Lean Income Statement

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Lean Income Statement Powered By Docstoc

A Workshop for Finance, Accounting
    and Operations Personnel

           Presented By:
       Prakash R. Mulchandani

                       October 12, 2001
•   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
Course Perspective
                        Course Perspective
                                    Objectives of
                                      the Firm

            Financial Statements                    Lean Manufacturing

Manufacturing                                                  Metrics
 Accounting                                     -First Time Through
                                                -Overall Equipment Effectiveness
                                                -Manufacturing Cycle Time (DTD)
                   Metrics                      -Build to Schedule
            -Operating Ratios                   -Total Cost
            -Profitability Ratios

Objectives of a Firm
          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
       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
              Accounting Functions
                          Accounting Data

                     Day-to-day             Summary Financial Reports
                     Operations             -Stockholder, lenders, other
                     -Bills                 stakeholders
 Revise              -Collect Money         -Uses GAAP
Decisions            -Payroll

                  Management Reporting      Tax Returns
                  -Budgets                  -Federal, state, local
Control           -Very detailed

     INTERNAL FOCUS                            EXTERNAL FOCUS
     -Management Accounting                    -Financial Accounting
Financial Statements
           Financial Statements
• Income statement
  Sales Revenue – Expenses = Profit = Net Income

• Balance Sheet
  Assets – Liabilities = Owner’s Equity

• Statement of Cash Flows
  Cash Flow from Income + Other Sources of
    Cash – Uses of Cash = Net Change in Cash
                     Income Statement
• Summarizes sales revenue and expenses for a period of
    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 Owner’s Equity
    shows up in retained earnings
  Income Statement for 1999
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
                 Income Statement for 1999
                                Quantities sold times the sales
                                prices for all products sold during
Sales Revenue      $12,038
                                the period.

Cost-of-Goods-      (7,824)     Sales quantities times the unit cost
Sold Expense                    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.

Gross Margin        $4,214
           Income Statement for 1999 (continued)
                                  Operating expenses that are driven
                                  by sales volume. Examples are
Variable operating expenses:
                                  packaging costs, and storage costs.
                                  If sales volume were to increase
Sales-volume-driven     $ (740)   20%, then these costs would also
                                  increase by 20%.

Sales-revenue-driven    (1,204)   Operating expenses that are driven
                                  by sales revenue. Examples are
                                  sales commissions based on sales
Contribution Margin       2,270   prices.
           Income Statement for 1999 (continued)

Fixed expenses:
                                  Operating expenses that are
                                  relatively fixed for the period.
Operating expenses     $(1,102)   Examples are employees’ salaries,
                                  rent, property taxes, and insurance.

                                  Listed separately because it is such
                                  an unusual expense. It is a portion
Depreciation expense     (226)    of the total original cost of the
                                  company’s fixed assets (except
Operating earnings        $942    land) that is allocated to this
                                  period. Calculated using straight
                                  line, DDB or SOYD methods.
             Income Statement for 1999 (continued)

                                  Depends on the amount of short
Interest expense      $(153)      term and long term debt
Earnings before        $798       outstanding during the year and the
income tax                        interest rates on each issue of debt.

Income tax expense     (268)      Federal, state and local taxes.

Net income             $521       The bottom-line profit for the
                  Balance Sheet
• Measures financial condition of the firm
• Lists Assets, Liabilities and Owners’ Equity
• Assets are economic resources owned by the
• 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
                               Balance Sheet
                                    12/31/99     12/31/98     (Decreases)
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
                      Balance Sheet (continued)
                               $(000)                                 Increases
                                     12/31/99        12/31/98        (Decreases)
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
Owner’s equity:
Capital stock                             1,450           1,250              200
Retained earnings                         2,348           2,016              332
Total Owner’s Equity                     $3,798          $3,266
Total liabilities & owner’s equity        6,928           5,945
                     Balance Sheet 12/31/99
                                  Cash is usually in one or more
                                  checking accounts. Cash
                                  equivalents such as highly
Cash                    $513      marketable, short-term securities
                                  may be included in the cash
receivable             1,156
                                  Three basic short-term operating
Inventory              1,956      assets.
Prepaid expenses        234
                                  Long-term operating assets whose
                                  useful lives range from 3 to 5 years
Property, plant, &                all the way to 30 or more years for
equipment              3,973      buildings. Their cost (except land) is
                                  depreciated over their useful life.
              Balance Sheet 12/31/99 (continued)

                                 Cumulative portion of the original
Less accumulated                 cost of the assets that has been
Depreciation             (904)   changed to depreciation expense
Total operating                  since the date of acquisition.
assets                  $6,928

Operating liabilities            Non-interest-bearing, short-term
                                 liabilities that arise from 2
Accounts payable:       $(778)   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.
                Balance Sheet 12/31/99 (continued)

                                   Expenses that have been recorded
Accrued expenses:       (376)
                                   to match all expenses for the period
                                   against sales revenue to measure
                                   profit for the period.
Income tax payable        (26)
Total operating
                                   Unpaid portion of tax expense,
liabilities           $(1,180)
                                   usually due within 2 or 3 months.

