Slide 1Process Analysis & Improvement© Van Mieghem Targeting Improvement Module Key Operational Metrics: Time T, Inventory I, Throughput rate R Link through.

Slide 1Process Analysis & Improvement © Van Mieghem

Targeting Improvement Module

Key Operational Metrics: Time T, Inventory I, Throughput rate R Link through Little’s Law

Link Operational Metrics to Financial Metrics Levers for Improvement

Firm & Divisional Level: MBPF Inc. Mkt-Ops: CRU Computer Rentals


What is an improvement?

Strategic fit & competencies

Financials & process view


Operational Performance Measures

Flow (Cycle) time - T Throughput / flow rate – R Takt Time Inventory - I Process Cost Quality


Price

Quantity

Material

Labor

Energy

Overhead

PP&E

Inventory

Other

Revenues

Costs

Capital invested

Weighted average cost of capital

x

+

+

+

+

+x

Profit

Opportunity cost

-

Economic value added (EVA)

Financial metrics Operational metrics

1. Increase price2. Increase

throughput

Improvement levers

3. Reduce costs4. Improve quality

5. Reduce capital intensity6. Reduce inventory

Reduce time

-

The business imperative: economic value creation


What is Toyota doing now?

Taiichi Ohno’s answer was very simple:

“All we are doing is looking at the time line from the moment the customer gives us an order to the point when we collect the cash. And we are reducing that time line by removing the non-value-added wastes.”

Simple but brilliant.

(Taiichi Ohno. Toyota Production System: Beyond Large-Scale Production. p. ix.)


How reduce flow time?There are only two available levers


Takt Time

Takt time =

– Takt time yields the rate at which customers demand product– and the production rate to stay synchronized with demand

Example: – Demand = 150,000 cars per year– Total available production time = 2 x 8 hrs/day x 250 days/yr = 4,000 hrs/year– Takt = 4,000 hrs/150,000 cars = 1hr/37.5 cars = 96 sec / car

What does Little’s Law say about takt time?

“The rhythm of the conductor to keep the

orchestra in time”

Total time available

Customer demand

metronome

Willys Jeep

http://www.youtube.com/watch_popup?v=lgwF8mdQwlw&feature=player_embedded

http://www.youtube.com/watch_popup?v=lgwF8mdQwlw&feature=player_embedded


Linking operational measures:Little’s Law

Inventory = Throughput x Flow Time

I = R x T

Inventory Turnover = Throughput / Inventory

= 1/ T

Inventory I[units]

Flow rate/Throughput R

[units/hr]... ...... ......

Flow Time T [hrs]


A Process Example using Little’s Law

5 min

Doctor requeststests for patient

Initial doctorconsultation

Patient checks in

Nurse takestests

Wait

12 min 5 min 30 min1 patient

25% quit

75%4 patients/hr

Wait

2 patients


Targeting Improvement Module

Key Operational Metrics: Time T, Inventory I, Throughput rate R Link through Little’s Law

Link Operational Metrics to Financial Metrics


Inventory Turns in Retailing and Its Link to Inventory Costs

Home Depot (1/30/2011)

Wal-Mart (1/31/2011)

Net Sales $67,997 $418,952

Cost of sales $44,693 $315,287

Net Income $ 3,338 $ 15,355

Inventories $10,625 $ 36,318

Months of Inventory

If Wal-Mart carried the same months of inventory as Home Depot, its inventories would be

I =

This would tie up about $ billion extra in inventory.


Cash Conversion CycleMeasures duration between purchase of inventory and collection of accounts receivable: Cash Conversion Cycle=

Days of Inventory + Days of Receivables - Days of Payables

How long does it take between outlay of cash and collecting the reward?

Inventory

AccountsReceivable

AccountsPayable

Cash

Cash-to-Cash Cycle


MBPF Inc.: Consolidated Statement

Net Sales 250.0

Costs and expensesCost of Goods Sold 175.8Selling, general and administrative expenses 47.2Interest expense 4.0Depreciation 5.6Other (income) expenses 2.1TOTAL COSTS AND EXPENSES 234.7

