LEAN MANUFACTURING A FINANCIAL PERSPECTIVE

1
LEAN MANUFACTURING A FINANCIAL PERSPECTIVE

• A Workshop for Finance, Accounting and Operations
  Personnel

Presented By Prakash R. Mulchandani October 12,
2001
2
Agenda

• Course Perspective
• Objectives of a Firm
• Financial Statements
• Ratio / Profitability Analysis
• Manufacturing Accounting
• Cost-Volume-Profit Analysis
• The Changing Business Environment
• Lean Manufacturing
• Measurables in Lean Manufacturing
• Financial Impact of Lean Techniques
• Conclusion

3
Course Perspective
4
Course Perspective
5
Objectives of a Firm
6
Objectives of the Firm

• Profit achieve profit goals through increasing
  sales and reducing costs
• Cash Flow generate cash flow through profits
  and use it wisely
• Liquidity control the financial condition and
  solvency of the business

7
Accounting System Overview

• Objectives of the firm are usually translated
  into financial terms (common denominator)
• Financial information is found in financial
  statements
• Financial statements are prepared from accounting
  database and records of the firm
• depend on accounting system
• Accounting system has both, an external and
  internal focus

8
Accounting Functions
9
Financial Statements
10
Financial Statements

• Income statement
• Sales Revenue Expenses Profit Net Income
• Balance Sheet
• Assets Liabilities Owners Equity
• Statement of Cash Flows
• Cash Flow from Income Other Sources of
• Cash Uses of Cash Net Change in Cash

11
Income Statement

• Summarizes sales revenue and expenses for a
  period of time
• yields profit
• It is the main determinant of the balance sheet
• Sales revenue increases an asset or decreases a
  liability
• Expenses decrease an asset or increase a
  liability
• Profits increase Owners Equity
• shows up in retained earnings

12
Income Statement for 1999(000)
Sales Revenue 12,038
Cost-of-goods-sold expense (7,824)
Gross margin 4,214
Operating expenses (3,046)
Depreciation expense (226)
Operating earnings 942
Interest Expense (153)
Earnings before income tax 789
Income tax expense (268)

Net income 521
13
Income Statement for 1999 (000)
Quantities sold times the sales prices for all
products sold during the period.
Sales Revenue 12,038


Cost-of-Goods-Sold Expense (7,824)




Gross Margin 4,214


Sales quantities times the unit cost of the
products sold. Costs change over time and
therefore the business has to decide between the
first-in, first-out (FIFO) or the last-in,
last-out (LIFO) method.
14
Income Statement for 1999 (continued) (000)
Operating expenses that are driven by sales
volume. Examples are packaging costs, and
storage costs. If sales volume were to increase
20, then these costs would also increase by 20.
Variable operating expenses Variable operating expenses
Sales-volume-driven (740)



Sales-revenue-driven (1,204)

Contribution Margin 2,270
Operating expenses that are driven by sales
revenue. Examples are sales commissions based on
sales prices.
15
Income Statement for 1999 (continued) (000)
Fixed expenses Fixed expenses
Operating expenses (1,102)



Depreciation expense (226)

Operating earnings 942
Operating expenses that are relatively fixed for
the period. Examples are employees salaries,
rent, property taxes, and insurance.
Listed separately because it is such an unusual
expense. It is a portion of the total original
cost of the companys fixed assets (except land)
that is allocated to this period. Calculated
using straight line, DDB or SOYD methods.
16
Income Statement for 1999 (continued) (000)
Depends on the amount of short term and long term
debt outstanding during the year and the interest
rates on each issue of debt.
Interest expense (153)
Earnings before income tax 798

Income tax expense (268)


Net income 521

Federal, state and local taxes.
The bottom-line profit for the period.
17
Balance Sheet

• Measures financial condition of the firm
• Lists Assets, Liabilities and Owners Equity
• Assets are economic resources owned by the
  business
• Liabilities are its debts (creditors, lenders)
• Owners Equity is the residual claim on Assets
  after satisfying Liabilities
• initial investments by owners, profits
• Balance Sheet is a position statement
• Summarizes financial condition at a point in time

