# Throughput Definition

Throughput is the number of units of output a company produces and sells over a period of time. Furthermore, only units sold count towards throughput. Do not count units produced but not sold during the time period as throughput. The goal of a profit-seeking organization is to maximize throughput while minimizing inventory and operating expenses.

For example, let’s take a company that makes guitars. At the beginning of the fiscal period, the company has no guitars in inventory. But over the course of the fiscal period, the company makes 500 guitars. During that same period, they sell 300 guitars. So this company’s throughput for the period would be the 300 guitars produced and sold that period.

## Throughput Variables

There is a formula for calculating throughput. Three variables or three components make up the formula. The three variables include the following:

• Productive capacity
• Productive processing time
• Process yield

Productive capacity refers to the total number of units of output that can be produced in a given time period. Whereas, productive processing time refers to the value-added time in the production process. Then value-added time in the production process is time spent increasing the value of the end-product to the consumer. Process yield refers to the percentage of units of output that are of good quality. For example, if a guitar shop produces 100 guitars but three of them are misshapen and unusable, then the process yield for the guitar shop is 97%.

Calculate productive capacity as the total number of units the process can produce divided by the processing time. Then calculate productive processing time as processing time divided by total time available. And calculate process yield as good units produced divided by total units produced.

### Throughput Formula

Use the following formula to calculate the number of units of output a company produces and sells over a period of time:

```Throughput = Productive Capacity x Productive Processing Time x Process Yield

Throughput =    Total Units    x    Processing Time    x    Good Units
Processing Time      Total Time    Total Units```

### Enhancement

You can enhance throughput by either increasing productive capacity, decreasing the processing time per unit, and/or increasing the process yield.

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Source:

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

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# SKU Definition

A SKU, defined as a stock-keeping unit, is a unique number which distinguishes one product from another. It is used, most often, for the purpose of accounting for inventory. Each product has a unique number, allowing smooth tracking as products move in and out of a warehouse or store. An SKU number is not unique to each item, as the bar code on common consumer products, but more is the number used to for each product type. This is the difference between SKU vs UPC.

## SKU Explanation

SKU, explained also as the only thing that makes sense of products in inventory, is an extremely useful tool. An SKU code is the base number for each type of product. From there, the SKU is entered into records. Inventory is counted, often by bar code or automatic radio frequency identification tag, as it moves in and out of the distribution center. This information is then placed with the SKU of the product in a database. An SKU, meaning the unique marker for a product, can then be combined with inventory levels for smooth processing and tracking.

## SKU Example

Ira is the distribution warehouse manager for a toy company. His attention to detail and consistent methods have aided him in his work. These traits are essential to someone with his position. Aside from this, the other important trait is leadership. Ira has showed this ability time and time again.

Ira’s leadership skills are to the test again. In this situation, product names have somehow become disassociated with their place in the inventory database. This could prove to be a huge catastrophe. Ira is worried but keeps his cool as he formulates a plan.

Soon, Ira is able to find an old record of inventory rates with their SKU configuration. Due to the fact that this is a direct printout from the database, Ira can task someone with simply reentering the Product names. Though the product name is not listed on the record Ira is hoping the SKU is. SKU, functioning similarly to product name, allows this situation to be simply fixed.

Ira resolves to keep a daily copy of the inventory database. He has learned his lesson and does not want this problem to happen again. Rather than blame workers, Ira is a leader who can find the simple solution to a tough problem.

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# Self-Liquidating Loans

The term “self-liquidating loans” is banker slang. It refers to a loan that is used to generate proceeds that are in turn used to repay the loan. Basically, a borrower takes out a loan used to finance business activities that generate revenue. Then the borrower takes the revenue generated from those business activities and uses it to repay the money that was borrowed to finance the activities.

## Self-Liquidating Loan Example

The term can apply to a company that experiences seasonal fluctuations in business. During the busy season when business is booming the company needs to borrow money to finance short-term assets such as inventory and accounts receivable. The company borrows money to buy more materials to take advantage of the increasing demand of the busy season.

