15 April 2022

Does cost reduction always foster reduction of Working Capital Needs?

By Xavier Perrin (xperrin@xp-consulting.fr)

Working capital represents the difference between a firm’s current assets and current liabilities. This financial definition isn't really useful for operations' managers. However, managing working capital is of foremost importance for companies, as when Working Capital Needs (WCN) increase, cash flow is reduced, and the need of short-term debt increases.

A better way to figure out Working Capital Needs is considering Cash-to-Cash Cycle Time.

Most managers are convinced of the necessity to reduce lead-times. First of all, short lead-times are valued by customers and facilitate On-Time-Delivery. Moreover, managers know that increased lead-times mean higher WIP inventories which increase WCN. Finally, years of promotion of lean approaches foster this conviction.

Nevertheless, I commonly observe practices, mostly regarding the way of measuring performance, which are in contradiction with the reduction of WCN.

Generally, operations managers are challenged for cost reduction. Thus, most common metrics used in operations result from traditional cost accounting methods, budgeting process, and income statement analysis: cost-per-unit, burden rate, utilization rate, efficiency rate, or other OEE percentage (Overall Equipment Effectiveness). Of course, additional metrics are used to reflect other competitive challenges and good practices in managing human resources and environmental considerations. SQCDME, standing for Safety, Quality, Cost, Delivery, Morale, and Environment, is a common structure for visual management and daily standup meetings.

Coming back to the question of WCN, none of the measures listed above help taking actions for reducing WCN, or cash-to-cash cycle time! For many managers, cost and delivery metrics are directly related to WCN. In fact, they are not! Reducing cost according to the metrics listed above encourages actions like increasing lot-sizes for higher OEE, overproducing parts for better utilization of equipment, reduced burden rates and higher absorption of overheads. It inevitably leads to increase WIP which, finally, increases WCN.

Well, but don't we also consider indicators about delivery, and delivery is related to lead-time, which is related to cash-to-cash cycle time, isn't it? Most of the time, the metric used in the "Delivery" field of dashboard is On-Time-Delivery. First, OTD isn't a specific objective of any single team as it is the result of all the factors affecting the supply chain, like ability to manage demand, ability to plan and schedule, adherence to production schedules, supplier performance… So, it doesn't measure the result of decisions and actions of a particular team, except of the Executive Committee. Second, OTD doesn't reflect lead-time length, it just measures how lead-times are respected. Third, it pushes teams to use expediting or priority rules instead of reducing lead-times. As a result, it creates more variability in lead-time, it doesn't reduce lead-time, or even it increases the average lead-time. In conclusion, the measures we generally use, even those measures related to cost and delivery, do not help at controlling or reducing WCN.

So, what should we measure for directing actions in the good direction, i.e., reducing cost and WCN?

"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." This quote from Taiichi Ohno, former vice-president of Toyota Motor Corp. and creator of the TPS, comes from his book "Toyota Production System, Beyond Large Scale Production". These few words brilliantly summarize the vision of M. Ohno which was latter formalized by the MIT in the corpus of lean production. Moreover, it gives us the key for choosing the right measures to control both WCN and costs. WCN, or Cash-to-Cash Cycle Time, is first a matter of lead-time. So, it is necessary to measure, in each department, the time between starting and achieving one product or activity. We call it Throughput-Time. Throughput-Time not only impacts WCN, but considering the difference between Throughput-Time and the sum of all pure processing time of a given product, it highlights wastes and their corresponding costs. Thus, Throughput-Times should be used as the main overall measure of cost reduction and delivery in the dashboards. All actions should be evaluated according to their impact on Throughput-Times. We should also avoid measuring productivity locally, as increasing productivity of a specific resource without considering the effect on other resources desynchronizes flows and creates inventories. A better way is to measure the overall productivity as the actual worked time of all people affected to a value-stream divided by the actual number of pieces produced by the value-stream in that period. This way of measuring productivity is called kosu.

In conclusion

Cash-to-Cash Cycle Time and WCN show the ability of a plant to control and accelerate its flows. Controlling and accelerating flows necessitates to identify obstacles which impede the material flow of products. Eliminating these obstacles eliminates associated costs. On the other hand, considering analytically local cost factors desynchronizes activities and degrades flows. It increases lead-times, WCN, and costs!! Certainly, getting ride off practices which are used for decades is difficult. This begins with understanding these mechanisms. Hope this post could foster this awareness!

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