In earlier discussions we talked in some detail about Break Even of a business (BE). Taking a big picture approach to the business and understanding how that business can operate while covering the cost of operation. We take this thought further in this paper by examining how to apply BE to the individual parts of a business to extract value and profitability.
The middle and the top of ‘things’
To begin this exercise, consider the initial outlay cost, the total outputs possible, and compare those figures with what can be charged to a customer per unit. The easiest way to illustrate this is by looking at the tangible “things” within a business like billable machines - i.e. printing press, industrial sewing machines, excavators, concrete mixers, delivery trucks, industrial ovens etc - they will all have a rating or maximum load that they can output. Let’s find out the BE and the maximum capacity of one of these machines then discuss what those figures means to the business.
Machine A has a cost $15,000 to purchase. We already know the maximum capacity from the manufacturers information - the total mechanical capacity is 100 units per week. The machine will be in use for 48 weeks in a year (with 2 week holiday shutdown and 2 week maintenance/service periods taken out).
Therefore, the breakeven cost per unit for Machine A at total capacity is $3.125 ($15,000 divided by 48 weeks divided by 100 units).
However….
Client sales figures tells us that the business uses this machine to produce a total of 80 units per week. And because we now have a lower output figure, the breakeven cost is higher at $3.91 ($15,000 divided by 48 weeks divided by 80 units). The business now has the confidence to know that minimum charge for a customers has to be above this break even price.
If the market can bear a price of $4.20 per unit and the orders can reach the maximum load (100 units) - the business stands to make an initial profit of $5,160 in the first year of the machine’s purchase and then a tidy sum of $20,160 year-on-year minus minimal maintenance/servicing costs thereafter. Not bad at all.
There are other strategies in increasing a machine’s capacity where there is seasonal fluctuations in demand that can include: increasing promotion on low-peak times, producing end-of-line products or product extensions, or simply choosing to do business with stable consistent customers(1) to level out the year and gain maximum capacity. The break even price per unit however will by and large remain the same and decisions on which strategy to act on can be made with much more certainty.
When the shoe doesn’t fit
Working with tangible objects within a business is, as we mentioned above, straightforward. Looking at people’s maximum capacity is a different kettle of fish as there is no label or guarantee of how much each person can take on. When it comes to this “different shoe” of human resources we will have to use a different measurement. Human Resources are measured in terms of total hours estimated to reach an end period of time (deadline), and the compare those estimated hours against the actual hours performed to reach the deadline. Below is an example of how to put it into practice:
Project Manager A is working 70 hours a week to reach a 4 week deadline and the estimated hours were only 45 hours a week (180 hours). The maximum capacity for the project is a total number of hours at 280 hours. The review of the completed project found that more administrational activities were required to be performed. The cost of the Project Manager was $150 per hour bringing the total cost to the business at $42,000 for this project.
Here is where it gets interesting.
Project Manager B was able to perform the same project in 50 hours per week for 4 weeks, however, this time, Project Manager B was able to utilise other resources within the business to complete the project. The cost of a Project Manager remained at $150 per hour bringing the total cost at $30,000 and the administrational assistant cost $25 per hour for the remaining 80 hours (total $2,000). The total cost to the business on this project was $32,000. That’s a $10,000 cost saving to the business for the same output.
Maximum capacity for a working week of a person can be tied into WH&S (please refer to a previous discussion we had on Workplace Health and Safety) and being constantly aware of a person’s level of fatigue and the ability to perform with a clear mind, in safety. There is a “saturation risk” with human resources, where a person has too much to do (perceived or real), with not enough time, tools or resources to get the job done(2). When the point of saturation takes hold, the person is unable to function normally and has a constant feeling of being overwhelmed, bringing their levels of output down (and potentially increasing errors). Not all people behave as machines do (some of us might like to think we do). Aside from the obvious overspend in using a senior staff member on certain tasks, the toll it will take on the long term viability of keeping that staff member can cost the business in the long run (through retraining and rehiring).
Finding efficiencies in systems, management techniques, redistribution of existing staff, employing temporary staff all are part of the human capital utilisation. Understanding this, and the total hours as the maximum utilisation point, the cost per hour will rest on how each project is managed.
100 and 1 ways
There are many ways to look at maximum utilisation. In the video for this topic the restaurant was the example. In this paper we gave further examples of this thinking and looked at both machinery (things) and people (human resources) and how to use break even and maximum utilisation to work out cost savings and profit margin increases. There are literally over one-hundred-and-one ways to cut the mustard when comes to applying this practice across a business and it is a subject that requires more understanding. When approaching this topic, the team at One Week At A Time believe there are only three ingredients needed to start the road to financial freedom: seeking and following sound advice, applying those strategies to your business, and building your personal confidence in the processes.
Resources
If you would like to discuss your maximum utilisation and break even points please contact Brett Burden, Senior Business Coach on 1300 971 763.
References
(1) Porter, Michael E. (1985). Competitive Advantage. Free Press. (p102)
(2) Murphy J. D., Boucousis C., (2016) On Time On Target: How teams and companies can cut through complexity and get things done...the fighter pilot way. Allen & Unwin. NSW Australia. (p124)
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