The higher your material spend to your Cost of Goods Sold, the more important it is to optimize this high cost to your business. Much money is lost yearly to material waste from employees not caring and operating inefficiently because of material variability.
Failure to be cost-efficient and productive with the materials you purchase and consume in your operations makes it nearly impossible to convert the money spent on materials into operating profit.
Overview
If your business primarily converts raw materials into finished goods, then smart material spending is likely to be the largest profit contributor to your business. If the size of this direct cost in relation to other costs is large, it will have a more significant impact on profit, relative to other investments.
Materials Spend Productivity is a Throughput Ratio that measures how important your material spend is to your business. It’s calculated by dividing the Gross Profit as the ending output for a period by the total costs incurred for that input in that same period. This productivity measure aims to help you determine how cost-efficient and productive your operations are in converting money spent on materials into operating profit.
The formula for calculating Materials Spend Productivity
Output (Gross Profit) / Input (Materials Expense)
A ratio of 1.2 means that the company is generating 1 dollar and 20 cents of operating profit for every dollar invested in materials. A 0.3 ratio means that $0.30 in Gross Profit is generated for every $1.00 spent on materials.
Higher Creates Opportunity: an increasing ratio indicates that this investment is becoming more important to your business’s success.
Lower Creates Challenges: a ratio significantly below 1 indicates materials are an insignificant contributor in producing Gross Profit.