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Balance Sheet(000)
12/31/99 12/31/98 Increases (Decreases)
Assets
Cash 513 624 (111)
Accounts receivable 1,156 964 192
Inventory 1,956 1,654 302
Prepaid expenses 234 184 50
Total current assets 3,859 3,426

Property, plant, equipment 3,973 3,197 776
Accumulated depreciation (904) (678) (226)
Net of depreciation 3,069 2,519
Total assets 6,928 5,945
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Balance Sheet (continued)(000)
12/31/99 12/31/98 Increases (Decreases)
Liabilities
Accounts payable 778 660 118
Accrued expenses 376 296 80
Income tax payable 26 23 3
Short-term notes payable 850 750 100
Total current liabilities 2,030 1,729
Long-term notes payable 1,100 950
Total liabilities 3,130 2,679
Owners equity Capital stock 1,450 1,250 200
Retained earnings 2,348 2,016 332
Total Owners Equity 3,798 3,266
Total liabilities owners equity 6,928 5,945
20
Balance Sheet 12/31/99(000)
Cash is usually in one or more checking accounts.
Cash equivalents such as highly marketable,
short-term securities may be included in the cash
amount.

Cash 513

Accounts receivable 1,156
Inventory 1,956
Prepaid expenses 234

Property, plant, equipment 3,973
Three basic short-term operating assets.
Long-term operating assets whose useful lives
range from 3 to 5 years all the way to 30 or more
years for buildings. Their cost (except land) is
depreciated over their useful life.
21
Balance Sheet 12/31/99 (continued)(000)

Less accumulated Depreciation (904)
Total operating assets 6,928

Operating liabilities Operating liabilities
Accounts payable (778)


Cumulative portion of the original cost of the
assets that has been changed to depreciation
expense since the date of acquisition.
Non-interest-bearing, short-term liabilities that
arise from 2 operating sources (1) the purchase
of inventory on credit, and (2) the acquisition
of services and other items charged to expense
that are not paid for immediately. In short,
these are unpaid bills.
22
Balance Sheet 12/31/99 (continued)(000)

Accrued expenses (376)


Income tax payable (26)
Total operating liabilities (1,180)

Net operating assets 5,748
Expenses that have been recorded to match all
expenses for the period against sales revenue to
measure profit for the period.
Unpaid portion of tax expense, usually due within
2 or 3 months.
23
Balance Sheet 12/31/99 (continued)(000)

Sources of capital Sources of capital Sources of capital
Short-term notes payable Short-term notes payable 850
Long-term notes payable Long-term notes payable 1,100
Total interest-bearing debt Total interest-bearing debt 1,950

Capital stock Capital stock 1,450
Retained earnings Retained earnings 2,016
Total stockholders equity Total stockholders equity 3,798

Total debt owners equity Total debt owners equity 5,748
Interest-bearing liabilities from borrowings.
Short-term means one year or less long-term can
be up to 20 or more years.
Owners equity arises from 2 sources (1) capital
invested by the owners for which they receive
shares of stock and (2) profit earned but not
paid out as a dividend, which is retained in the
business.
24
Cash Flow Statement

• Shows sources and uses of cash
• Does not equal the profit for the period
• However, profits do generate cash flow over the
  long run
• may be lag before profit is converted to cash

