Do you know how the profit & loss statement, balance sheet and cash flow relate to each other and how do they relate to your daily work? Do you understand their mutual dependencies and do you know your company’s situation? Few have the courage to admit that they do not understand.
Random fluctuation is always present in the organization’s operation, both in the order inflow (quantity, schedule) and in the resources (someone ill, machine broken). In each supply chain, some element has just as much flexibility. The flexibility can be placed into A) inventory, B) the delivery lead time (i.e. work queue), C) capacity utilization rate or D) a combination of these. If this is not explicitly decided, the flexibility will most often drift into the inventory or the delivery lead time.
By deciding that the flexibility will be in the utilization rate, the queues can be cut off. Thus, it is very often possible to shorten the delivery lead time to one tenth. Now there is no need for large inventory anymore. If the inventory is shrank e.g. to one fifth, the inventory carrying cost also falls to one fifth. This saving flows directly to the profit, which often has multiplied. With the released capital the company can, for example, pay back a loan or build a new production line. The key element is the industry specific inventory carrying cost, the main factors being price erosion and obsolescence.
In one case, the true delivery lead times of a single product family in a factory in Italy were analyzed. It came out that it is possible to drop the delivery lead time promised to the customer from 45 days to one tenth, or four days, because the value adding time in manufacturing is less than 24 hours. The new delivery lead time could well be 4 days.
Inventory (EUR 100 million) could then be reduced to one fifth (EUR 20 million), thus obtaining EUR 80 million to cash to be used once.
So the inventory will be 80 MEUR lower in the future. If the inventory carrying cost is 25% of the inventory value (rarely below it), the annual saving will be 25% x 80 MEUR = 20 MEUR. This saving adds directly to the profit, each year, compared to the starting point.
Could the same be possible in your own business?
This can be found out by making your supply chain a light “Health Check”, which explores two things:
- Is it possible to drastically shorten the lead time, for example, to one tenth of the existing?
- If so, how much can the inventory be reduced, how much capital will be released and how much annual inventory carrying cost will be saved?
Based on this information, it is possible to calculate whether it is worth investing in additional capacity, which allows low utilization rate, the elimination of queues and, thereby, lower inventory. In one case the company sacrificed 1% unit of its sales margin. This funded 14% more manufacturing capacity which eliminated queues. Through reduction in the inventory carrying cost, benefit of multiple size of lost sales margin was obtained. This gets realized through the balance sheet.
If it starts to look evident that it is worth placing the flexibility in the capacity utilization, the benefit will not show up until the change in the way to operate is really implemented into daily work. Normally, such an implementation project funds itself in a few months.