Story 2: Cash Is King
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THE STORY: Terry, a young plant supervisor, was heading back to his office and talking to himself. 'This has to be the worst day of my life. The bank just turned the company down for an extension to its credit line. Why? We have tons of assets, new equipment, and a new plant laid out using the latest techniques. We are in an area where labor and the cost of living are not expensive.'
As he was going up the steps to the mezzanine where his office was located, he could see the entire plant. 'Look at all those people who may lose their jobs,' he thought to himself. As he viewed the operation of the plant he still could not believe what he was just told in the meeting. 'At one end of the plant I have raw material and supplies. There must be $500,000 there. Even used, the equipment was worth $2,000,000 and the plant at least $1,500,000. There was even some finished goods inventory, maybe $700,000 to $800,000 worth. Why with all these assets didn't the bank give us the money?'
He decided to talk with the controller to get a better understanding of why the company was turned down. As he entered Keith's office, Keith was on the phone with a vendor. "I know we owe you $250,000 and it's past due. But I need this material to get this job coming up. Look, if I get this job I'll be able to pay you something on the past due. No, I can't pay you COD, I don't have the money. I'll pay you when I get paid. No, I won't sign over the payable, I need the cash to stay alive. Well, thanks. Good bye."
Terry jumped in, "Keith, did I just hear you right. We can't get material to build a job?"
"You got it Terry."
"Why don't we just go to another vendor?"
"We don't have any other vendors to turn to because we owe them all money."
"How did we get so deep into our vendors?"
"Well, Jim the old purchasing agent would buy truck loads of material to get a great deal on price and freight. You know Terry, for his Purchase Price Variance."
"So if we were going to use it, who cares?" replied Terry.
"It's a little deeper than that. Jim would look out four to six months on orders and forecast and buy material. The old plant manager would combine like orders and parts to get the best yield off the material."
"So?" replied Terry.
"Well, look at the load of parts on lines 1 and 3."
Terry shakes his head. "We are only missing one part to complete that order and then we could assemble it. Why don't we just run the other part?"
"We can't because we don't have material to run the part and the vendor has cut us off."
"Why didn't we buy enough material?"
"We did, but when Tom combined orders for better yield and to reduce set-up, the material went into another product. So now we have two products out there that we can't finish."
"But what about all the raw material we have out there, we must have something we could use?"
"Most of the material out there is either obsolete from a product we discontinued or is spoiled or damaged. Even the finished goods fall into the same category."
"How can that happen?"
"When you look too far out to build an order, there is a big opportunity for your customer to change his mind on color, amount on order or just cancel the order."
"Then why don't we throw it away?"
"Because it's an asset on our books."
"Yes an asset. Although recently the bank has been giving us trouble about the value of our inventory, which is why we are in this cash bind. What really hurts is that most of the material you see sitting around is what we owe the vendor for."
DISCUSSION: What Terry heard and saw was only the tip of the iceberg. On the other side, customers were getting their orders late. Depending on how late, orders could be canceled, or the company could up end up paying penalties to the customer for not meeting promise dates. This would have a two-fold effect on cash flow: first, by trying to maximize the productivity numbers, the cash can be tied up for some time. (Example: two items on the line were not finished because they couldn't get material from the vendor). Second, expediting, overtime and penalties, which reduce both your profit (if any) and again cash flow. Another thing that could result from this practice is to lose customers. These issues can be compounded if a layoff is done in the attempt to cut cost, in turn causing management to want to reduce indirect activities putting even more pressure on cash flow. All of this can put a company into a death spiral that could result in Chapter 11, or even worse, Chapter 7.
THOUGHT: If a plant is to the point in this story the game is not over. First, everyone must look at cash flow daily. (This is a good practice anyway just to see what actions or measures may be driving you in the opposite direction from where you want to go.) Next is to get the customer to buy you the material for the job. (This may work if you have a long-term relationship with the customer(s)). Liquidation of finished goods to a wholesaler or even to the employees may raise some short-term cash to buy the material needed to finish off the items on the line or buy more material COD. As for the raw material, either make it into something you can turn into cash or find someone to buy it at a reduced price (usually small mom & pop operations will buy material this way to cut corners.)
Obviously, the best solution is not to get into this position in the first place. Yield is only a number. If it means tying up cash flow and extending lead times, you should think twice about trying to maximize it. Combining runs to get better efficiencies or variances could result in nothing getting out on time and lots of overtime to go with it. Run what you need when you need it. Fix the issues or problems, don't hide them.
And then there is absorption. More sins are committed in the manufacturing world for absorption than all the other problems that measures cause. Absorption is meant to measure our ability to absorb the cost of doing business. But if we make a part and it sits and waits for other parts, what did we absorb? Nothing! Absorption should be placed on the item went it is sold because before that we have received no funds to pay for the operation. In closing, don't do actions for internal performance numbers, do it for CASH FLOW. You can't take productivity numbers to the bank.