25
Cash Flow Statement for 1999
Cash flows from operating activities Cash flows from operating activities Cash flows from operating activities Cash flows from operating activities Cash flows from operating activities
Net Income Net Income 521
Changes in operating assets liabilities Changes in operating assets liabilities Changes in operating assets liabilities Changes in operating assets liabilities
Accounts receivable Accounts receivable (192)
Inventory Inventory (302)
Prepaid expenses Prepaid expenses (50)
Accounts payable Accounts payable 118
Accrued expenses Accrued expenses 80
Income tax payable Income tax payable 3
Depreciation expense Depreciation expense 226 (117)
Cash flow from profit-making operations Cash flow from profit-making operations Cash flow from profit-making operations Cash flow from profit-making operations 404
26
Cash Flow Statement for 1999 (continued)
Cash flows from investing activities Cash flows from investing activities Cash flows from investing activities
Purchases of property, plant, and equipment Purchases of property, plant, and equipment (776)
Cash flows from financing activities Cash flows from financing activities
Short-term debt increase 100
Long-term borrowings 150
Capital stock issue 200
Cash dividends to stockholders (189) 261
Decrease in cash during year (111)
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Cash Flow Statement for 1999(000)
Net income is the starting point.
Net income 521
Changes in operating assets and liabilities Changes in operating assets and liabilities Changes in operating assets and liabilities
Accounts receivable increase (192)
Inventory increase (302)
Prepaid expense increase (50)



All three of these short-term operating assets
increased their ending balances were more than
their beginning balances. These increases
decreased cash flow.
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Cash Flow Statement for 1999 (continued)(000)
Changes in operating assets and liabilities (continued) Changes in operating assets and liabilities (continued) Changes in operating assets and liabilities (continued)
Accounts payable increase 118
Accrued expenses increase 80
Income tax payable increase 3 (343)

Operating cash flow before depreciation 178

All three of these short-term operating
liabilities increased their ending balances were
more than their beginning balances. These
increases increased cash flow.
This is the net total impact on cash flow due to
changes in the companys short-term operating
assets and liabilities.
29
Cash Flow Statement for 1999 (continued)(000)

Depreciation expense Depreciation expense 226





Cash flow from profit-making operations Cash flow from profit-making operations 404

Depreciation is not a cash outlay in the year
recorded as expense. The cash outlay occurred
years ago when the assets being depreciated were
bought.
The business is free to do anything it wants to
with this cash flow.
30
Cash Flow Statement for 1999 (continued)(000)
Cash flows from investing activities Cash flows from investing activities Cash flows from investing activities
Purchases of property, plant, equipment Purchases of property, plant, equipment (776)

Cash flows from financing activities Cash flows from financing activities Cash flows from financing activities
Net increase in short-term debt 100
Long-term borrowings 150
Capital stock issue 200
Cash dividends to stockholders (189) 261
Increase (decrease) in cash during year (111)
These purchases are called capital expenditures.
The company raised capital from these three
sources during the year.
The company paid cash dividends of this amount
during the year, which is about one-third of net
income.
31
Cost of Capital

• Business has 5.7 million in capital invested in
  net operating assets
• This capital is supplied by debt (1.9 million)
  and equity (3.8 million)
• Each one has an associated cost
• The weighted average cost of capital is as
  follows

32
Cost of Capital (continued)
Source Amount (000) Weight Source Cost Weighted Average
Debt 1,950 34 10 3.4
Equity 3,798 66 15 9.9
Total 5,748 100 13.3
33
Ratio / Profitability Analysis
34
Ratio Analysis

• Accounts Receivable Turnover
• A measure of the ability to control accounts
  receivable. Measures how rapidly collections
  occur.
• Accounts Receivable
• Turnover Credit Sales
• Average Accounts Receivable
• 12,038 11.35 turns
• .5 (1,156964)

35

• Accounts Receivable Turnover (continued)
• Days to Collect Receivables 365 days
• Accounts Receivable Turnover
• 365 32.2 days
• 11.35

36

• Inventory Turnover
• A measure of assessing capital tied up in raw
  material, work-in-process and finished goods
  inventory. Measures how rapidly inventory is
  converted into sales.
• Inventory Turnover Cost of Goods Sold
• Average inventory
• 7,824 4.3 turns
• .5 (1,9561,654)

37

• Asset Turnover
• A measure of asset efficiency, or use of assets
  to generate sales.
• Asset Turnover Net Sales
• Average Assets
• 12,038 1.87 turns
• .5 (6,9285,945)

