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Speed up your operations

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Publisher: U.S. Bank - Posted on 03/15/2012

Why speeding up your operations is so important

If you are short on cash and have too much working capital tied up in inventory and payables to suppliers, your problem might actually lie in your operations.  By controlling speed you may manage and control the working capital tied up in your day-to-day operations.  The faster you produce and deliver your goods and services, the less cash you will need in your operating cycle.

Many businesses tie up too much cash in the form of excess work in process inventory, idle people, and under-utilized equipment because their operations are not as productive as they could be. A productive business ties up less working capital. Speeding up your operating cycle eliminates this wasted time, effort, and spending. Speed also improves the return on capital equipment like heavy equipment, plants, and machinery that is used in the creation of goods and services.  In fact, spending time and resources to find ways of doing what you do best faster is probably the safest, most profitable, and most predictable investment you may make.

The ability to speed up your operations is a very important skill since most businesses rely on cash from operations to keep running.  Productive business owners focus on making their cash work as hard as possible by finding ways to stop wasting cash on idle equipment and workers, unnecessary overhead, or excess inventory.  This impacts the bottom line because:

  • Shrinking the operating cycle improves your working capital efficiency by allowing you to put cash back to work in the business faster;
  • A faster operating cycle also allows you to generate more inventory turns per year;
  • Speeding up your operations may also differentiate your company with faster delivery of goods and services and greater responsiveness to client needs.

Practical steps you can take to speed up your operations

To free up working capital and save money, you should consider taking practical steps to more fully understand your true operating cycle and find ways to speed it up.  There are several practical steps you can take to tune up your business performance by eliminating the top bottlenecks and constraints that slow down your operating cycle.

Practical Steps You Can Take To Better Track And Control Your Cash

  1. Measure and benchmark the production and delivery steps in your operating cycle
  2. Look for constraints and bottlenecks that are slowing you down
  3. Eliminate production and delivery constraints by changing work practices, reallocating capacity, and automating tasks

Measure and benchmark the production and delivery steps in your operating cycle

The ability to speed up your production and delivery process may significantly improve your cash flow by reducing the amount of time equipment, inventory, and workers sit idle.

A practical first step to speeding up your operations is to understand in greater detail just how long the production steps in your business operating cycle are taking today.   Lay out the production steps in your operating cycle from the time you receive supplies and finished goods to the time they are delivered to your customer.   This can be as detailed an exercise as you want to make it.  For the exercise to pay off, you should walk away with a high level of understanding of a few key aspects of your production:

  1. Calculate the time it takes for you to execute each step of production and how long the production process takes in total.
  2. Break the production process into different “work streams” associated with your major products and services.
  3. Estimate the amount of people, equipment, overhead, and materials tied up in each step.

Armed with this information, you can start to measure and benchmark your production process to quickly identify how big an opportunity you have to improve and speed up your processes. 

Once you understand the length of your production and delivery components, you should be able to get a sense of your overall operating cycle – from purchase of supplies to collection of cash – by looking at your financial statements.  By adding the time it takes to get paid from Customers (Accounts Receivable Turnover in Days) and subtracting the time it takes to pay for supplies (Accounts Payables Turnover in Days), you can calculate the entire length of the operating cycle.  The exact math and ratios are explained in greater detail in the callout box below.

Calculating the length of your operating cycle.

The operating cycle attempts to measure the amount of time it takes to purchase, produce and sell a product or service ending with the collection of cash. The time it takes to buy, produce, deliver and collect is represented by this simple equation.

Operating Cycle = Inventory Conversion Time  + Receivables Conversion Time – Payable Deferral Time

In plain English, this means you add the time it takes to make and deliver something to the time it takes to get paid cash after delivery, and then subtract the time difference between when you ordered the parts and materials and when you paid for them to calculate your operating cycle.  For example, if it takes 60 days after orders are placed to receive and process raw materials into finished product and deliver to the client, then the Inventory Conversion Time is 60 days.  If you assume you pay for the raw materials 45 days after the arrival, then Payable Deferral Time is 45 days.  Finally, if it takes 30 days to receive cash payment after the delivery date, then Receivables Conversion Time is 30 days.  Using the math outlined above, the operating cycle for your business would be 60 + 30 – 45 or 45 days.

The next step is to learn if your production cycle is very fast or very slow.   If it is very slow relative to comparable businesses in your industry, then you may save a lot of money by speeding up.  You may determine this by comparing your operating cycle metrics with industry averages. 
  • Operating cycle time (or the number of turns per year)
  • Working capital ratio
  • Production cycle time

Your banker can show you operating benchmarks for your particular industry to help you make this comparison.