Then when business slows down the company will have less of a need for borrowed funds to finance short-term assets like inventory accounts – the need for financing will decline as the need for inventory declines. At this point, the company will have generated profits from the busy season, and will now be able to use those profits to repay the loans it took out to finance operations during the busy season. And this is called a self-liquidating loan.

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### Source:

Higgins, Robert C. “Analysis for Financial Management”, McGraw-Hill Irwin, New York, NY, 2007.

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# Mezzanine Financing

A mezzanine lender, provider of mezzanine financing, functions similar to a bank in terms of providing a source of capital for companies. They get their capital from private investors who look to make a profit off of the investments the mezzanine lenders make. Often times, the firm is structured as a limited partnership for tax purposes.

There comes a time in every company’s life cycle when the company and/or the entrepreneur need some more cash. Perhaps the company needs more working capital or some additional money to help fund an expansion. Or, maybe the entrepreneur feels that it’s time to reap the benefit of all those years of hard work. Whichever the case may be, the entrepreneur will be faced with many different financing options. An interesting and often over-looked option is that of bringing in a private equity partner in the form of mezzanine funding.

## Mezzanine Lenders

Mezzanine lenders are similar to banks … but they are not banks. The interest they charge is going to be higher than what commercial banks charge. Many entrepreneurs blench at the thought. But consider, other than maxing out your credit cards, what other alternatives do you have? Mezzanine lenders will charge you approximately what credit cards charge you. Their cost of capital ranges from the high teens to low twenties (18-23%). This may seem quite high, but if your enterprise is so risky that a bank will not touch it, then it is only fair that you reward someone for taking on this extra risk. Also, what bank would feel comfortable about an entrepreneur taking the bank’s money and pocketing it for personal gain? No bank would. Mezzanine lenders do.

Mezzanine lenders can also benefit the firm in other ways as well. They can help entrepreneurs upgrade their talent resources by finding professional management staff. They can help with finding better technology, placement with new customers or help you find sourcing alternatives. Remember, the best business partner is someone who brings more than just money to the table.

Financing typically comes in the form of either a loan and/or equity interest. Sometimes the debt is convertible into equity. Many people worry when they hear that their equity is compromised. This is actually not so. Mezzanine lenders are open to having their equity interest bought out. Think of it as a “pop” for taking on the risk.

## Purpose of Mezzanine Financing / Mezzanine Capital

So, what is the purpose of mezzanine financing or mezzanine capital? First, let us consider a common business dilemma: 1) lack of working capital or 2) lack of funds for capital expansion. Entrepreneurs by nature are optimists and passionate people, especially when it comes to their companies. They want and need a financial partner that can grow with them. Typically, your first option of choice is your friendly, neighborhood commercial bank. There are several issues that one often encounters here:

1. Debt – Is your company too leveraged for the bank to accept?

2. Profitability – Is there enough profit to sustain the enterprise?

3. Cash Flow – Is your company generating enough cash to pay the bills?

4. Inventory – Are you turning it over fast enough?

5. Equity – Do you have enough skin in the game?

If your firm can pass the litmus test, then by all means you should go with your friendly, neighborhood commercial bank. They are typically your cheapest source of money.

Next, let us consider a more interesting question from the entrepreneur’s perspective. I’ve worked this long and hard. Don’t I deserve to be rewarded? Don’t I deserve to be a millionaire? If you don’t already have a million dollars in the bank, then the bank will probably be the first to tell you, “No.” So what’s a hard-working entrepreneur to do? Surprisingly, this issue is one that is faced by countless business owners as they face retirement or just want to “take some chips off the table” for security purposes.

The above cases represent typical situations where it makes sense to consider other financing options such as a Mezzanine Debt Financing.

## Recapitalization Example

Below are some typical scenarios where you might want to consider working with a mezzanine lender:

1: Company needs capital infusion for either working capital or CAPEX.

2: Entrepreneur would like to buy out a partner.

3: Entrepreneur would like to “take some chips off the table” to provide security for his/her family.

4: Entrepreneur would like to pass along management to next generation.

5: Entrepreneur would like to share some equity with management staff and/or employees.

6: Entrepreneur would like help with selling the company to a strategic buyer at a good profit so s/he can retire.

### Mezzanine Recapitalization: Conclusion

Entrepreneurs should consider mezzanine lenders a strategic financial resource. They many not always be your first choice, but they just might be your best choice. They have a higher cost of capital than banks. But, for the money, they provide a lot of strategic options to the entrepreneur that commercial banks could not be party to.