38

• Current Ratio
• A measure of coverage of short term debt
  (solvency).
• Current Ratio Current Assets
• Current Liabilities
• 3,859 1.90
• 2,030

39

• Debt to Equity
• Amount of assets provided by creditors for each
  dollar of assets provided by stockholders.
• Debt to Equity Total Debt
• Stockholders Equity
• 3,130 .79
• 3,978

40

• Times Interest Earned
• Measure of firms operations which provide
  protection to the long term creditor.
• Times Interest Earned Income before Interest
  Taxes
• Interest Expense
• 942 6.16
• 153

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Profitability Ratios

• Return on Assets
• Measure of how well assets have been employed.
• ROA Net Income
• Average Assets
• 521 8.1
• .5 (6,928 5,945)

42

• Return on Assets (continued)
• Sometimes use operating income divided by
  average net operating assets
• ROA Operating Income
• Average Net Operating Assets
• 942 18.2
• .5 (5,748 4,606)

43

• Return on Equity
• Measure of how well the stockholders equity has
  been employed. Usually higher than ROA due to
  financial leverage.
• ROE Net Income
• Average Stockholders Equity
• 521 14.8
• .5 (3,798 3,266)

44

• Return on Sales
• Measure of profitability as a function of sales.
• ROS Net Income
• Net Sales
• 521 4.3
• 12,038

45

• Gross Margin Percentage
• A broad gauge of profitability. Engineered
  products have high margins, while commodities
  have low margins.
• Gross Margin Percentage Gross Margin
• Net Sales
• 4,214 35.0
• 12,038

46
Manufacturing Accounting
47
Manufacturing Accounting

• Two common manufacturing cost processes
  encountered
• Process costing (chemicals, beverage, foods)
• Job order costing (custom furniture, airplanes)
• Manufacturing Costs consist of
• Raw materials (purchased parts)
• Direct Labor (production workers)
• Manufacturing overhead (all other manufacturing
  costs)

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Manufacturing Accounting (continued)

• Raw materials and direct labor are variable costs
• Manufacturing overhead costs
• Variable (electricity, supplies, indirect labor
  ?)
• Fixed (rent, depreciation, manufacturing
  supervisor
• Allocated to product using activity base (labor
  hours, machine hours)
• Uses pre-determined overhead rate
• Manufacturing costs are also called inventoriable
  or product costs
• Expensed as cost of goods sold when sales take
  place

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Manufacturing Cost Report for Year
Annual production capacity Annual production capacity 16,000
Actual output Actual output 16,000
Basic cost components Per unit Total
Raw materials 720 11,520
Direct labor 120 1,920
Variable overhead 140 2,240
Fixed overhead 220 3,520
Total manufacturing costs 1,200 19,200

To 15,000 units sold 1,200 18,000
To 1,000 units inventory 1,200 1,200
Total manufacturing costs 19,200
These 4 basic types of manufacturing costs are
called product costs. They became attached to
the product and thus are not charged off to
expense until the product is sold.
The cost of the 1,000 units manufactured but not
sold is added to the inventory asset account.
increase
50
Operating Profit Report for Year
Sales volume 15,000 units
Per unit Total
Sales revenue 1,600 24,000
Cost-of-goods-sold expense 1,200 18,000
Gross profit (or gross margin) 400 6,000
Variable operating expenses 100 1,500
Fixed operating expenses 1,000
Operating profit (before interest taxes) 3,500

Cost-of-goods-sold expense equals the sales
volume times the unit product cost.