Net operating
assets                 $5,748
                  Balance Sheet 12/31/99 (continued)

                                       Interest-bearing liabilities from
Sources of capital                     borrowings. Short-term means one
Short-term notes payable       $850    year or less; long-term can be up to
Long-term notes payable                20 or more years.
Total interest-bearing debt   $1,950

                                       Owners’ equity arises from 2
Capital stock                  1,450   sources: (1) capital invested by the
Retained earnings              2,016   owners for which they receive
                                       shares of stock; and (2) profit
Total stockholders’ equity    $3,798   earned but not paid out as a
                                       dividend, which is retained in the
Total debt & owners’ equity   $5,748   business.
             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
          Cash Flow Statement for 1999
Cash flows from operating activities
Net Income                                            $521
Changes in operating assets & liabilities:
      Accounts receivable                    $(192)
      Inventory                               (302)
      Prepaid expenses                         (50)
      Accounts payable                         118
      Accrued expenses                          80
      Income tax payable                         3
      Depreciation expense                     226    (117)
Cash flow from profit-making operations               $404
 Cash Flow Statement for 1999 (continued)

Cash flows from investing activities
Purchases of property, plant, and equipment           (776)
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)
                  Cash Flow Statement for 1999

Net income                               Net income is the starting
Changes in operating assets and
Accounts receivable    $(192)            All three of these short-
increase                                 term operating assets
Inventory increase      (302)            increased; their ending
Prepaid expense          (50)            balances were more than
increase                                 their beginning balances.
                                         These increases
                                         decreased cash flow.
         Cash Flow Statement for 1999 (continued)
Changes in operating assets and          All three of these short-
liabilities: (continued)                 term operating liabilities
Accounts payable                         increased; their ending
increase                $118             balances were more than
                                         their beginning balances.
Accrued expenses                         These increases increased
increase                   80            cash flow.
Income tax payable
increase                    3 $(343)
                                         This is the net total
                                         impact on cash flow due
Operating cash flow                      to changes in the
before depreciation               $178   company’s short-term
                                         operating assets and
         Cash Flow Statement for 1999 (continued)

                                      Depreciation is not a cash
Depreciation expense           $226   outlay in the year
                                      recorded as expense. The
                                      cash outlay occurred
                                      years ago when the assets
                                      being depreciated were

                                      The business is free to do
Cash flow from profit-making
                                      anything it wants to with
operations                     $404
                                      this cash flow.
         Cash Flow Statement for 1999 (continued)
Cash flows from investing activities
Purchases of property, plant,             These purchases are
& equipment                      $(776)   called capital
Cash flows from financing activities
                                          The company raised
Net increase in short-                    capital from these three
term debt                  100            sources during the year.
borrowings                 150
                                          The company paid cash
Capital stock issue        200            dividends of this amount
Cash dividends to                         during the year, which is
stockholders             (189)     261    about one-third of net
Increase (decrease)                       income.
in cash during year              $(111)
                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
          Cost of Capital (continued)

            Amount             Source   Weighted
 Source      (000)    Weight    Cost    Average
Debt         $1,950   34%      10%       3.4%
Equity       $3,798   66%      15%       9.9%
Total        $5,748   100%               13.3%
Ratio / Profitability Analysis
                 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 (1,156+964)
• Accounts Receivable Turnover (continued)

Days to Collect Receivables =    365 days
                                 Accounts Receivable Turnover

                           =     365    =   32.2 days
• 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 (1,956+1,654)
• 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 (6,928+5,945)
• Current Ratio
  A measure of coverage of short term debt (solvency).

Current Ratio   =   Current Assets
                    Current Liabilities

                =   $3,859      = 1.90
• 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
• Times Interest Earned
  Measure of firm’s operations which provide protection
  to the long term creditor.

Times Interest Earned =   Income before Interest & Taxes
                          Interest Expense

                     =    $942       = 6.16
              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)
• 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)
• Return on Equity
 Measure of how well the stockholders equity has been
 employed. Usually higher than ROA due to financial

ROE =      Net Income
           Average Stockholders Equity

    =      $521                = 14.8%
           $.5 (3,798 + 3,266)
• Return on Sales
  Measure of profitability as a function of sales.

