Your Operations Audit Will Enable You To Benchmark Your Cost Of Goods Sold.

Doing an operations audit will examine and evaluate each of the process component parts making up your cost of goods sold. In taking your first step, you need to break down you operations process into its smallest logical measurable components. Although this sounds a bit abstract, you can easily do this for your own business.


To assist you in identifying those smallest logical measurable components, the following example could be helpful. A machine shop may have several separate machines involved in making a specific part. Work is done on the part at each machine, and it then moves to the next machine. Each machine may have one or more people involved in its operation. Each machine can be considered as being a smallest measurable component.


In doing your operations audit, there is another step you will need to take. Remember that the intent is to allow you to benchmark your cost of goods sold. You need to determine your overall cost of goods sold. Then compare it with the best fitting industry standard that you can identify. That will provide you with a gross measurement that will give you valuable information. However one more step may be quite revealing.


Deduct the cost of raw material from the cost of goods sold. Compare that with the best fitting industry standard that you can identify. This will allow you to identify whether you are higher or lower than the industry standard in cost of raw material, and your cost of processing that material.


Using an example may help illustrate this distinction. Consider a business doing quick oil changes on automobiles. Its raw materials are oil and filters. These are largely commodity items, costing much the same everywhere. An exception might be made for a business with huge volumes and related buying power.


So your operations audit measurements will need to focus on those items that you can control. Remember that gross profit and related profit improvement are the business objective. So the measurable items within your control are the cost of removing the old oil and filter, and the cost of adding new oil, and installing the filter. Isolate and collect this information. How does it compare with the industry standard. If it is high, either hourly labor costs are high, or labor productivity is low.


Labor productivity can usually be improved by improved processes or capital investment. Improved processes include how you organize the work. This may involve establishing and enforcing achievable standards for employee performance. It may also include altering the pay structure to include a performance component. Again remember the objective of your operations audit.


Capital investment is almost self explanatory. It is a strategy for replacing scarce, costly, or unproductive labor with capital equipment. If you identify an opportunity to improve your cost of goods sold by making a capital investment, you will have a decision to make. Is this something that you want to do as part of preparing your business for sale?


Although the quick oil change business has few identifiable measurable processes, your business may have many. As you identify and analyze each, be on the look out for improvement opportunities for each. Remember that each process you improve, will result in reducing cost, and improving the gross profit. That should boost your expected selling price. And isn't that the reason for doing an operations audit?


A business that I was evaluating to buy can serve as a great illustration of the need for an operations audit. It had recently replaced an old piece of machinery with a new one. The new one operated at four times the speed of the machine it replaced. And it was much more precise in what it did. However, after six months of operation, the cost of goods sold had not decreased. In fact, the labor cost for each dollar of revenue remained about the same. And the cost of raw material had not increased.


This very simple analysis, the kind of thing you will do, was highly revealing. But before doing it, the owner was only able to complain, and not take remedial action. Hopefully you will not be confronted with such a gross mismanagement problem as you evaluate your operations process. But an opportunity of this magnitude, can result in a huge cost saving, and even larger improvement in gross profit margin. Leading to a higher selling price.


The focus of an operations audit is cost. That can be direct, as in the case of raw material. It can also be indirect as in the case of operational process. The way work is organized. Here indirect means that the improvement must come from an analysis of the process. It is more obvious where it is direct as with raw material cost.


As you apply this to your own business, remember to go top down. Start with your gross profit, and your benchmark of the related gross profit margin. However, a word of caution. Don't just accept that because your gross profit margin compares well with the industry standard, there are no improvement opportunities. Make the effort and examine each process in turn. You may be amazed at the opportunities that you uncover.


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