Glossary

Survey Definitions

Employee Turnover Rate — Computed by the following formula: (Total W-2s issued - Total employees at year end less temporary employees)/Total W-2s issued.

Indirect Labor — Employees that support the direct labor or production function, but are not directly involved in producing a product.

Percentage Utilized — Equipment utilization percentage is measured by total hours used, divided by total hours available. Total hours available are 8,760 (365 days times 24 hrs/day).

Production Tooling — Tooling used by a molder to produce production parts.

Complexity — A ratio that measures all the ingredients that are scheduled to make a specific part - press, resin, and the mold. Employees may not be scheduled on specific presses and are more interchangeable. Therefore, they are not part of the complexity ratio (employee turnover/absences may exacerbate scheduling difficulties). 

Statistical Definitions

Median — A measure of central tendency, the median of a sample is the value for which one-half (50%) of the observations (when ranked) will lie above that value and one-half will lie below that value.

Correlation — A measurement of the relationship between two or more variables. Correlation coefficients can range from -1.00 to +1.00. The value of -1.00 represents a perfect negative correlation while a value of +1.00 represents a perfect positive correlation. A value of 0.00 represents a lack of correlation.

This survey used the Pearson R correlation coefficient to determine and measure the relationship between variables to obtain a 95% confidence interval. For this survey a correlation coefficient had to exceed .40 to be noted as a meaningful correlation and .70 to be noted as a strong correlation and .90 to be noted as a very strong correlation.

Quartiles — The lower and upper quartiles are the 25 th and 75 th percentiles of the distribution (respectively). The lower quartile is the value such that 25% of the values fall below that value. Similarly, the upper quartile is a value such that 75% of the values of the variable fall below that value.

Mean — An average of the total responses. In an environment where the upper or lower limit is not contained the calculated mean may be highly skewed by the responses at the limits. A mean provides better meaning in a controlled environment (i.e., a percentage of sales as all the responses have to be between 0 and 100). 

Explanation of Various Ratios

Earnings before Interest, Taxes and Owner's Compensation to Net Sales

Frequently in a small or closely-held business the owners may have an opportunity for bonuses, employee benefits or other perquisites which must be considered in analyzing net income , and especially in comparing net income percentages to other companies. For this reason we consider earnings before owner's compensation.

A final note of caution in understanding net income . In a partnership or S corporation (which is essentially taxed as a partnership), the taxes on income are borne by the owners or partners. Consequently, net income does not include taxes. In a corporation, the taxes on income are paid by the business. Therefore, in this case, the net income is net of taxes. In using and understanding net income , one must be aware of the tax status of the entity.

For these reasons, earnings before interest, taxes and owner's compensation to net sales is used in place of net income to sales or profit margin.

Gross Profit

Gross profit is net sales, less cost of goods sold, but before general, administrative and selling expenses. In a manufacturing concern the cost of goods sold would include not only materials and direct labor, but would also include factory overhead. Factory overhead, sometimes called burden, includes such items as indirect labor, payroll-related expenses, supplies, occupancy costs, etc.

In a non-manufacturing concern, such as a distributor or retailer, cost of goods sold generally is limited to material costs, with other costs and expenses being included in categories such as selling, delivery, warehousing, etc.

Gross profit is frequently expressed as a percentage of net sales. For example, a company with sales of $1,000 and cost of goods sold of $770 would have gross profit of $230, or 23%.

Comparisons of gross profit percentages are very beneficial, both in terms of trends within a company and industry comparisons. Care should be exercised when analyzing such figures to make certain that the components of cost of goods sold are comparable, since there are frequently judgmental areas in terms of classification of various costs and expenses, particularly in a manufacturing environment.

In a manufacturing situation the cost of goods sold will include both variable and fixed costs. Fixed costs are those that in the short term do not vary with production levels. Variable costs are those that vary based upon output. In analyzing gross profit in circumstances where costs are fixed and variable, additional detailed analysis is usually required.

Current Ratio

The current ratio is probably the ratio best known to business people. Because of this fact, this ratio is sometimes given more weight than it really deserves. However, since this ratio is often emphasized, especially by lenders, it takes on a relatively high degree of importance.

The ratio is computed by dividing current assets by current liabilities. Current assets consist of cash and items which will be converted to cash (such as accounts receivable and inventory) during the next 12 months. Current assets also include prepaid expenses which would otherwise require the outlay of cash during this same period. Current liabilities are those which must be paid during the next 12 months, including payments due on long-term liabilities.

The ratio is an attempt to measure a company's ability to cover its liabilities. For example, if the ratio is 3:1, the company would theoretically be covering its current liabilities three times. A weakness in the current ratio is that it is strictly a quantitative measurement. To further analyze a company's ability to pay its short-term liabilities, one must assess the quality of the current assets, beginning with an analysis of the composition of the current assets. For example, do current assets consist of 10% cash, 25% accounts receivable and 65% inventory, or are they comprised of 80% cash, 15% receivables and 5% inventory? Obviously, these situations are significantly different.

A further investigation would include a valuation of the assets. Are the receivables all collectible? When? Is the inventory properly valued? How long does it take to convert raw materials into finished goods? Are there overstocks? On the liability side the key question relates to the timing of payments. For example, accounts payable could be seriously past due. At the other extreme the current liabilities may consist primarily of term debt, possibly even including a credit line, which technically could be due on demand, but which, as a practical matter, may be constantly rolled over.