ROS =       Net Income
            Net Sales

     =      $521         =   4.3%
• Gross Margin Percentage
  A broad gauge of profitability. Engineered products
  have high margins, while commodities have low

Gross Margin Percentage = Gross Margin
                          Net Sales

                       = $4,214          = 35.0%
Manufacturing Accounting
         Manufacturing Accounting
• Two common manufacturing cost processes
    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)
 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
                Manufacturing Cost Report for Year

       Annual production capacity=        16,000
                        Actual output=    16,000
                                                   These 4 basic types of
Basic cost components         Per unit     Total
                                                   manufacturing costs are
Raw materials                    $720 $11,520      called product costs.
Direct labor                      120      1,920   They became attached to
                                                   the product and thus are
Variable overhead                 140      2,240   not charged off to
Fixed overhead                    220      3,520   expense until the product
Total manufacturing costs      $1,200 $19,200      is sold.

To: 15,000 units sold          $1,200 $18,000      The cost of the 1,000
To: 1,000 units inventory                          units manufactured but
   increase                                        not sold is added to the
                               $1,200      1,200
                                                   inventory asset account.
Total manufacturing costs                $19,200
                 Operating Profit Report for Year

                           Sales    15,000     Cost-of-goods-sold
                           volume = units      expense equals the sales
                           Per unit    Total   volume times the unit
Sales revenue               $1,600 $24,000     product cost.
Cost-of-goods-sold                             Both sales-volume- and
expense                      1,200    18,000   sales-revenue-driven
Gross profit (or gross                         expenses are shown here
margin)                        400    $6,000   in one total amount.
Variable operating                             These expenses are non-
expenses                       100     1,500   manufacturing cost, i.e., not
Fixed operating expenses                       part of the production process.
                                               They are called period costs
Operating profit (before                       because they are charged off to
interest & taxes)                     $3,500   the period in which they are
                                               recorded and do not become
                                               part of product cost.
Another Look at Operating Profit
                         Contribution Format
                               $ (000)
    Sales Revenue                                 $24,000

    Variable Costs:
    Raw Materials                      (10,800)
    Direct Labor                        (1,800)
    Variable Overhead                   (2,100)
    Variable Operating                  (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
                Another Example
• Let us consider another example of manufacturing
• 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
Rate =
             Estimated direct labor hours
     = $6,520,000
       250,000 hours
     = $25 / direct labor hour
                         Flow of Manufacturing Costs
               Direct Materials
                $30        BI
               (380)                                Sequential Tracking
                $50        EI

                                   $20       BI
                                   380               $10 BI
Direct labor
                                   360               940                    $900
24,000 hours @ $15/hr              600              (900)
Mfg. Ovd.                         (940)              $50 EI
$25 / direct labor hr.            $300       EI     Finished Goods   Mfg. Cost of goods sold
           Application of Overhead Costs
                     Manufacturing Overhead
Actual Mfg. Overhead Incurred       Mfg. Ohd. Applied to WIP
                             $25 per direct labor hour times   $600
Indirect Labor          $190 24,000 hours
Factory Salary             50
Perishable Tools           60
Supplies                   60
Scrap/Rework               70
Rent                       40
Depreciation               40 Overabsorbed mfg. Overhead       $85
Other                       5 (transferred to COGS)
           Total        $515
          Income Summary

Sales                                 $1,310
Less Cost of Goods Sold:
         Manufacturing Costs           (900)
         Overabsorbed Mfg. Overhead       85
         Net COGS                      (815)
Gross Margin                           $495
Selling & Admin. Expenses                330
Profit (before tax)                    $165
• Production far exceeded sales
• Extensive inventory build
     Raw material            $20
     Work-in-process         300
     Finished goods           40
                Total       $360

• 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)
             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
               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
                               Backflush Costing Flow
               Direct Material         $(000)
 Purchases       $20     BI
                 130               100,000 units
                                   @ $10 / unit
                 $50      EI

                                                                        Finished Goods                   COGS
                                                        100,000 units   $400     BI      110,000 units
                                                                        3,000                            $3,300
                                                        @ $30 / unit                     @ $30 / unit
                                                                        $100     EI
                 Conversion Cost
Direct labor                                       $2,000
Mfg. Ohd.                                100,000 units
                  $2,150 total           @ $20 / unit
     Backflush Costing Observations
• Material and conversion costs per unit are
• 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
      Backflush Costing Observations

• Eliminates WIP inventory and associated
  production reporting
    Implications for manufacturing efficiency and WIP

• Accounting does not strictly match GAAP
    WIP exists, but not recognized
    Users cite materiality concept in support of system
    WIP very small
 (CVP) Analysis
          Increasing Profitability