Both sales-volume- and sales-revenue-driven
expenses are shown here in one total amount.
These expenses are non-manufacturing cost, i.e.,
not part of the production process. They are
called period costs because they are charged off
to the period in which they are recorded and do
not become part of product cost.
51
Another Look at Operating Profit
Contribution Format (000) Contribution Format (000) Contribution Format (000)
Sales Revenue 24,000

Variable Costs
Raw Materials (10,800)
Direct Labor (1,800)
Variable Overhead (2,100)
Variable Operating Expenses (1,500)
Total Variable Costs (16,200)
Contribution Margin 7,800

Fixed Costs
Fixed Overhead (3,300)
Fixed Operating Expenses (1,000)
Total Fixed Costs (4,300)

Operating Profit 3,500
52
Another Example

• Let us consider another example of manufacturing
  costs
• Beginning inventory exists in direct materials,
  work-in-process and finished goods
• Pre-determined overhead rate for the firm is
  calculated as follows
• Est. total manufacturing overhead costs
• Estimated direct labor hours
• 6,520,000
• 250,000 hours
• 25 / direct labor hour

Rate
53
Flow of Manufacturing Costs(000)
Direct Materials
30 BI 400 (380) 50 EI
Purchases
Sequential Tracking
20 BI 380 360 600 (940) 300 EI
10 BI 940 (900) 50 EI
900
Direct labor 24,000 hours _at_ 15/hr Mfg. Ovd. 25
/ direct labor hr.
Mfg. Cost of goods sold
Finished Goods
Work-in-process
54
Application of Overhead Costs(000)
Manufacturing Overhead Manufacturing Overhead Manufacturing Overhead Manufacturing Overhead
Actual Mfg. Overhead Incurred Actual Mfg. Overhead Incurred Mfg. Ohd. Applied to WIP Mfg. Ohd. Applied to WIP
Indirect Labor 190 25 per direct labor hour times 24,000 hours 600
Factory Salary 50
Perishable Tools 60
Supplies 60
Scrap/Rework 70
Rent 40
Depreciation 40 Overabsorbed mfg. Overhead 85
Other 5 (transferred to COGS) (transferred to COGS)
Total 515
55
Income Summary(000)
Sales 1,310
Less Cost of Goods Sold Less Cost of Goods Sold
Manufacturing Costs (900)
Overabsorbed Mfg. Overhead 85
Net COGS (815)
Gross Margin Gross Margin 495
Selling Admin. Expenses Selling Admin. Expenses 330
Profit (before tax) Profit (before tax) 165
56
Comments

• Production far exceeded sales
• Extensive inventory build
• Raw material
• Work-in-process
• Finished goods
• Total
• Increased profits by 85
• Possible reasons
• Increase manufacturing efficiency
• Increase utilization
• Increase profits
• Reporting for WIP and finished goods are also
  used to update inventory levels for material
  control (MRP)

20 300 40 360
57
Backflush Costing

• An alternative to sequential tracking
• Omits recording some accounting entries
• We will consider example in which work-in-process
  inventory entries are not made
• a variation also eliminates finished goods
  inventory

58
Backflush Costing

• Used in companies with JIT production systems
• Toyota
• Eagle-Gypsum
• Amounts in WIP are small
• Uses pre-determined material and conversion costs
  (labor and mfg. ohd.) for each product
• These costs enter finished goods inventory
• Variances are expensed as period costs is COGS

59
Backflush Costing Flow(000)
Direct Material
20 BI 130 (100) 50 EI
Purchases
100,000 units _at_ 10 / unit
1,000
Finished Goods
COGS
400 BI 3,000 3,300 100 EI
3,300
100,000 units _at_ 30 / unit
110,000 units _at_ 30 / unit
Conversion Cost
2,000
Direct labor
600 1,550 2,150 total
Mfg. Ohd.(actual)
100,000 units _at_ 20 / unit
60
Backflush Costing Observations(000)

• Material and conversion costs per unit are
  predetermined
• Difference between actual costs and predetermined
  costs are expensed in COGS
• 150 in previous example
• Total COGS thus equals 3,450 (3,300 150)
• Inventory consists of direct materials and
  finished goods only
• 50 and 100 respectively

61
Backflush Costing Observations(000)

• Eliminates WIP inventory and associated
  production reporting
• Implications for manufacturing efficiency and WIP
  profits
• Accounting does not strictly match GAAP
• WIP exists, but not recognized
• Users cite materiality concept in support of
  system
• WIP very small