Look for constraints and bottlenecks that are slowing you down

If your production cycle is slower than the competition, or if you want to find ways to speed it up, the next step is to hunt for the root cause.  When it comes to production speed, the root cause is almost always a bottleneck or constraint in the production process.  A bottleneck is the weak link in the production process, the main factor slowing you down.  For example, a bottleneck may be a machine that runs slower than the production equipment before or after it.  Another example is an inspector who cannot keep up with workload, or a lawyer who is holding up a ten person negotiating team while waiting to finish a contract.  In any of these cases, you will spot the bottleneck by the stack of unfinished inventory, parts, paper or idle workers.  This is because when it comes to production, “A chain is no stronger than its weakest link."  This means work piles up behind the slowest resource (generally a person, a machine or policy) in the production chain. 

A constraint is anything that prevents your production and delivery system from moving smoothly. There are many ways that constraints can show up.  Constraints can be internal or external to your company.  The top three constraints to look for are:

  1. Equipment: The way equipment is currently used in your production and delivery process limits the ability of the system to produce faster.  For example, a truck may be too small to deliver a full load of parts to a customer on any given day, leaving parts sitting on the loading dock.
  2. People: Lack of enough skilled people in the right places at the right time hinders your production.  For example, if you have more people preparing patients for surgery than transporting them there, prepped patients will start to pile up.
  3. Policies: A written or unwritten policy or belief system can slow your production and delivery process as much as any person or machine.  Examples of this include inventory buffer policies that require more inventory stock that is necessary or approval policies that delay decisions and action.

So the key to speeding up your operations lies in searching for “hot spots” in your production and delivery process where a constraint or bottleneck is slowing things down.  Your goal should be to identify the biggest constraint first.

Eliminate production and delivery constraints by changing work practices, reallocating capacity, and automating tasks

Once you have identified your biggest bottleneck, you need to find ways to remove it.  You may eliminate a constraint to speed up production several ways including:

  • Reallocating resources to “hot spots” that are holding you up.  If you have too many people prepping patients and not enough transporting them, move some people around.  If you have ten highly paid investors sitting around waiting for one lawyer to review a contract, then it makes business sense to bring in another lawyer.
  • Eliminate steps.  Often, an ill-conceived policy or process is slowing things down.  Explore ways to consolidate work and eliminate steps in the process. For example, delivering production schedules directly to a key supplier in advance avoids the delay caused by a “middleman” relaying orders at the last minute.
  • Change incentives. Make sure your employees are aware of the big bottlenecks that are costing you time and money in your business. Create incentives for them to avoid the conditions that lead to the constraint, or work extra hours to reduce the bottleneck when it occurs.
  • Invest in more speed. Once you understand the true cost of your production and delivery time in terms of working capital and cash carrying costs, it will be simpler to cost justify investments that speed things up.  Faster shipping, production, assembly, and ordering processes may pay off handsomely in terms of cost and capital saved.
  • Add throughput capacity at bottlenecks.  If a truck is too small to deliver all the goods on a given day, then try to add another truck or borrow one carrying a less time sensitive payload. (Provided the delay in payment from the customer justifies the additional expense).

How U.S. Bank may help

U.S. Bank has solutions, resources, and tools that may help you speed your production.  Ask your business banker to:

  • Provide you peer operating benchmarks that can help you understand performance levels and best practices in your industry;
  • Connect you with local business advisors from SCORE and SBDC who may help you define and optimize your production process;
  • Teach you about SBA equipment loans for funding equipment and process improvement or a business line of credit providing adequate short term working capital to fund the operating cycle properly.

The Theory Of Constraints: How Eliminating Bottlenecks Creates More Profits

Increasing throughput by eliminating production bottlenecks and constraints is the key to reducing operating costs and improving cash flow, according to Eli Goldratt, the inventor of the Theory of Constraints and the author of The Goal: A Process for Ongoing Improvement.(7)  Production bottlenecks are a problem because they slow production and delay deliveries.  They also create idle employees and piles of work in process inventory that sit around and tie up cash while increasing overhead.   Speed cuts the costs and capital required to produce because the faster you make something, the fewer current assets you tie up.  Whether you are in services, distribution, retail, or manufacturing, speeding up your operations will:

  1. Reduce inventory carrying costs – physical inventory does not sit around and turns over more frequently
  2. Increase return on assets – asset utilization improves because people and equipment don’t sit idle
  3. Reduce operating costs – work gets done in less time with less labor
  4. Improve working capital – the operating cycle shrinks, thereby increasing turnover
  5. Improve sales – the more operating cycles, the more goods available for sale more quickly
 

 

Why Speeding Up Your Production Cycle May Tune Up Your Performance

The operating cycle is the length of time, in days, that it takes your company to convert resource inputs into cash flows. The operating cycle attempts to measure the amount of time it takes to purchase, produce and sell a product or service ending with the collection of cash.  Every business has a unique operating cycle. Your capital is tied up in three areas, purchasing materials and goods from your suppliers, producing the goods and services you sell, and collecting cash from customers.

For many companies, the biggest opportunity to improve lies in production. For example, manufacturing and distribution companies typically have 75% of their capital tied up there.  Software or services companies have over 70% capital tied up in people executing the service.(1)  Speeding up the production steps of the operating cycle reduces the amount of capital tied up in your business by generating more inventory turns per year and making sure people and equipment don’t sit idle for very long.  Speeding up your operations may also grow profits because more operating cycles means more sales, and clients may be willing to pay more for faster delivery of goods and services and greater responsiveness to their needs.

