evaporating cash constraint

8/3/2019 Evaporating Cash Constraint

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Evaporating Cash ConstraintEvaporating Cash Constraint



Agenda Agenda Organizational Goal

Conventional measurements for the Goal

Five levels of Goal achievement New operational measurements

Concept of Constraint

ProcessOf On Going Improvement -Five focusing steps

Implemented case studies from India

Constraint identification

Cash Constraint-definition

Issues with cash constraint

Managing cash constraint

± Exploitation and subordination

Right measurements

Increasing cash to cash velocity Selling obsolete material

Elevating cash

Next steps after breaking cash constraint

Summary



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The Goal?The Goal?

What is the Goal of your organization?



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The Goal?The Goal?The Goal?The Goal?

Some organizations state that their Goal is to be a

World Class Quality Company. Stateddifferently they would like to delight their

customers now as well as in future.



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The Goal?The Goal?The Goal?The Goal?

Many other organizations say that their Goalis to keep their employees happy now and in

future.



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The Goal?The Goal?

A few organizations declare that their Goal

is to make money now and in future!



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The Goal?The Goal?

Is there any conflict between the three Goalsstated or a hierarchy of Goals?



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The Goal?The Goal? For example let us choose that our Goal is to

delight customers now and in future.

In order to achieve our chosen Goal i.e. todelight our customers now and in future, it is

absolutely necessary to keep our employees

happy now and in future. Similarly it is imperative to make money now

and in future in order to continue to keep our

employees happy.



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The Goal?The Goal? Now let us decide that our Goal is to keep our

employees happy now and in future.

In order to achieve our chosen Goal, it isabsolutely necessary to make money now and

in future.

It is impossible to make money now and infuture unless we continue to delight our

customers now and in future.



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The Goal?The Goal? Now if we decide that our Goal is to make

money now and in future, is it really possible to

achieve it without delighting our customersnow and in future!

And can we satisfy our customers without

keeping our employees happy now and infuture!



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The Goal?The Goal? In reality there is no conflict between the three

different Goals.

Choose any of the three Goals, the other two become the necessary conditions for achieving

the chosen Goal!

For the purpose of this presentation we willassume that the Goal is making money now

and in future.



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Measures for the GoalMeasures for the Goal--MakingMaking

MoneyMoneyGenerally accepted measures are

Profit

Return on investment Cash flow

We do not question the validity of these

measures. However we do question theusefulness of these measures as operationalmeasures!



Current situationCurrent situation Only 23 out of 3000 (0.8%) companies actively

trading on the Bombay Stock Exchange have

increased their profits continuously in the last 10years (The Economic Times 24th September 2005)

And the Goal of the organization is to makemore and more money

Hence as per our agreed definition of Goal,99.2% organizations are not achieving their Goal!

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Five levels of financial healthFive levels of financial health

Making more and more moneyMaking more and more money1. Unable to meet financial commitments

2. Meeting financial commitments but not making

profits3. Meeting financial commitments, not making

losses, but profits fluctuating

4. Profits increasing continuously period after

period5. Return On Investment (R OI) / Return On Capital

Employed (R OCE) increasing continuously

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What measurementsWhat measurements

should we use?should we use? For the average employee, seeing the effect that

any given action has on Net Profit (NP) or

Return On Investment (R OI) is almostimpossible.

As a result we have created local measures like

efficiency & utilization because we believe thatthey are linked to NP or R OI.

We do know that 99%+ organizations are not

achieving their Goal.



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What measurementsWhat measurements

should we use?should we use?

New O perational Measures

Throughput (³T´)

Investment (³I´)

O perating Expense (³OE´)



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Flow of money

--

OE

RM

I

+ S

Goal

Units



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Throughput (³T´)Throughput (³T´)

The rate at which Contribution Rupees are

coming into organization.

Only Rupees generated by the system arecounted; e.g., Rupees spent on purchasing raw

material or services do not count as they are

passed on to your suppliers.

T=(Net sales-all truly variable costs)



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Investment (³I´)Investment (³I´)

All the money currently tied up inside the

system.

All the inventory in raw material, WIP, or inFinished Goods.

Money blocked in plant and machinery.

Receivables are also part of ³I´.



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Operating Expense (³OE´)Operating Expense (³OE´)

All the money that system spends on converting

inventory into throughput.

All the expenses are clubbed together as ³OE´and are thought as fixed.