62
Cost-Volume-Profit (CVP) Analysis
63
Increasing Profitability

• Operating Profit (also called Earnings before
  Interest Taxes, EBIT) depends on three primary
  factors
• sales volume
• unit profit margin (contribution)
• fixed expenses

64
Increasing Profitability (continued)

• Lets say,
• selling price per unit 250
• variable cost per unit 150
• thus, contribution margin per unit 100
• fixed cost 35,000

65
Increasing Profitability (continued)

• Breakeven Point is when total contribution equals
  fixed cost
• breakeven units 35,000 / 100/unit 350
  units
• Each unit sales above breakeven yields 100
  profit
• a very powerful concept
• profitability is enhanced substantially with
  increased volume
• For sales of 500 units
• Profits 100/unit x 150 units over breakeven
• 15,000

66
Variable Cost Reduction

• We are able to reduce costs by 25 per unit
• rework, scrap, productivity
• Contribution margin increases to 125 per unit
• Breakeven volume decreases
• breakeven units 35,000 / 125 contribution per
  unit
• 280 units
• For sales of 500 units
• Profit 125 contribution / unit x 220 units
  over breakeven
• 27,500

67
Improve Quality Decrease Cost and Increase
Sales

• Rework / scrap costs reduced by 25 per unit
• leads to improved quality
• more customer orders
• Sales volume increases to 600 units
• Profit 125 contr. / unit x 320 units over
  breakeven 40,000

68
The Changing Business Environment
69
The Changing Business Environment

• The last two decades have been a period of
  tremendous change in the business environment
• Competition has become worldwide in scope
• Pace of innovation in products and services has
  accelerated
• This has led to lower prices, higher quality and
  more choices
• Though good for consumers, this has been a period
  of upheaval for businesses

70
The Changing Business Environment (continued)

• Traditional ways do not work anymore, and major
  changes are needed in transforming processes and
  people
• Improvement programs include
• Just-in-Time (JIT)
• Total Quality Management (TQM)
• Theory of Constraints (TOC)
• Process Reengineering
• Lean Manufacturing

71
The Changing Business Environment (continued)

• Major benefits of these programs are to
• enhance quality
• reduce cost
• increase throughput
• shorten customer delivery time
• increase profits (ultimately)

72
The Balanced Scorecard

• Balanced scorecard translates organizations
  mission and strategy
• into set of performance measures
• provides framework for implementing its strategy
• Focuses on financial and non-financial objectives
• Short and long term
• Four key perspectives
• Financial (common denominator)
• Customer
• Internal business perspectives
• Learning and growth

73
The Balanced Scorecard

• Measures fundamental changes in the company
• Signals prospects of creating economic value for
  the future
• Management compensation is often tied to both
  financial and non-financial objectives

74
Linking Strategic Intent to Measurable Objectives

• Customer Perspective
• Order Fulfillment
• Delivery Performance
• Build to Schedule
• Quality
• Price
• Financial Perspective
• Cash Flow
• Inventory , Turns DOH
• Market Share and Growth
• ROI and ROA

• Internal Perspective
• Lead Time
• Manufacturing Cycle Time
• Productivity
• Value-adding Ratio
• Quality and Safety
• Throughput
• Learning Perspective
• Innovation
• Vision Development
• Employee Involvement
• Responsive Systems

75
Lean Manufacturing
76
Lean Manufacturing Vision

• Develop a lean, flexible and disciplined
  manufacturing system defined by a set of
  principles and processes
• That employs groups of capable and empowered
  people learning and working safely together
• In the production and delivery of products that
  consistently exceed customers expectations

77
Techniques

• Lean means that we eliminate
• unnecessary duplication and waste in processes.
• anything that doesnt add value for the customer.