INCOME BEFORE INCOME TAXES 15.3PROVISION FOR INCOME TAXES 7.0NET INCOME 8.3

RETAINED EARNINGS, BEGINNING OF YEAR 31.0LESS CASH DIVIDENDS DECLARED 2.1RETAINED EARNINGS AT END OF YEAR 37.2

NET INCOME PER COMMON SHARE 0.83DIVIDEND PER COMMON SHARE 0.21


MBPF Inc.: Balance Sheet

CURRENT ASSETS Cash 2.1 Short-term investments at cost (approximate mkt.) 3.0 Receivables, less allowances of $0.7 mil 27.9 Inventories 50.6 Other current assets 4.1 TOTAL CURRENT ASSETS 87.7 PROPERTY, PLANT AND EQUIPMENT (at cost) Land 2.1 Buildings 15.3 Machinery and equipment 50.1 Construction in progress 6.7 Subtotal 74.2 Less accumulated depreciation 25.0 NET PROPERTY, PLANT AND EQUIPMENT 49.2 Investments 4.1 Prepaid expenses and other deferred charges 1.9 Other assets 4.0 TOTAL ASSETS 146.9

(Selected) CURRENT LIABILITIES

Payables 11.9


Business Process Flows at MBPF, Inc:Cash to Cash cycle

C2C = - Days payable + Days of inventory + Days receivables


Period Ending Dec 31, 2010

Total Revenue 34,204,000

Cost of Revenue 26,561,000

Gross Profit 7,643,000

Selling General and Administrative 6,237,000

Operating Income or Loss 1,406,000

Income from Continuing Operations

Total Other Expenses Net 130,000

Earnings Before Interest And Taxes 1,536,000

Interest Expense 39,000

Income Before Tax 1,497,000

Income Tax Expense 352,000

Net Income From Continuing Ops

1,152,000

Net Income 1,152,000

Amazon Income Statement


Period Ending Dec 31, 2010

Cash And Cash Equivalents 3,777,000 Short Term Investments 4,985,000 Net Receivables 1,783,000 Inventory 3,202,000

Total Current Assets 13,747,000 Property Plant and Equipment 2,414,000 Goodwill 1,349,000 Intangible Assets - Other Assets 1,265,000 Deferred Long Term Asset Charges 22,000 Total Assets 18,797,000

Accounts Payable 10,372,000 Short/Current Long Term Debt -

Total Current Liabilities 10,372,000 Long Term Debt - Other Liabilities 1,561,000

Total Liabilities 11,933,000

Total Stockholder Equity 6,864,000

Net Tangible Assets 5,515,000

Amazon Balance Sheet


MBPF Inc.: Inventory and Cost of Goods

INVENTORYRaw materials (roof) 6.5Fabrication WIP (roof) 15.1Purchased parts (base) 8.6Assembly WIP 10.6Finished goods 9.8TOTAL 50.6

COST OF GOODS SOLDRaw materials 50.1Fabrication (L&OH) 60.2Purchased parts 40.2Assembly(L&OH) 25.3TOTAL 175.8


Raw Materials(roofs)

Fabrication (roofs)

$60.2/yrLabor & OH

Assembly

$25.3/yrLabor & OH

Purchased Parts (bases)

Finished Goods

$6.5$50.1/yr

$40.2/yr$8.6

$15.1

$10.6

$110.3/yr

$40.2/yr

$175.8/yr$9.8

$175.8/yr

MBPF Inc.: Detailed Financial Flows


MBPF Inc.: Detailed Flow Times

Raw Materials

Fabrication Purchased Parts

Assembly Finished Goods

Throughput R $/Year 50.1 110.3 40.2 175.8 175.8 $/Week 0.96 2.12 0.77 3.38 3.38 Inventory I ($) 6.5 15.1 8.6 10.6 9.8 Flow Time T = I/R (weeks)

6.75 7.12 11.12 3.14 2.90


Where target improvement?

Flow rate R($/week)

0.96

Flow Time T (weeks)

Accounts

Receivable

Finished

GoodsAss

embl

y

Fabrication

Raw MaterialsPurchased Parts

11.12 6.75 7.12 3.14 2.90 5.80

0.77

2.12

3.38

5.0


Case: CRU Computer Rentals

Linking Financial and Operational Flows&

Targeting Areas for Improvement

Handouts to be distributed in class

Slide 1Process Analysis & Improvement© Van Mieghem Targeting Improvement Module Key Operational Metrics: Time T, Inventory I, Throughput rate R Link through.

Documents

cash cycle slide

cost quality slide

throughput inventory

days of inventory

balance sheet slide

process example

months of inventory

purchase of inventory