All employee expenses are part of ³OE´.



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Financial LinksFinancial Links

Is there any link between the new O perational

Measures ³T´, ³I´, & ³OE´, and conventional

measures as ³P´, ³R OI´, & ³Cash Flow´? P = T- OE

R OI = P/ I = (T-OE)/I

What happens to P, R OI & cash flow when weimprove either ³T´, ³I´ or ³OE´, keeping other

two as constant?



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Financial LinksFinancial Links

If we increase T keeping I & OE constant,

P=(T-OE) improves, R OI= NP/I improves, and

so does the cash flow.

If we decrease I, keeping T & OE constant, P

improves due to reduced carrying cost, R OI

improves, and of course cash flow improves.

When we reduce OE keeping T, and I constant,P, R OI, and cash flow improve.



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Financial LinksFinancial Links Improving Throughput, Investment and

O perating Expense have a positive co-relation

with improving P, R OI, and cash flow. Throughput, Investment and O perating Expense

are valuable operational measures that can

guide our day to day actions to making money

now and in future.



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Constraint for making moneyConstraint for making money

What is that limits your organization toachieving more of its Goal - to make more and

more money?



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Theory of Constraints (TO

C)Theory of Constraints (TO

C)

The core idea in the Theory of Constraints isthat every real system such as a profit-makingenterprise must have at least one constraint thatlimits the system to achieving its Goal.

Every µfor profit organization¶ will have aconstraint in Supply, O perations, or Market.Current constraint may shift, but there cannot

be any situation when there is no constraint.Had it been so, its profit would have been

infinite!



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C)

Constraints are neither good nor bad.

They are facts of life.



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C)There is really no choice in the matter.

Either you manage the constraints or the

constraints will manage you.

The constraints will determine the output of the

system whether they are acknowledged andmanaged or not.



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Organization as a chain


An organization can be compared to a chain.

The activities that constitute a business are

µchain¶ of dependent events. For example we do not dispatch components

unless they are packed, and we do not pack

parts until they are manufactured.



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The output of the organization is achieved

through the synchronized efforts of various

functions. The output is limited by the weakest area.

The strength of the chain is determined by the

strength of the weakest link. What should be done to improve the output of

an organization?



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Organization as a chainOrganization as a chain Should we improve all functions or all links? Or should we strengthen the weakest function

or the weakest link?

It is common sense that unless we improve theweakest link, the organizational output or chain

strength would not increase at all.

Is it possible that overall organizationaleffectiveness is reduced by improving

performance in one department ?



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The global improvement is not the sum total of

all the local improvements.

Often organizations spread their energies thin inall areas in order to improve the output.

In the TOC world optimizing a sub-system

would sub-optimize the whole system.



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How does TOC helpHow does TOC help

companiescompanies

1. Focusing improvement efforts where it will

have the greatest immediate impact on the bottom line.

2. Providing a reliable process that insures

Follow Through



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A process of on going A process of on going

improvement (POOGI)improvement (POOGI)1. Identify the constraint.

2. Exploit the constraint

3. Subordinate all policies, decisions and procedures to exploiting the constraint.

4. Elevate the constraint. If we need still more

output from the constraint, elevate it.5. Avoid inertia. If in a previous step constraint

shifts, start the cycle once again.



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POOGI: Step 1POOGI: Step 1

Identify the Constraint.

The constraint can be internal or external to

your organization. Internal constraint is preferable.

The constraint can be tangible or intangible.

For example it could be an equipment or a policy.

Invariably (> 95%) the constraint is a policy.



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Exploit the Constraint.

Get the most possible out of the existing

capacity of the constraint. Utilization at the constraint is critical.



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POOGI: Step 3POOGI: Step 3S

ubordinate all decisions to exploiting theconstraint.

All policies and measurements must bedesigned to get the most out of the constraint.

Utilization and efficiency at the non-constraintresources must not be measured. However thisdoes not imply that there are no measurementsfor non-constraint resources.

This step is often missed, and thereby themajority of financial benefits of TOC is lost.This is the toughest step.