A popular barometer is the 2:1 current ratio. A company with a 3:1 ratio may have serious problems meeting current obligations, while another company with less than a l:l ratio may have no problems keeping current. As with other analytical tools, the current ratio should be analyzed in depth, watched as a trend and compared to industry standards.

A variation on the current ratio is the acid ratio or acid test, which is basically the same computation, but uses only cash and accounts receivable in the computation. This is a more severe test, but suffers from many of the flaws mentioned above. Despite the many cautions mentioned above, the current ratio is important, particularly because it is given heavy attention by many lenders and financial analysts.

Debt Ratios

This frequently used ratio is calculated by dividing total liabilities by net worth (equity). For example, a company with total liabilities of $200 and net worth of $150 would have a debt to equity ratio of 133%.

This ratio measures the relative "investment" in the business between owners and outside creditors. Obviously, if the equity is greater the owners have a larger proportionate investment and greater control. Lenders often view this an indicator of the owners' level of commitment. This ratio is a favorite of lenders and prospective lenders.

Fixed Assets To Net Worth

If a company is solvent, the owners/managers must make decisions regarding the allocation of its capital or net worth in order to produce optimum results within given risk parameters. These decisions involve the apportionment of capital as between current assets, miscellaneous assets and fixed assets. The ratio of fixed assets to net worth measures the allocation of capital to fixed assets. It is calculated by dividing fixed assets by net worth.

Fixed assets are generally non-liquid and "permanent" in nature. A heavy investment in fixed assets may give rise to additional debt and heavy fixed costs, both of which may depress earnings. Further, this reduces the capital available for current assets and productive miscellaneous assets.

The ratio of fixed assets to net worth may possibly be distorted by inadequate net worth or may appear excessively high as a result of above-average fixed assets and below-average net worth.

If a company has excessively high amounts of net worth committed to fixed assets its working capital will be adversely affected. This would impact such areas as the current ratio, and both inventory and accounts receivable relationships to working capital. For example, with working capital adversely affected by heavy investments in fixed assets, one would expect to find disproportionately high levels of inventory and receivables to working capital. This naturally leads to the numerous problems associated with inadequate working capital.

Collection Period

The Collection Period is an extremely important ratio - being one of the so-called causal ratios. This ratio is sometimes referred to as "days outstanding" or "days in receivables". It is calculated by dividing annual sales by 360 (or 365) days to arrive at average sales per day. The resulting figure is divided into the total accounts receivable to determine the number of days of (average) sales in receivables.

Obviously, a low number of days in receivables is very desirable as it reflects prompt collections and means that sales are being converted to cash more quickly. Only in a rare situation would a low number be of concern, such as when the number is below comparable industry standards, which might indicate that the company's payment terms are "tighter" than industry norms and/or that the company is losing sales to competitors that offer more favorable terms to customers. This would be a rare situation.

In analyzing Collection Period results one must first look to the company's payment terms. For example, if terms are "Net 30 days" one would expect to find the days in receivables close to this number. In reality, the results might show something between 25 and 45 days on average, or more. If the figure is high, then collection efforts should be accelerated. Comparisons to companies in the same industry may also be helpful.

Of all the causal ratios, the Collection Period is perhaps the one that should be most closely monitored on a continual basis. The costs associated with unsatisfactory collections may be enormous, including both interest costs to finance receivables and the strong likelihood of greater bad debt experience which invariably results when collections lag.

Inventory Turnover

Inventory turnover is computed by dividing the cost of sales by the average inventory. For purposes of our report, we used the ending inventory. If your ending inventory is significantly different from your average, you should recalculate your turnover ratio.

Inventory turnover is an excellent predictor of throughput, or the ability to respond to a customers demand and manufacture an order. Companies in a more focused environment or with a more stable production schedule can have much lower safety stock and thus faster inventory turnover. Custom molders tend to have more complexity, shorter production runs, and less stable production schedules and thus have lower inventory turns. Still, improving inventory turns will help cash flow, reduce obsolescence, and improve customer responsiveness.

Value Added Metrics

Value added has been the mantra for enhancing profitability in manufacturing industries since the decade of the 90s.

Put simply, value added is conversion cost plus S,G,&A, taxes, interest and profit. It is calculated by subtracting material, purchased components, and outside processing costs from revenue.

According to the APICS dictionary (eighth edition), value added is “the actual increase of utility from the viewpoint of the customer as a part is transformed from raw material to finished inventory. It is the contribution made by an operation or plant to the final usefulness and value of a product, as seen by the customer”. Value added is the sum of various cost elements including direct and indirect labor, press and equipment depreciation, perishable tooling, shop supplies, utilities, occupancy costs, repair and maintenance, laundry, general and administrative expenses, selling (including commissions) and marketing costs, interest, taxes, and profit.

Value-add per labor dollar combine productivity issues as well as cost of labor comparisons and is more often being used by international companies as a comparison of cost to produce between countries. If labor rates are not a significant comparison issue, most companies use value-add per employee due to its simplicity. 

The complexity ratio reflects the typical molder scheduling difficulty of having the right mold, materials, and machine available to manufacture a part for the customer. We have calculated 3 different complexity ratios: probable case - commonly used resins times commonly used molds (active molds plus insert configurations) times presses; worst case - all resins times all molds times presses; and best case - commonly used resins times only active molds (not inserts) times presses. More variables to schedule require a robust process to manage. Increased complexity generally also requires additional investment in inventory. Many molders are unaware of the increasing complexity they need to manage as they grow or age. It just creeps up on them, like age. There is no "right" ratio, but each molder should review its trend data to assess whether they should refocus on select variables or invest in more dynamic scheduling capabilities.