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# Raise or Increase Inventory Turnover Ratio

In order to increase inventory turnover ratio for a company, it is important to understand the calculations that go into calculating the turnover ratio. Once this is achieved, a company can go about the necessary efforts to raise this ratio, increasing the overall inventory sold.

## Inventory Ratio Calculation

Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

For example, assume annual credit sales are \$10,000, and inventory is \$5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

For example, assume cost of goods sold during the period is \$10,000 and average inventory is \$5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

### Inventory Turnover Ratio: Example

For example, Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

Annual credit sales are \$10,000 and inventory is \$5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.

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Inventory Turnover Ratio Analysis

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# Quick Ratio Analysis Definition

The quick ratio, defined also as the acid test ratio, reveals a company’s ability to meet short-term operating needs by using its liquid assets. It is similar to the current ratio, but is considered a more reliable indicator of a company’s short-term financial strength. The difference between these two is that the quick ratio subtracts inventory from current assets and compares the quick asset to the current liabilities. Similar to the current ratio, value for the quick ratio analysis varies widely by company and industry. In theory, the higher the ratio is, then the better the position of the company is; however, a better benchmark is to compare the ratio with the industry average.

## Quick Ratio Explanation

Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more conservative because it does not include inventories which can sometimes be difficult to liquidate. For lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the worst possible condition.

Although the quick ratio gives investors a better picture of a company’s ability to meet current obligations the current ratio, investors should be aware that the quick ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash (such as retail stores and fast food restaurants).

### Quick Ratio Formula

The current ratio formula is as follows:

Current ratio = (Current assets – Inventories) / Current liabilities

Or = Quick assets / Current liabilities

Or = (Cash + Accounts Receivable + Cash equivalents) / Current liabilities

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Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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# Quick Ratio Analysis Benchmark Example

Quick ratio calculation is a useful skill for any business that may face cash flow issues. Furthermore, quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. It normally includes cash, marketable securities, and some accounts receivables.

Current liabilities represent financial obligations that come due within one year. It normally included accounts payable, notes payable, short-term loans, current portion of term debt, accrued expenses and taxes.

For example, a business has \$5,000 in current assets, \$1,000 in inventories and \$2,500 in current liabilities.

Quick ratio = (5,000 – 1,000) / 2,500 = 1.6

Since we subtracted current inventory, it means that for every dollar of current liabilities there are \$1.6 of easily convertible assets.

### Quick Ratio Example

The following is a quick ratio analysis benchmark example. Suzy has started a boutique-style bakery which is mainly servicing customers who desire wedding cakes. Suzy, who works in a trade which she is truly passionate about, is by no means an expert in financial statements. She is, however, an expert in the operations of her business. She knows that if she wants to scale, something that her customers are driving her to as much as her own desires for financial success, she needs a partner who can provide the business expertise. About the time she realizes this Suzy meets Monica, an experienced restauranteur. The two women quickly develop a rapport. Suzy learns that Monica is looking for a new deal and communicates her needs over lunch. They resolve, after a testing period, to support each other by applying their expertise to Suzy’s business. The two women become partners.

#### Calculation

Monica knows that lack of cash is one of the main reasons that causes any business, especially in food-service, to close doors. As Monica takes her initial look at the financial statements of the business she keeps this in mind.

Monica wants to know if the company can pay its debts. Due to the fact that the business desperately needs all inventory to continue scaling, she resolves to use quick ratio vs current ratio calculation. Since there is no quick ratio accounting calculator, she performs this calculation:

If:

Current Assets = \$5,000 Inventory = \$1,000 Current Liabilities = \$2,500

Quick ratio = (5,000 – 1,000) / 2,500 = 1.6

This means that for every dollar of current liabilities there are \$1.6 of easily convertible assets.

This is a major relief to Monica. Finishing her analysis of the company statements Monica feels very confident. As long as employee turnover remains the same the two women have avoided two of the most important issues a business could face.

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