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$90/U

100 U/week

$100/U

50 U/week

D

15min./U

D

5min./U

C

10min./U

C

5min./U

B

15min./U

A

15min./U

B

15min./U

A

10min./U

RM1

$20/U

RM2

$20/U

RM3

$20/U

BIC

$5/U

P Q

Exercise-Profit

MaximizationPerfect operation (no defects)Same selling price to any clientsFixed market potentialSet-up times nil4 workers (skills are not

interchangeable):1 worker with skill A1 worker with skill B1 worker with skill C1 worker with skill D

Each worker is available 5 days aweek, 8 hours a day (i.e. 2400minutes a week)

Total operating expenses of thecompany are $6000 per week(which includes salaries, and

everything else)



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Elevate the constraint.

If more capacity is required after steps 2 &3 to

meet the market requirements, increase itthrough capital investment, outsourcing, or off-load the constraint by defining alternativeroutings, processes or design. Capital

investment should not be the first option. Often times, Exploitation and Subordination are

sufficient to reach the needed output. Do not increase the invest ment too soon.



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Avoid Inertia.

If in a previous step the constraint is broken, go

back to Step 1. Do not let inertia be the systemconstraint.

Often times when a new constraint is identified,

it is necessary to change the policies you have just made!



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Avoid Inertia.

The long term strategic application of TOC

does not call for continuous removal of allconstraints.

Rather, the idea is to choose where the

constraint should be in order to best exploit themarket opportunities, and then keep it there!



Case study 1: Capital goodsCase study 1: Capital goodsmanufacturer manufacturer

Background ± Capital goods manufacturer for refractory equipment

± It was losing money for 2.5 years

± Owner has decided to close the plant in six months

± Constraint: cash / Goal achievement level 1

Actions ± Stopped measuring machine utilization

± Stopped measuring local performance parameters to prevent

bad multi tasking ± Focus on cash generation

± Weekly review

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Case study 1: Capital goodsCase study 1: Capital goodsmanufacturer manufacturer

Results ± Turned around in 100 days

± Turnover increases by 30 times in 5 years

± Current profit > 3 times turnover in 2000

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Case study 2: Auto componentCase study 2: Auto componentmanufacturer manufacturer

Background ± manufacturer of automotive gears

± Losing money for last 5 years

± Action initiated for divestment

± Constraint:O perational policies / Goal achievementlevel 2

Actions

± Stopped measuring ³Tons´

± All functional heads Key Result Areas (KRAs)abolished

± Started measuring OTIF (On time in full)

± Focus on throughput instead of sales

± Weekly review © Goldratt India



Case study 2: Auto componentCase study 2: Auto componentmanufacturer manufacturer

Results ± Throughput increases by 70% within 2 years

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Case study 3: RefractoryCase study 3: Refractorymanufacturer manufacturer

Background ± manufacturer of refractories for steel and cement

industry

± Inconsistent profits

± Constraint:Orders / Goal achievement level 3 Actions

± Stopped measuring ³Tons´

± Started measuring ³Throughput loss´

± Focus on throughput instead of sales ± Weekly review

Results

± Throughput increases by 25% within 3 months

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Constraints: IdentificationConstraints: Identification

Every system will always have only

one weakest link at any given time-

ConstraintConstraint is in market if market

share > 50% of world market

Constraint is orders if On Time inFull (OTIF) > 95%

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Supply is constraint if material availability <95% despite payments being on time

± Suppliers if consumption is > 50% of world

consumption ± Supplier policies if consumption < 50% of

world consumption

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Constraint is operations when OTIF <95%, and material availability > 95%

± Equipment if OEE (Overall

Equipment Effectiveness) for at leastone equipment >95% on 24X7 basis

± Operational policies if OEE < 95%

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Cash ConstraintCash Constraint

There is Cash Constraint only and only if there are sufficient orders i.e. OTIF < 95% manufacturing capacity i.e. OEE < 95% for all

equipments

right suppliers there are raw material shortages as suppliers are

refusing to supply unless paid upfront additional cash cannot be easily arranged Cash shortage does not necessarily imply cash

constraint.

However if cash shortage is not managed properly, it will lead to cash constraint

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Cash Constraint: definitionsCash Constraint: definitions

Cash to cash cycle time is the total time it takesfrom taking cash outflow to cash inflow (n) periods

Throughput rate (T) is defined as the contribution per unit of constraint resource over one period of time

When constraint is cash, it is defined as the

contribution in $ per unit of time per $ of cashavailable

T = ((s/tvc)^(1/n) -1) per unit of cash for one period of time where s is the unit selling price andtvc is the unit totally variable cost

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C h C i Th h l l i



Cash Constraint: Throughput calculationexample

Parameter P Q

Selling price per unit (s) in $

Totally Variable Cost per unit (tvc) in $

Manufacturing lead time in weeks

Credit period in weeks

Total cash to cash time (n)T / Week ={(s / tvc )^(1/n)}-1 0.12 0.17

100 80

50

2

1

3

50

2

4

6

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Cash Constraint: definitions contd..Cash Constraint: definitions contd..

