Profit Velocity Analysis is a method of evaluating the products to find out which products take highest time to get pushed from the manufacturing bottle neck. Most of the companies use contribution margin to find out the products that are hardest to push where all the variable costs are subtracted from the total sales of a company. However the contribution margin calculation ignores a very important point that is the time a product spends in manufacturing unit that also adds a considerable amount in the variable costs of the products. If a product spends large amount of time in manufacturing bottleneck and the rate of rejection related to that product is high the management needs to manufacture extra products so that high volume of products can be manufactured where the contribution margin is low. The time issue can be dealt with the help of profit velocity analysis.
Let’s take an example of a company that is producing two products ABC and XYZ. The product ABC has a high contribution margin that is 40 percent where as the product XYZ has a low contribution margin of only 20 percent. However the production time required by product ABC is four hours where as the production time required by product XYZ is only one hour. Selling price of both the products is same that is$ 250. Now the velocity of the profit on both the products can be find out as under
Product ABC = 2 units x 250 x 40 percent contribution margin = $200
Product XYZ = 8 units x 250 x 20 percent contribution margin= $ 500
This shows it is more profitable for a business to sell products that have low contribution margin along with low number of production hours.
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