Value added ratio

Overview of the Value Added Ratio

The value added ratio (VAR) is the time spent adding value to a product or service, divided by the total time from the receipt of an order to its delivery. A less expansive variation only includes in the denominator the period from the beginning of production or service through delivery.  In either case, the VAR is designed to showcase the very large proportion of time and money that a company wastes during its servicing of customers. As such, it is a cost-reduction tool that complements constraint analysis.

Example of the Value Added Ratio

The International Plastic Case Company (IPC) manufactures cases for a high-end MP3 player that is assembled and marketed by a Swedish consumer goods company.  The value-added steps of the case production process are a few seconds of molding time during a long injection molding batch run, as well as hand trimming and spraying three layers of urethane gloss on the case. Including drying time for the urethane gloss, these steps require six hours per case. Non value-added steps include moving plastic resin pellets to the injection molding machine, wait time at the machine, batch setup time, multiple movements between the molding, trimming, and painting workstations, and the storage interval before a full truckload is available for shipment. Thus, non value-added time is one week, which results in a VAR of 6 hours divided by 168 hours, or 3.6%.

The VAR percentage in the example is typical, and would be considered quite respectable in some industries.  A world-class manufacturing company, such as Toyota, rarely exceeds a VAR of 20%. Clearly, a detailed analysis of the processes underlying a VAR calculation can be used to pinpoint a considerable amount of wasted time in the production process, which can then lead to much greater inventory turnover and higher order fulfillment speeds.

Other Uses of the Value Added Ratio

We can apply the VAR to the effectiveness of the accounting function by dividing the time spent on business risk management and decision support by the total time worked by all accounting staff.  This is an excellent way to determine the effectiveness of the department in supporting strategic company activities (rather than the usual transaction processing functions).

Alternatively, we can include incremental changes in VAR in a capital expenditure request form.  By doing so, applicants can show how an investment will change the value added amount of a process.  However, since capital expenditures are not usually needed to improve the VAR, it can be used to deny capital expenditures.

If the VAR is used as a principal management metric, then watch out for a shift to outsourced administrative and production processes.  Managers will simply avoid the metric by shifting work away from the company, where it can only be measured with the active cooperation of suppliers.

In short, the value added ratio is a useful analysis tool that focuses on the effectiveness of time spent.

Related Courses

Capital Budgeting 
Constraint Management
Lean Accounting Guidebook