Throughput ratio (t) = s / tvc

Survival Time: This is the time the organizationcan run with current cash. Survival time = Cashin hand / OE (O perating Expenses)

Minimal cash required for survival = n*OE

Adequate survival cash = n*OE*{t/(t-1)}

Sufficient survival cash = n*(OE + Cash required

for full capacity utilization for one period)

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Cash Constraint calculations

Parameter P QThroughput ratio (t) ~ s/tvc 2 1.6

Total cash to cash time (n) 6 3

OE / week in $ 500 500

Cash available in $ 2000 2000

Survival time in weeks 4 4

Survival cash requirement: n*O.E. 3000 1500

Adequate cash requirement: n*OE*{t/(t-1)} 6000 4000

Cash required / week for full capacity 1000 1000

Sufficient cash requirement: n*(OE+1000) 9000 4500

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Cash Constraint: IssuesCash Constraint: Issues

Cash constraint is the worst constraint Cash shortage does not necessarily imply cash

constraint

Exploiting and subordinating cash constraintalso elevat e s cash constraint

Cash constraint impacts throughput non-l inear ly

Cash Constraint is the fastest constraint to shift!

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C h C t i t S CC h C t i t S C



Cash Constraint: Some CommonCash Constraint: Some Commonnonsensenonsense

Purchase more than immediate requirement to take

advantage of quantity discount

Combine supplies to get freight advantage

Produce more than immediate requirement for better

capacity utilization

Batch dispatches to reduce freight cost

Not selling obsolete material below purchase price / book value

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Guiding PrinciplesGuiding Principles Eli Goldratt: Measurements Drive Behaviors

Warren Buffett: Take a few right decisions

provided you do not make too many wrong

decisions ± Responding to a question for recipe for

success at the Berkshire Hathaway AGM 2003

Eliminating current wrong practices is moreimportant than initiating new right actions-

Ravi Gilani

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E l i i d b di iE l i i d b di i



Exploiting and subordinatingExploiting and subordinatingCash constraint: MeasurementsCash constraint: Measurements

Remove wrong measurements

± Sales, profit, market share, gross margin, net

margin (some times even throughput!)

± R OI, productivity, capacity utilization

Monitoring right measurements

± Survival time, cash available, adequate cash

requirement, overdue payments

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Exploiting and subordinating: Exploiting and subordinating: IncreasingIncreasingcash to cash velocitycash to cash velocity

Cash to cash cycle time (n) reduction has huge non-linear impact on throughput, cash availability, survivaltime, adequate cash requirement etc.

For product P, reducing cash to cash cycle time from 6

weeks to 3 weeks, throughput / week increases bymore than 100%

Reduce cash to cash cycle time by shrinking

± Customer payment time - get money immediately

even at deep discount of 20-40% ± Manufacturing lead time (Choke release of work)

± Supplier lead time (offer 5-10% price increase for immediate delivery)

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Exploiting and subordinating:Exploiting and subordinating: SellingSellingobsolete materialobsolete material

Often organizations do not sell obsolete material at below purchase price/ book value

In most cases selling unwanted stock even at adiscount of 80-90% of purchase price is the right

decision. (negative throughput!) For product Q, selling obsolete material even at 85%

discount will generate cash > purchase price in just 13weeks! (Apart from the fact that it also increases

chances of survival ) Any addition in cash increases survival time

immediately

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Elevating Cash Constraint:Elevating Cash Constraint:



Elevating Cash Constraint:Elevating Cash Constraint: Additional Cash induction Additional Cash induction

Cash constraint organizations do have difficulty inorganizing loans even at high interest rates of 18-24%

per year

However even these organizations, cash may be

available at 1-4% per week!

For a cash constrained organization selling product P,

borrowing even at 4% per week makes sense as P

generates T @ 12% per week (Q even better @ 17% per week)

Interest cost control is not the Goal of the

organization!

