 - Maximizing Profits through Product Mix Analysis

Learning Objectives

In this chapter, we will focus on ways to maximize profits as it relates to the product mix of a company. Many corporations create a special product and then go onto other products without understanding how the product fits into the overall profitability scheme. We will focus on

• Examples of product mix and relation to profits,

• The process to determine optimal product mix,

• Use of MS Solver as a tool to solve optimization problems, and

• The impact of constraints as they apply to the product mix.

Profitability and Product Mix Analysis¹

Businesses are always confronted by optimization challenges to make the highest profit. Consider the following examples where optimization is necessary:

• A distribution company that has 100 panel trucks visiting customers on a daily basis – which routes will allow it to be the most efficient.

• A meat packing plant which produces hamburgers – customers require a specific lean content in the finished product. However, the purchasing department can obtain many varieties of meat with different lean content. The blending of the different lean contents will arrive at the specified customer content (all of the meat has different prices/pound).

• A metal stamping company can process orders on several different machines (which have different hourly costs) and it can use different laborers (only on certain machines – and each laborer has a different cost per hour).

Any of these scenarios could lead to complex matrices of hundreds or thousands of possible answers. The challenge is to create a process which will enable the company to choose the most profitable means without spending inordinate amounts of time trying to determine the ideal product mix.

This section will outline the necessary steps, challenges, and possible pitfalls of a practical application of product mix analysis to improve the profitability of an operation or business.

The first step in the process is to obtain the data needed for a product mix study. Unfortunately it does not come in a handy form, nor is it ready to analyze as will be the case in our example. Obtaining and formatting the necessary information for analysis requires at least a few days and up to several months, depending upon the scope, complexity, and purpose of the analysis.

The second step is to create the ideal mix – usually with the aid of financial software such as a spreadsheet. Even though the process is automated, the analyst must be realistic that the model may be omitting key information and therefore is incorrect. In practical applications, the product mix study is rarely a one-shot deal, taking time and effort. Analysis is iterative, each iteration representing one of numerous different business and/or production scenarios.

The third step is implementing the solution. Even after an "optimal" product mix is found, the realization of the product mix within the operation is a challenge. An optimized product mix usually represents an idealized and somewhat macro view of the production profile, delivering a profit obtained in the analysis. In many cases, however, operational constraints in production and in the supply chain that were not or cannot be specifically formulated into the product mix optimization, such as availability of raw materials, seasonality of customer demand, and bottlenecks of equipment and resources may deem your product mix results infeasible.

Therefore to improve the success rate of product optimization, use the following roadmap:

Steps of a product mix study:

1. Define the product mix problem.

2. Collect data for baseline product mix evaluation.

3. Develop new scenarios for additional product mix analyses.

4. Select the optimal product mix profile.

5. Map out the actual production sequence to verify the feasibility of the optimal profile.

Step 1: Define the Product Mix Problem

The purpose of a product mix study for a profit-making entity is usually to maximize the profit. Assuming this general principle, one needs first to define and understand the project. The following questions clearly identify the problem/opportunity and provide focus to the project.

• What is the objective of this product mix study project?

• What are the issues involved with this project?

• Why is it important?

• Who is the sponsor for this project?

• Who should be working on this project?

• When should the project start? Finish?

• What is the current product mix?

• What is the current profit picture?

By answering the above questions, the user can achieve a much better understanding of the issues involved and point the project in the right direction toward a successful analysis.

Step 2: Collect Data for Base-Line Product Mix Evaluation

The most important decision of this step is to define the product categories to use as the basic unit to collect needed information. A typical company sells hundreds or even thousands of products representing various product lines, product classes, product sub-classes, packing codes, etc. It is extremely cumbersome and difficult to conduct product mix analysis at the lowest product classification level with thousands of categories. Aggregation of product subclasses is always needed.

This is a very time-consuming period of the project. In the case of an entity with a good database containing accurate financial and operation information, effort is usually spent on the aggregation of information to arrive at the desired product category level. To alleviate any ambiguity during the data collection and aggregation process, design a spreadsheet, clearly listing product categories and information to be collected first. With a clear list of information needs, the goal of the data collection is simply to complete the spreadsheet that was specifically designed for data collection.

Typical information to be collected for product mix analysis will include items such as product price, product costs – fixed, variable, and overheads – and estimated demand for the product at the planned horizon.

With all the needed information collected in a spreadsheet, formulate the product mix question using a spreadsheet solver (in the following example, MS-Solver is used). If there is too much information for a standard solver, you are probably unnecessarily complicating your product mix analysis with too many product categories.

Step 3: Develop New Scenarios for Additional Product Mix Analyses

The so-called "optimized" product mix output from Step 2 is the current best under a limited scope – no changes are made to the currently available equipment and resources. The real challenge of a product mix analysis is to create new business and production scenarios that frequently require major "structural" changes. The structural changes might involve the bold "reengineering" of the business; for example, shutting down some portion of the operation, thereby eliminating some product lines, or adding some product lines by realigning existing equipment/resources among several production sites, or acquiring new equipment/resources etc. The principle concept behind the scenario development is to come up with a viable and feasible business plan and structure that will improve the bottom line. The scenario development is by far the most challenging part of a product mix study because it involves business strategy, breaking the existing product mix paradigm and invoking "outside-the-box" thinking to brainstorm good scenarios for the business to pursue.

For each scenario, appropriate data will of course need to be added and incorporated into the existing data structure discussed in Step 2. Product mix analysis will need to be conducted for each scenario. Results will need to be evaluated for assessing the viability of the scenario.

¹ The selection on Product Mix was based on an article written by Thomas Hsiang, Ph.D., Director of Management Science at Sensient Technologies Corporation in Milwaukee.

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