You are ready to begin building your cost model, or perhaps you are in the process of electing/upgrading your ERP software and want to plan through how it will support your cost model. As we have discussed, at the core of a cost model is the business processes that make up your cost – plus any materials used, of course. This column will discuss four concepts to guide your thinking. Especially when considering the platform (e.g., ERP or Excel) where you will build your Cost Model, you must determine if your ERP system will accommodate some of these cases. A skilled Excel modeler can accommodate just about anything! By and large, these concepts apply to manufacturing situations and are most easily understood in that context.

Discrete and Batch Processes

In a discrete manufacturing process, finished parts are distinct and identifiable. What this means is that even though you may make 10 or 10,000 at a time, they are made individually. The time, effort or resources (costs) to make discrete products are driven by the countable number made. Examples are common household products like a toaster or a PC. Cost models for discrete processes are the easiest to model because most costs follow the formula of Time/each or QTY/each, and cost can be calculated by multiplying by the cost rate ($/time or $/qty) to get cost.

Batch process products are made a batch at a time. A common example is a chemical reactor process. Materials are placed in the reactor, heat is applied and some fixed time period later (an hour, for example) a batch of reacted chemicals is ready. The batch size can be 100, 200 or 2,000 gallons up to the size of the reactor tank, but it takes an hour to process regardless. Batch costing requires assumptions about the average batch size to be manufactured at any one time. Products with sequential batch process steps can be tricky because efficient operation requires operation not always at the max of all “tanks” but in fitted sets. Well-designed and well-engineered processes will typically be set so that a big tank feeds exactly x smaller tanks. This is often not the case in real life because recipes change faster than hard, fixed assets.

Continuous Processes

 A continuous process is best thought of as a batch process in interconnected pipes. This is different than a highly automated discrete process that seems to flow, but each unit is still an individual. An example of continuous processes are oil refineries. Here flow rates per hour and costs per hour and varying yield rates are common elements of costing.

Other complexities typically arise in continuous processes as a common feedstock branches into different products undergoing different processes along the way. Other common issues are dealing with and assigning a negative cost to byproducts that are generated and sold off to reduce cost. Other challenges often involve items like catalysts, which are used in the process and can be regenerated for a lower cost than buying new and recycled back into the process. Manpower in continuous processes is often quite low and heavily weighted toward fixed costs.

Man vs. Machine Processes

Many manufactured products require both manpower and machinery to perform. Sometimes the relationship between man hours and machine hours is 1:1. Sometimes it is less when a single man can tend to multiple machines. Sometimes a crew runs a machine. Calculation of cost rates in man/machine environments is usually best attacked by developing a man cost rate and a machine cost rate and then tracking and applying those rates separately. Some of the challenges in developing these rates are addressed in the final article.

For developing the overall approach to your Cost Model, however, recognizing that you have both man and machine rates is important. Most sophisticated ERP systems allow both rates, which makes cost modeling much easier at even the most granular level. Man/machine processes are very common in certain construction projects, and the same concepts apply.

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Cellular Processes

A close cousin to man/machine processes is cellular processes. Cellular processes typically involve a number of machines executing sequential process steps manned by one to several operators. While similar to the simple man/machine model, a cell is costed based on its “takt” time, which is the manufacturing term that describes the product assembly duration to produce a single part. Takt time is sometimes confused with cycle, but takt time is used to design work. It measures the average time interval between the start of production of one unit and the start of production of the next unit when items are produced sequentially. It is calculated as the time to produce parts divided by the number of parts demanded in that time interval.

The cost for the collective manpower and machine cost gets spread to an individual part based on the time to complete the entire cycle. This contrasts to calculating the cost at each of the machine steps and summing it. The cellular cost is based on the time of the slowest of bottleneck processes in the cell. In a culture of continuous improvement, the pacing process can change and the takt time reduced.

Conclusion

Careful construction of your model to allow for changes will make your updating process much easier and quicker. These special processes are the most common in manufacturing costing. Thinking through what kind of processes will speed your path to building a model as you recognize common process type can be duplicated for specific individual cost elements.

The next column will provide a hands-on guide to cost modeling.

For additional information, visit www.FocusCFO.com.