LEAN MANUFACTURING A FINANCIAL PERSPECTIVE

1. LEAN MANUFACTURING A FINANCIAL PERSPECTIVE A Workshop for Finance, Accounting and Operations Personnel Presented By: Prakash R. Mulchandani October 12, 2001

2. Agenda • 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

3. Course Perspective

4. Objectives of the Firm Financial Statements Lean Manufacturing Manufacturing Accounting Metrics -First Time Through -Overall Equipment Effectiveness -Manufacturing Cycle Time (DTD) -Build to Schedule -Total Cost Metrics -Operating Ratios -Profitability Ratios Reconciliation Course Perspective

5. Objectives of a Firm

6. 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

7. 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 focus

8. Accounting Data Continuous Improvement Day-to-day Operations -Bills -Collect Money -Payroll Summary Financial Reports -Stockholder, lenders, other stakeholders -Uses GAAP Revise Decisions Management Reporting -Budgets -Costs -Variances -Very detailed Tax Returns -Federal, state, local Analysis & Control INTERNAL FOCUS -Management Accounting EXTERNAL FOCUS -Financial Accounting Accounting Functions

9. Financial Statements

10. 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

11. Income Statement • Summarizes sales revenue and expenses for a period of time • 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

12. Income Statement for 1999$(000)

13. Income Statement for 1999 $(000) Quantities sold times the sales prices for all products sold during the period. Sales quantities times the unit cost 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.

14. Income Statement for 1999 (continued) $(000) Operating expenses that are driven by sales volume. Examples are packaging costs, and storage costs. If sales volume were to increase 20%, then these costs would also increase by 20%. Operating expenses that are driven by sales revenue. Examples are sales commissions based on sales prices.

15. Income Statement for 1999 (continued) $(000) Operating expenses that are relatively fixed for the period. Examples are employees’ salaries, rent, property taxes, and insurance. Listed separately because it is such an unusual expense. It is a portion of the total original cost of the company’s fixed assets (except land) that is allocated to this period. Calculated using straight line, DDB or SOYD methods.

16. Income Statement for 1999 (continued) $(000) Depends on the amount of short term and long term debt outstanding during the year and the interest rates on each issue of debt. Federal, state and local taxes. The bottom-line profit for the period.

17. Balance Sheet • Measures financial condition of the firm • Lists Assets, Liabilities and Owners’ Equity • Assets are economic resources owned by the business • 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 time

18. Balance Sheet$(000)

19. Balance Sheet (continued)$(000)

20. Balance Sheet 12/31/99$(000) Cash is usually in one or more checking accounts. Cash equivalents such as highly marketable, short-term securities may be included in the cash amount. Three basic short-term operating assets. Long-term operating assets whose useful lives range from 3 to 5 years all the way to 30 or more years for buildings. Their cost (except land) is depreciated over their useful life.

21. Balance Sheet 12/31/99 (continued)$(000) Cumulative portion of the original cost of the assets that has been changed to depreciation expense since the date of acquisition. Non-interest-bearing, short-term liabilities that arise from 2 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.

22. Balance Sheet 12/31/99 (continued)$(000) Expenses that have been recorded to match all expenses for the period against sales revenue to measure profit for the period. Unpaid portion of tax expense, usually due within 2 or 3 months.

23. Balance Sheet 12/31/99 (continued)$(000) Interest-bearing liabilities from borrowings. Short-term means one year or less; long-term can be up to 20 or more years. Owners’ equity arises from 2 sources: (1) capital invested by the owners for which they receive shares of stock; and (2) profit earned but not paid out as a dividend, which is retained in the business.

24. 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

25. Cash Flow Statement for 1999

26. Cash Flow Statement for 1999 (continued)

27. Cash Flow Statement for 1999$(000) Net income is the starting point. All three of these short-term operating assets increased; their ending balances were more than their beginning balances. These increases decreased cash flow.

28. Cash Flow Statement for 1999 (continued)$(000) All three of these short-term operating liabilities increased; their ending balances were more than their beginning balances. These increases increased cash flow. This is the net total impact on cash flow due to changes in the company’s short-term operating assets and liabilities.

29. Cash Flow Statement for 1999 (continued)$(000) Depreciation is not a cash outlay in the year recorded as expense. The cash outlay occurred years ago when the assets being depreciated were bought. The business is free to do anything it wants to with this cash flow.

30. Cash Flow Statement for 1999 (continued)$(000) These purchases are called capital expenditures. The company raised capital from these three sources during the year. The company paid cash dividends of this amount during the year, which is about one-third of net income.

31. 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 follows:

32. Cost of Capital (continued)

33. Ratio / Profitability Analysis

34. 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)

35. Accounts Receivable Turnover (continued) Days to Collect Receivables = 365 days Accounts Receivable Turnover = 365 = 32.2 days 11.35

36. 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)

37. 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)

38. Current Ratio A measure of coverage of short term debt (solvency). Current Ratio = Current Assets Current Liabilities = $3,859 = 1.90 $2,030

39. 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 $3,978

40. 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 $153

41. 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)

42. 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)

43. Return on Equity Measure of how well the stockholders equity has been employed. Usually higher than ROA due to financial leverage. ROE = Net Income Average Stockholders Equity = $521 = 14.8% $.5 (3,798 + 3,266)

44. Return on Sales Measure of profitability as a function of sales. ROS = Net Income Net Sales = $521 = 4.3% $12,038

45. Gross Margin Percentage A broad gauge of profitability. Engineered products have high margins, while commodities have low margins. Gross Margin Percentage = Gross Margin Net Sales = $4,214 = 35.0% $12,038

46. Manufacturing Accounting

47. Manufacturing Accounting • Two common manufacturing cost processes encountered • 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)

48. 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

49. Manufacturing Cost Report for Year These 4 basic types of manufacturing costs are called product costs. They became attached to the product and thus are not charged off to expense until the product is sold. The cost of the 1,000 units manufactured but not sold is added to the inventory asset account. increase

50. Operating Profit Report for Year Cost-of-goods-sold expense equals the sales volume times the unit product cost. = Both sales-volume- and sales-revenue-driven expenses are shown here in one total amount. These expenses are non-manufacturing cost, i.e., not part of the production process. They are called period costs because they are charged off to the period in which they are recorded and do not become part of product cost.