 

Financial Metrics That Measure Your Production Cycles

If you understand the length of your production and delivery cycle, you can estimate the length of your entire operating cycle – from purchase of supplies to collection of cash – by calculating some metrics from your financial statements.  You can calculate the entire length of the operating cycle by adding the time it takes to get paid from Customers (Accounts Receivable Turnover) and subtracting the time it takes to pay for supplies (Accounts Payables Turnover).  To learn more about how to calculate and use these metrics to monitor your business health, ask your accountant or get a copy of the Small Business Report Card Report from U.S. Bank (A)

  1. Accounts receivable turnover – Much of your working capital is tied up in the collections portion of your operating cycle. The accounts receivable turnover ratio shows you how many days it takes to collect the money owed to you by customers.  To calculate this, you divide accounts receivables by your net sales. The fewer days it takes to collect the better you are at managing collections, and the more cash you have to fuel your operating cycle.
  2. Payables turnover – One practical way to get the goods and materials critical to your operating cycle running on as little cash as possible is to borrow from your suppliers.  As you do this, you will grow accounts payable.  Your accounts payable turnover metric shows you how quickly you are paying your suppliers back. To calculate your accounts payables turnover, divide your accounts payables by your purchases in any given year.  If your supplier credit terms come with high interest rates or penalties, you do not want this number to be too high.  If on the other hand, you have a long production cycle and are tight on cash, you don’t want the number to be too small.  In either case, it is an important metric to track.
  3. Inventory turnover – A lot of the working capital in your operating cycle goes to fund current inventory assets in warehouses, on store shelves or on the production floor.  This metric shows you how many days it takes to sell (or turn over) this inventory into cash. To calculate this metric, divide inventory by cost of goods sold.  The faster you can sell off your inventory, the better you are managing those assets. Inventory carrying costs may be thousands of dollars a day.  So every day counts.
  4. Working Capital – Cash is the lifeblood of the business.  Every business needs some minimum level of cash to run day-to-day operations and pay current bills.  The working capital formula helps you ensure you have enough cash on hand to fund daily operations. To calculate this metric, subtract your current liabilities from your current assets (cash, account receivables and inventory).  To keep your business running without finding extra money, the number must be positive.  The bigger the number, the better you will be able to sleep at night. 

 

Appendix

Citations & References

  1. Understanding and Controlling Cash Flow Report, U.S. Small Business Administration Financial Management Series, 2009
  2. The 2010 Federal Reserve Payment Study – Non-Cash Payment Trends In The United States 2006-2009, The Federal Reserve System
  3. U.S. Bank survey of 2,725 small business owners, 2010
  4. Study of Consumer Payment Preferences, BAI Research & Hitachi Consulting, November 2010
  5. Bizstats Industry Financial Benchmarks for S Corporations, 2011
  6. Robert S. Kaplan and David P. Norton. The Balanced Scorecard: Translating Strategy into Action. Harvard Business School Press, 1996.
  7. Eliyahu M. Goldratt and Jeff Cox. The Goal: A Process of Ongoing Improvement. North River Press, 2004.
  8. Robert Kikosaki.  Rich Dad Poor Dad: What The Rich Teach Their Kids About Money That the Poor and Middle Class Do Not. Plata Publishing, 2011.
  9. Bob Fifer. Double Your Profits in Six Months or Less.  Harper Business, 1995.

Links to resources and papers

  1. The Small Business Report Card
  2. Scoreboard demonstration
  3. Online banking /bill pay demonstration
  4. Remote deposit capture demonstration
  5. Standard Industry Classifications
  6. Update Your Expense Control Systems: Expense Controls that Make it Easier to Budget and Track Expenses
  7. Payment Trends: New Technologies That Can Help You Track and Manage Cash Flow
  8. Adapt and Accelerate Your Collections:  Streamline Your Billing and Collections Processes by Taking Advantage of the Latest Payment Trends and Behavior
  9. Speed Up Your Operations:  How Improving Your Productivity and Shrinking Your Operating Cycle Is One of The Best Investment You Can Make
  10. Streamlining Your Supply Chain: Five Keys to Shrinking Inventory and Cycle Times while Accelerating Cash Flow
  11. The Customer Quality Review: How to Grow Profits by Rebalancing Your Customer Base
  12. Maximize Your Return on Assets:  Six Steps to Getting More Profits From Your Property, Plant, and Equipment Assets

 

This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or a guarantee of future results. Deposit products offered by U.S. Bank National Association. Member FDIC. Credit products offered by U.S. Bank and subject to normal credit approval. U.S. Bank and its representatives do not provide tax or legal advice. Each tax and financial situation is unique. Consult your tax and/or legal advisor for advice and information concerning a particular situation. 

The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not responsible for and does not guarantee the products, service or performance of its affiliates or third parties. U.S. Bank is not affiliated with other organizations mentioned in this publication.

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