You run a manufacturing facility that makes monster trucks. Every time you receive a shipment of parts, the guy driving the forklift drives in a circle three times before he takes the items off the shipping deck and puts them into the warehouse. Are the three spins adding to final product? Or does the forklift guy just...have issues?
Time for a little process value analysis. It's a formalized process of looking at what everyone at the company is doing, and then deciding whether it adds to the final product.
Managers utilize PVA to judge the processes involved in producing a company's goods or services. The goal is to identify activities that don't add value to the process (and eliminate them), or find procedures that could be made more efficient.
Basically, the managers look at each of the firm's business operations and assign all the company's costs to the various tasks. That way, they can see where productivity improvements can be made, where they can eliminate steps (like spinning a few forklift donuts before moving shipments into the warehouse), and where more resources should be invested.
Related or Semi-related Video
Cost Accounting: What is CVP and Cost-Vo...2 Views
And finance Allah shmoop What is CVP and or cost
volume Profit analysis All right For starters CVP is not
that thing that runs a computer That cpu Yeah And
it's not a drugstore that c v s And it's
not a fancy name for resumes That's uh just CV
CVP cost volume profit analysis Well CVP is all about
profits rather than optimizing profits Yes subtle thing There you
are running a company You make foam padding for people
who experienced a psychotic breaks to put on their bedroom
walls You're trying to figure out what pricing delivers the
best operating or net income returns All right what time
is it Yes it's time for CVP analysis Yet you
knew going well this thing helps you find the answer
in a kind of matthew way to optimizing your problems
You know So you're not just throwing darts or shaking
a magic eight ball or something although we think that's
pretty cool OK well when you run a CVP you
make some assumptions You use a whole lot of scenarios
that don't necessarily reflect real life but they help the
math along For instance you assume all of your inventory
gets sold like you're not monkeying around with inventory ballooning
on your shelves and hiding profits Nor are you depleting
it suddenly to generate suddenly a lot of cash and
well taxes Maybe you're also assuming that pricing is flat
You're neither raising nor lowering pricing and your margins then
should pretty much stay about the same You know like
if you're keeping prices flat the price per square yard
stay steady for the head butter two thousand And that
thing which is your primary product right You're also assuming
that your cost of producing the foam is flat and
squishy Well the variable costs remain constant flat you know
like the padding And you're assuming that there are no
meaningful changes to your phone fixed costs like rent or
insurance or the machine that squeezes out the patting twenty
four by seven The on ly change here the on
ly input in the equation you're going to monkey with
is act activity I e volumes sold So the basic
question you're asking How does prophet change when we change
the amount of stuff we make What happens if we
make Maur What happens if we make less That's what
we're asking Well the star of the show and CVP
analysis is country abuse Shin margin So you're producing million
yards of patting CVP is all about figuring out what
happens when you produce that million and one thir million
and first yard of padding When you produce your first
yard will that yard costs a fortune right from a
mass standpoint you bought all that equipment hired all those
workers built a whole factory just to make one yard
of patting very expensive But as you make more well
the cost gets spread out over more product All the
fixed costs like rent insurance and so on get applied
to a larger number of units There Amor ties across
a bigger base right the per unit cost then drops
well Once you're running the factory and churning out patting
it becomes all about contribution margin like that's the rule
that runs your company Optimize it So if that last
pad sells for ten bucks a yard and it cost
you six bucks a yard to make well then your
contribution per yard is four bucks and your contribution margin
is forty percent Yeah that works for over ten It's
basically revenue or rather sales than subtracting all the variable
costs in making that yard That's on a per unit
basis If the whole company's sold twenty million dollarsworth of
lunatic padding in a given year and it had total
variable cost If I'LL say fourteen million well then companywide
contribution margin delivery would be about six million bucks right
Twenty minutes fourteen contribution think donation to profits from sales
or something like that So the next big thing think
about is the break even point At what volume or
level of sales does the head butter two thousand cover
It's fixed Recurring costs where profits are zero and the
company is joss squeaking by like How much should it
produce Well let's say your factory has six million dollars
in fixed costs That amount covers things like rent on
the factory in the cost of the machines and so
on When you make that first yard of patting it
cost six million dollars sell it for ten bucks and
you've lost five million nine hundred ninety nine thousand nine
hundred ninety dollars Good for you Okay so we need
to figure out just how many yards you have to
make until that bottom line reaches zero Well At what
point Teo sales cover costs wealth the math equation sales
At this point this break even point equals total variable
cost plus total fixed costs and fixed costs are the
same as the contribution totals So the Head Butter two
thousand has fourteen million dollars invariable costs The cost of
the raw materials and labor IT center all included in
there and there are six million dollars in fix recurring
cost So then it's sales of twenty million box It's
just breaking even That sales volume equates to two million
yards worth of padding Sold it ten bucks each with
two million yards you're covering for the cost of the
patting itself and the labor and the electricity and the
raw materials and the facility caused and sales and marketing
and all of it together is fourteen million dollars invariable
costs Well you're also covered for the six million bucks
worth of fixed recurring cost like rent insurance and loading
dock snacks and so on And note that some cost
like manufacturing or sales can be both fixed and variable
right You're storing tons of patting You need rent more
storage space so your rent goes up So when you
put together a mini income statement like this you label
it contribution margin income statement because it's not a gap
compliance set of numbers There's no set of laws that
makes you Adam up in a certain way right They're
just there to help managers you know manage okay back
to break even The fancy formula runs like this Break
even Sales is or equals total fixed costs over contribution
margin ratio Well in your case you have six million
dollars in fixed costs and a contribution margin of seven
twenty It's or thirty five percent So you divide the
six million by the point three five to get twenty
mill in sales as break even see it's like magic
Well given the cost structure to break even I'ii stop
losing money on the whole deal You need to reach
twenty million in sales After that you've taken care of
all the fixed costs the rent the equipment and so
on more than twenty million in sales and you start
to book profits Yeah which should keep your shareholders from
hitting their heads against the wall though if they did 00:06:05.295 --> [endTime] Well at least you'd have some new customers
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