Get Your Pencil…
At least twice (once today) I’ve been asked about the logarithms and formulas I employ to measure business processes. This question embarrasses me slightly because I don’t really know what a logarithm is. That was undoubtedly in one of the math classes that I managed to avoid in high school and thankfully (for me) neither of my degree pursuits required higher math.
Now all that said, I admit that I get as goosed as the next guy about a statistically valid random sample and I know better than to use the work “significant” about any results unless I can back that statement up with statistics. But I believe strongly that business measurement needs to be done on a regular basis by business people, most of whom don’t use advanced mathematics on a daily basis (or even weekly, if you can imagine).
Most measurement can be (and often should be) done with a pencil on the back of a napkin with basic math (addition, subtraction, multiplication and division).
Many of the key measures in any business map to time and materials. How long it took to do something or how much stuff it took to make something. Time is easy: hours to perform a task, multiplied by the hourly wage that workers are paid, is the cost it takes to perform the process.
Materials is even easier. The cost of the materials it takes to make a product just get added up to determine the materials cost. And here’s the exciting part, campers. If you add the materials cost to the time cost you get pretty close to TOTAL cost! Yes, there are Finance Wonks out there who will tell you that you need to include equipment depreciation and facility surcharges and utilities and such. Finance Wonks are like herd dogs…they’re going to yap at you until you gallop the way they want you to. So just ask them what number you should add, subtract, multiply or divide your other numbers by in order to get to the “right” number (“right” is in quotes because it is, as we all know, relative), and they will be mollified.
So if we own a mechanic shop and want to understand how much to charge to change a tire, here’s the process:
- Measure how much time it takes to fix a tire. We might track the time on 20 tire fixes (using addition) and then take the average time among those 20 (using division).
- Then ask whoever does payroll at our shop to tell us what the hourly rate is for your tire-fixers. They, being fledgling Finance Wonks, will ask us whether we want the straight hourly rate or the fully burdened rate. We always want the fully burdened rate (the hourly wage + what it costs to provide benefits and pay employment tax).
- Multiply the hourly rate (in dollars) by the average number of hours it takes to change a tire. (using multiplication…you get the idea here, right?)
- Add margin. OK, I admit this takes a little more thought, but it DOESN’T take any more math. Margin is, of course, what we charge a customer to fix a tire minus what it costs us to fix that tire. It’s the amount of money we have to make above the cost in order to be able to pay ourselves and our rent. Too much margin and the shop down the street will get all our business. Too little margin and we won’t be able to pay our bills.
- The result of all this easy back-of-a-napkin math is how much we should charge to fix a tire. Expressed in coolio math: Price = (Time x Hourly Rate) + Margin
Of course, this also works with a sandwich shop, a wireless provider, a gardener, a global aerospace manufacturing company, a software development company, whatever. Sometimes the scale is different but the math is usually the same.
Yes, Finance Wonks, there are exceptions. But they’re just that…exceptions. Business can definitely be managed by tracking the inputs and outputs of your business with a pencil. Go ahead…test me…
~Geek~
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