78
Techniques (continued)

• Flexible is being able to
• take advantage of new information, changing
  markets and new technologies quickly.
• produce a greater variety of products in smaller
  batches
• produce just-in-time
• minimize capital investment
• launch new products faster

79
Techniques (continued)

• Disciplined means
• building according to a schedule based on
  customer demand
• using common methods that keep processes stable
• Fully use facilities and people without stops and
  starts because of fluctuating demand

80
Techniques (continued)

• Groups of capable, empowered people learning and
  working safely together means
• People are educated and trained to do their jobs
  and to continuously improve themselves

81
Techniques (continued)

• Working together allows people to build on the
  abilities of co-workers and themselves to
• impact cost, quality and timing
• provide products that exceed expectations

82
Techniques (continued)

• Exceeding customers expectations means providing
  products that fill more than basic needs and
  wants when it comes to
• QUALITY They are well built with superb fit and
  finish, with zero defects
• COST They deliver value for the money and
  trouble free ownership
• TIME Products are first to market delivered on
  schedule, when the customer wants them. Time is
  also speed of delivery (short lead time)

83
Measurables in Lean Manufacturing
84
Primary Lean Manufacturing Measurables

• Manufacturing Cycle Time (Dock to Dock)
• First Time Through Capability
• Overall Equipment Effectiveness
• Build to Schedule
• Total Cost

85
Manufacturing Cycle Time

• The elapsed time between unloading raw materials
  and releasing finished goods for shipment.
• Total units in inventory of control part
• End of line production rate

MCT
86
Where Does the Time Go?
Set-up Time Queue Time WIP Stores Wait Time MRB Crib Process Time Test Time
95 Non-production time
5 Manufacturing Time
87
Calculate End of Line Rate

• Determine the end of line rate for the week by
  dividing the number of units produced by the
  number of plant production hours, excluding
  breaks and lunch.
• units built per week of control part
• production hours per week (plant)

EOL rate
88
Calculate MCT Production Hours

• Total the units found in production, and then
  divide by the end of line rate
• total units
• end of line rate

MCT production hours
89
Manufacturing Cycle TimePerformance
Measures/Metrics
Performance Measure Financial Benefits Financial Metrics Impacted
Inventory Reduction Increased Inventory Turns Profits, ROA, Times
- work in process - dollars in inventory Interest Earned
- finished goods - interest expense reduced

Reduce Scrap / Rework Scrap / Rework Expense reduced Profits, ROA
90
Manufacturing Cycle TimePerformance
Measures/Metrics (continued)
Performance Measure Financial Benefits Financial Benefits Financial Metrics Impacted
Increase Equipment Effectiveness Increase Equipment Effectiveness Increase Capacity / Revenue Profits, ROA
- throughput - throughput

Reduce Floor Space Reduce Floor Space Reduce Rent Expense Profits, ROA

Reduce material handling/dunnage Reduce material handling/dunnage Reduce Expense Profits, ROA
91
First Time Through Capability (FTT)

• Calculates the percentage of units completing
  each sub-process (not scrapped, reworked,
  retested, diverted for off-line repair, or
  returned)
• Units entering process minus defective units
• Units entering process

FTT

• Defects include
• Scrap
• Rework
• Retests
• Repairs off line
• Returns

92
Why First Time Through (FTT)?

• Also called First Time Capability
• Measures internal quality
• Asks Is it right the first time?
• Indicates waste, process efficiency, and quality
  containment effectiveness

93
First Time ThroughPerformance Measures / Metrics
Performance Measure Financial Benefit Financial Metrics Impacted
Increase throughput Increase capacity / revenue Profits, ROA
Increase efficiency Reduce labor cost Profits, ROA
Reduce scrap/rework Reduce expenses Profits, ROA
Reduce inventory Decrease interest expenses / increase turns Profits, ROA
Improve manufacturing cycle time Various Various
Increase equipment effectiveness (OEE) Various Various
Improve build to schedule capability Various Various
94
Overall Equipment Effectiveness (OEE)
OEE is a measure of the availability, performance
rate, and quality rate of a piece of equipment
and a capacity measure for constraint
operations. OEE Availability X Performance X
Quality
95
OEE Definitions