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Managing Cash Constraint Example

Parameter Value

Throughput ratio (t)~ (s/tvc) 2

Cash to Cash cycle time in weeks (n) 6

OE / week 500Cash in hand 2000

Current customer receivables over 6 weeks 2550

Time in weeks for bankruptcy 12

Alternative product Q

Interest rate / week at which money couldbe available

1-4%

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Managing Cash Constraint



Managing Cash ConstraintSubstituting Q for P

Parameter Value

Throughput ratio (t)~ (s/tvc) 1.6

Cash to Cash cycle time in weeks (n) 3OE / week 500

Cash in hand 2000

Current customer receivables over 6

weeks

2550

Time in weeks for shifting cash constraintto capacity

10

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Managing Cash Constraint



Managing Cash ConstraintBorrowing cash @ 4% per week

Parameter ValueThroughput ratio (t)~ (s/tvc) 2

Cash to Cash cycle time in weeks (n) 6

OE / week 500

Cash in hand 2000

Current customer receivables over 6 weeks 2550

Cash inducted @ 4% week interest 4000

Time in weeks for shifting cash constraint tocapacity

13

Time in weeks to return borrowed cash 27-29

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Cash ConstraintCash Constraint--case studycase study

A mass manufacturing organization in electricalindustry, had a constraint in cash

Material cost ~ 40% of sales

Manufacturing lead time ~ 3 days

Collection time ~ 60 days Capacity utilization ~ 30%

OTIF < 10%

Suppliers were willing to provide material off the shelf

provided they could get payment upfront The constraint shifted from cash to orders within13 weeks by shrinking collection time at 50% discount!

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Cash Constraint-case study

Data elements Existing New

Selling price per unit (s) in $ 100 50

Totally Variable Cost per unit (tvc) in $ 40 40

Throughput ratio (t=s/tvc) 2.5 1.25

Manufacturing lead time in days 3 3

Credit period in days 60 4

Total cash to cash time (n) in days 63 7

T / week ={(s/tvc)^(1/n)}-1 10.7% 25%

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Next step after cash constraint isNext step after cash constraint is



Next step after cash constraint isNext step after cash constraint isbrokenbroken

Current crisis in the world is not due

shortage of cash

Currently it is due to slowing down of money

rotation. We have very severe shortage of trust!

What can we do? Increase the money flow!

Offer early payment to your suppliers withcash constraint with or without price

discount!© Goldratt India



© Goldratt India

SummarySummary

A company must know its Goal.

All the players in the organization must

understand how is the scoring done

Then it must identify the Constraint(s) that islimiting the level of achievement of that Goal.

The Theory of Constraints is about

± Focus on global improvement in place of localimprovements everywhere.

± Process of On Going Improvement.

TOC Summary:TOC Summary:



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TOC Summary: TOC Summary: Process of On Going ImprovementProcess of On Going Improvement

1. Identify the constraint.2. Exploit it.

3. Subordinate all other decisions to the

necessity of exploiting the constraint.4. If after # 2 & # 3 more capacity is needed to

meet market demand Elevate the constraint.5.

Go back to # 1, but do not let inertia becom

ethe system¶ s constraint . Choose your constraint.



SummarySummary

You have Cash Constraint only and only if

there are sufficient orders i.e. OTIF < 95%,

sufficient manufacturing capacity i.e. OEE<95% for all equipments, right suppliers,

and suppl i e s are suffering as suppliers have

not been paid on time due to cash crunch

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SummarySummary

Exploiting and subordinating cashconstraint also elevates cash constraint

Cash constraint impacts throughput non-linearly

Cash Constraint is the fastest constraint toshift!

Eliminate wrong measures and implementright measures

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SummarySummary

Shrinking cash to cash cycle time has themost immediate impact on cash

Elevating cash by selling obsolete materialeven at very low price impacts cashsignificantly

Borrowing cash at very high interest couldalso be an option during the duration of cash

constraint situation In most cases cash constraint can be shifted

within 13 weeks!

© Goldratt India



SummarySummary

Once we have adequate cash, offer toconstruct Win-Win with your cash

constrained suppliers.We cannot live in an island of prosperity

surrounded by a sea of misery!

© Goldratt India

Thi i h E d



© G ld tt I di

This is not the End.

It is not even the beginning of the End.

It is perhaps the End of the beginning!

THANK YOU!

Ravi Gilani

[email protected]

evaporating cash constraint

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