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

• Let’s say,
  selling price per unit =   $250
  variable cost per unit =   $150
  thus, contribution margin per unit = $100
  fixed cost = $35,000
    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
• For sales of 500 units
    Profits = $100/unit x 150 units over breakeven
             = $15,000
             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
             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
   The Changing
Business Environment
  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
• This has led to lower prices, higher quality and
  more choices
• Though good for consumers, this has been a
  period of upheaval for businesses
          The Changing Business
          Environment (continued)
• Traditional ways do not work anymore, and major
  changes are needed in transforming processes and
• Improvement programs include:
    Just-in-Time (JIT)
    Total Quality Management (TQM)
    Theory of Constraints (TOC)
    Process Reengineering
    Lean Manufacturing
           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)
           The Balanced Scorecard
• Balanced scorecard translates organization’s
  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
         The Balanced Scorecard

• Measures fundamental changes in the
  Signals prospects of creating economic value
   for the future

• Management compensation is often tied to
  both financial and non-financial objectives
              Linking Strategic Intent
             to Measurable Objectives
• Customer Perspective           • Internal Perspective
      Order Fulfillment               Lead Time
      Delivery Performance            Manufacturing Cycle Time
      Build to Schedule               Productivity
      Quality                         Value-adding Ratio
      Price                           Quality and Safety
                                       Throughput
• Financial Perspective
      Cash Flow                 • Learning Perspective
      Inventory $, Turns +DOH         Innovation
      Market Share and Growth         Vision Development
      ROI and ROA                     Employee Involvement
                                       Responsive Systems
Lean Manufacturing
        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

• Lean means that we eliminate:
   unnecessary duplication and waste in
   anything that doesn’t add value for the
          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
  produce just-in-time
  minimize capital investment
  launch new products faster
          Techniques (continued)

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

• Working together allows people to build on
  the abilities of co-workers and themselves
  impact cost, quality and timing
  provide products that exceed expectations
            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)
Measurables in Lean
        Primary Lean Manufacturing

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

• The elapsed time between unloading raw
  materials and releasing finished goods for

        Total units in inventory of control part
  MCT =
        “End of line” production rate
         Where Does the Time Go?

Set-up Queue    WIP     Wait     MRB    Process   Test
 Time  Time    Stores   Time     Crib    Time     Time

    95% Non-production time

                               5% Manufacturing Time
          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
EOL rate =
             production hours per week (plant)
    Calculate MCT Production Hours

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

                            total units
MCT production hours =      end of line rate
              Manufacturing Cycle Time
            Performance 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               Profits, ROA
                         Expense reduced
         Manufacturing Cycle Time
  Performance Measures/Metrics (continued)
   Performance Measure     Financial Benefits   Financial Metrics Impacted
Increase Equipment       Increase Capacity /    Profits, ROA
Effectiveness            Revenue
- throughput

Reduce Floor Space       Reduce Rent            Profits, ROA

Reduce material          Reduce Expense         Profits, ROA
   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
                                              Defects include:
                                              • Scrap
                                              •Repairs off line
     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
              First Time Through
        Performance Measures / Metrics
                                                    Financial Metrics
  Performance Measure        Financial Benefit          Impacted
Increase throughput     Increase capacity /          Profits, ROA
Increase efficiency     Reduce labor cost            Profits, ROA

Reduce scrap/rework     Reduce expenses              Profits, ROA

Reduce inventory        Decrease interest            Profits, ROA
                        expenses / increase turns
Improve manufacturing Various                           Various
cycle time
Increase equipment      Various                         Various
effectiveness (OEE)
Improve build to        Various                         Various
schedule capability
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
                   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
           Overall Equipment Effectiveness
           Performance 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 /         Profits, ROA
                       increase turns
                 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
 BTS: Calculate Volume Performance

• Volume Performance

     actual number of units produced
     scheduled number of units
    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)
 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)
               Build to Schedule
        Performance Measures / Metrics
 Performance Measure       Financial Benefit       Financial Metrics
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
            Why Total Cost (TC)?

• Measures total cost-per-unit

• Total cost per unit equals the affordable business

• 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?
 Traditional Costing

Manufacturing Cost

   Profit Margin

  Today’s Costing


   Profit Margin

Manufacturing Cost
 Typical Plant Cost Structure

      5% 5%

                       Labor & Overhead
                       Freight & Other
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
          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
Financial Impact of
 Lean Techniques
           Lean Manufacturing Impact $(000)
                                                                       Financial Impact
               Item                 Current    Percent
                                   Amount, $   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
       Financial Impact on Firm $(000)

                                   Net     Average
                      Revenue    Income     Assets   ROS   ROA
Base Case              $12,038      $521    $6,436 4.3%    8.1%

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

Impacted Results       $13,242    $1,061    $5,714 8.5%    18.6%

• 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

Description: Lean Income Statement document sample