• Availability
• Operating Time / Net Available Time
• Performance Rate
• (Ideal Cycle Time X Total Product Run) /
  Operating Time
• Quality
• (Total Products Run Defective Parts) / Total
  Products Run

96
Overall Equipment EffectivenessPerformance
Measures / Metrics
Performance Measure Financial Benefits Financial Metrics Impacted
Increase Throughput - Increase Capacity / Revenue Profits, ROA
- Reduce investment ROA

Improve Quality Decrease Cost Profits, ROA
-Scrap / rework

Reduce Inventory Reduce Interest Expense / increase turns Profits, ROA
97
Build to Schedule
Build to Schedule reveals how well a plant
executes plans to produce precisely what
customers want, in the proper sequence and
mix. BTS Volume X Mix X Sequence
98
BTS Calculate Volume Performance

• Volume Performance
• actual number of units produced
• scheduled number of units

99
BTS Calculate Mix Performance

• Mix Performance
• actual units built to mix
• lower of actual units produced or scheduled
• Actual units built to mix
• the number of units built that are included in
  the daily production schedule (no overbuilds)

100
BTS Calculate Sequence Performance

• Sequence Performance
• actual units built to sequence
• actual units built mix
• Actual units built to sequence
• the number of units built on a given day in the
  scheduled order (only units after the first
  having a sequence number larger than all
  predecessors)

101
Build to SchedulePerformance Measures / Metrics
Performance Measure Financial Benefit Financial Metrics Impacted
Inventory Reduction Increase Inventory Turns Profits, ROA
Reduce Interest Expense

Customer Satisfaction Increase Revenue Profits, ROA

Reduce Transportation Decrease Freight Expense Profits, ROA

Improve Efficiency Decrease Labor Costs Profits, ROA
- changeovers
102
Why Total Cost (TC)?

• Measures total cost-per-unit
• Total cost per unit equals the affordable
  business structure
• Can we provide high quality products with
  desirable feature and performance at prices our
  customers are willing and able to pay for and
  STILL make a profit?

103
Traditional Costing
Manufacturing Cost

Profit Margin
Price
104
Todays Costing
Price
-
Profit Margin
Manufacturing Cost
105
Typical Plant Cost Structure
106
How Can Plant Total Cost be Reduced?

• Total Cost can be lowered by
• Reducing material costs
• Work with Purchasing and suppliers to create
  win-win opportunities
• Reduce labor and overhead costs
• Achieve best-in-the-world levels of efficiency
• Reduce warranty costs
• Build it right the first time

107
How Can Plant Total Cost be Reduced? (continued)

• Total Cost can also be lowered by
• Reducing freight and other costs
• Build to the production schedule
• Make good trade-off decisions
• 3 Material Cost Reduction for a 1 Plant
  Operating Cost Increase

108
Financial Impact of Lean Techniques
109
Lean Manufacturing Impact (000)
Financial Impact Financial Impact Financial Impact
Item Current Amount, Percent Change Revenue Income Assets
Cost Reduction
Scrap/Rework 300 75 225
Productivity, Direct Labor 1,400 10 140
Material Handling / Dunnage 200 30 60
Maintenance 400 5 20
Warranty 200 50 100
Floor Space, Rent 400 20 80
Revenue Increase
Throughput / Capacity 12,038 10 1,204 421
Asset Decrease
Inventory 1,805 40 72 722
Less Costs of Implementing Lean (300)
Total Impact Before Tax 1,204 818 722
Total Impact After Tax 1,204 540 722
110
Financial Impact on Firm (000)
Revenue Net Income Average Assets ROS ROA
Base Case 12,038 521 6,436 4.3 8.1

Financial Impact of Lean Manufacturing 1,204 540 (722)

Impacted Results 13,242 1,061 5,714 8.5 18.6
111
Conclusion
112
Conclusion

• Continuous improvement is critical for survival
• Financial measures / metrics are the common
  denominator for business entities
• Lean manufacturing is the optimum means for
  process improvement
• Lean metrics are easily translated into financial
  terms