Throughput: How Bottleneck Equipment is Impacting Your EBITDA
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a measure of financial performance that is directly tied to the valuation of a manufacturing company. According to Manufacturing Magazine, investors look directly at EBITDA when applying valuations to manufacturing businesses. Depending on the size of the manufacturing business, the valuations range between 5.8- 7.7 times their EBITDA.
Investors and analysts like using EBITDA as a valuation metric because it’s a representation of the true earning power of a business that is capital intensive like most food processing plants are. From our article, “How CFOs Can Increase EBITDA Using IIoT”:
“Generally, EBITDA displays the amount of available cash flow a company possesses to either reinvest in itself or pay dividends. The efficiency of a company’s production activity is revealed and overall, EBITDA provides an accurate representation of a manufacturing company’s performance by removing many factors that can distort its actual value.”
Clearly, any technologies that can improve a food processing plant’s EBITDA can make a dramatic impact on business cash flow and valuation.
In our latest e-book, Leveraging Technology to Improve OEE in Manufacturing, we are able to demonstrate that implementing a Worximity TileBoard can drive overall equipment effectiveness (OEE) higher, which has a dramatic impact on EBITDA.
A snapshot of this analysis is here:
Throughput is directly connected to business financial performance metrics, including EBITDA.
Throughput is a basic, widely used metric in manufacturing that refers to the number of units of a product produced over a certain period of time. It is one of the most important manufacturing metrics because how many products a machine, line, or facility produces is directly related to profitability.
Inefficiencies in production, such as downtime and bottlenecks, can have a negative impact on throughput and, therefore, on earnings metrics such as EBITDA.
Downtime and production inefficiencies are widely known and discussed issues, but what are bottlenecks, and how do they factor into throughput and EBITDA?
Bottlenecks Are the bane of maximizing throughput.
A bottleneck is a term used in many applications, including applications outside of the manufacturing industry. For example, a narrow road along an important route with high traffic flow will cause traffic jams, making this spot on the road a bottleneck. The use of the term bottleneck is much the same in manufacturing; it refers to a machine in a production line with the lowest throughput rate. Because the bottleneck machine has the lowest throughput rate, it becomes the limiting factor of throughput through an entire process because the maximum speed of the line is dictated by its slowest machine.
If machines earlier in the process have higher throughput, there will be a buildup of material waiting to be sent through the bottleneck machine, quickly causing problems, limiting overall throughput, and inhibiting financial performance. Even if machines in the process after the bottleneck have higher throughput capabilities, they will end up waiting on the bottleneck equipment, causing overall throughput to remain low.
Thankfully, the negative effects of bottlenecks can be reduced or even eliminated. Sometimes the solution is as simple as optimizing the equipment via part replacement, general maintenance, or relocation within a facility to improve process flow.
How does throughput apply to EBITDA?
EBITDA is intended to be an alternative to net income when evaluating a company’s earnings. If a potential investor were to look only at net income, it could paint a company in a negative light when it invests in new machinery or facilities. These investments raise costs, hurting net income and making the company look bad, despite the opportunity the investments grant to increase future revenue. EBITDA is a pure measure of revenue relevant to the goods produced, meaning that after investing in a new facility, a company’s EBITDA will improve due to the increased output. You can learn more about the relationship between EBITDA and machinery investment here.
Unfortunately, bottleneck equipment has the potential to severely limit EBITDA improvement. Let’s say a facility invests in a new machine in a production line. In theory, EBITDA should increase. However, if a bottleneck machine is present in the line and isn’t optimized or improved in any way upon the installation of the new machine, EBITDA will not improve. While this new machine should increase EBITDA due to its increased throughput and/or efficiency, the line or facility still only operates as quickly as its slowest machine or bottleneck.
Worse yet, not only will EBITDA fail to improve as intended, but net profit will suffer even further. Despite net profit falling, without bottleneck equipment, the increase in throughput or efficiency should help offset at least part of the decrease in net profit. With bottleneck equipment, no improvement in throughput would occur, causing the net profit not to recover at all. Unless bottleneck equipment itself is replaced, it will continue to negate efforts to improve both net profit and EBITDA.
Maximizing throughput is essential to the performance of manufacturing businesses. In nearly every company that we partner with, we’re able to help them to uncover why throughput is limited and where there are opportunities for improvement. TileBoard is able to easily and cost-effectively discover both short-term adjustments that can sometimes radically improve throughput and where long-term investments should be allocated to remove bottlenecks and the potential return on investment.
Worximity is a proven partner in Smart Factory Analytics implementations. We have the demonstrated ability to implement Worximity TileBoard and quickly make an impact on the critical manufacturing key performance indicators (KPIs) that matter to manufacturers. Worximity’s expertise and technology provide significant leverage, with relatively small investments leading to substantial gains in KPIs such as throughput. These gains contribute directly to improved cash flow and increased EBITDA.
To learn how Worximity can help you to evaluate your operations and identify and reduce bottlenecks, request a demo below!