03 - John Darlington_21 TOCPA_UK_11 Nov 2015_for Web

Flow Accounting

John Darlington, Value Flow, & University of Buckingham, UK

11th November 2015

21st International Conference of the

TOC Practitioners Alliance - TOCPAwww.tocpractice.com 11 November 2015, UK


TOC Practitioners Alliance - TOCPAwww.tocpractice.com

John Darlington

John Darlington is a management consultant specialising in TOC & Lean applications applying the principles across the entire enterprise, from design to delivery.

He develops programmes of practical implementation integrating improvements to the physical flow of the product or service, and the information flow that converts customer demand into actions.A qualified accountant John won the Toyota “Prize for Best New Idea” at the South African Production and Inventory Control Society and has been a guest speaker at APICS.

Career historyJohn worked for AlliedSignal Turbochargers from 1986 – 1999. During this time, he held a variety of roles including Finance Director and IT Manager of the Original Equipment site and Plant Manager of the Turbocharger European Aftermarket. A Director of AlliedSignal Limited John qualified in Constraint based management with Goldratt Institute and as a Lean and Six Sigma Expert through Renault Institute. As Kaizen Director of United Engineering Forgings, the largest independent forging and machining group in the UK, John led the systematic introduction of Improvement methodologies across the 6 U.K. sites with particular emphasis on practical application to improve bottom line performance.

He combines application with teaching for the University of Buckingham where he is Director of the MSc in Lean Enterprise and was appointed Visiting Professor of Practice at The University of Wales Newport Business School in June 2011.

Contact details: [email protected]+44 (0) 7811 440847



Formula and Experience

Though their particulars are thoseThat each particular artist knowsUnique events which once took place Within a unique time and space In the new field they occupy The unique serves to typifyBecomes though still particular An algebraic formulaAn abstract model of events Derived from dead experimentsAnd each life must itself decideTo what and how it be applied

W.H. Auden New Year Letter 1940



Observations about Improvement Activity both Operational and Accounting



Most “improvement” activity does not improve the bottom line! Why?

Local efforts tackling isolated parts of the system to no overall beneficial effect

Poor understanding of demand and capacity: plant not being run to maximise the flow of value through the bottleneck

Naïve application of “lean” tools and techniques: often in the wrong place at the wrong time

Inappropriate delegation of leadership for improvement



There is a problem with conventional accounting systems

Actively work against flow

Lead us to the wrong decisions

Are confusing and complex to people

1. Encourage bigger batches to reduce “unit costs”

2. Treat bottlenecks and non bottlenecks the same

1. Focus on costs instead of value2. Encourage local efficiencies

1. Give credit for over production2. Encourage “cost reductions” which often

prove to be mirages



What is Flow Accounting?

Flow accounting is a management accounting methodology. The objectives of a flow accounting implementation are -

– To show in monetary terms how the systems interacts with the outside world– To make sure that sub systems understand how to contribute positively to the overall goal of the

organisation – To assist in working out the scope for improvement in money– To encourage the right behaviours.

It is based on “common sense” and developed out of practical application.

It is not a new way to allocate overhead

It does emphasise growth of value adding rather than “cost reduction”



Structure of the Flow Accounting Process

•Financially quantified current state

• Financial consequences of the future state agreed

Tackle the whole in one

Break down into chunks

Clarification of the financial consequences of the current state

Quantitative financial assessment of the initial future state

Big Picture Financial Mapping - a diagnosis of the Current State

Demand Analysis Capacity Analysis Inventory AnalysisPolicy Analysis

Value Flow Accounting & Decision Making

Value Flow Performance Measures

Data Acquisition Structure & Modelling

Flow Accounting Process

Demand



Completing the Current State Map



Typical Feedback


What is the profile of the demand and how well are promise dates made and adhered to?

Demand AnalysisDemand



Demand Categories

Type Description

Normal Continuous history with relatively high volumes, can be forecast with confidence. (Up to 2 periods of zero demands)

Erratic Intermittent history with medium to high volumes, can be forecast with reasonable confidence (Between 3 and 6 periods of zero demand)

Lumpy Very intermittent history with medium to high volumes, can be forecast but with limited confidence. Preferably not made to stock. (Between 7 and 10 periods of zero demand)

Management Control

New

Very intermittent and unpredictable demand. Should not be made to stock. (Between 10 and 11 periods of zero demand)

More than 6 periods with zero demand but with 4 most recent periods with demand greater than zero

All Demands Zero No demand in the last 12 months



Demand Analysis: Normal



Demand Analysis: Lumpy



Demand Analysis: Beltline

39

29

19

4

35

0

10

20

30

40

50

Normal Erratic Lumpy New Man Control

Beltline

No of Items 31.0%

23.0%

15.1%

3.2%

27.8%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%


Beltline

No of items as a %

47194

2099 697 649 1450

10000

20000

30000

40000

50000


Beltline

Average Demand Per Month92.9%

4.1% 1.4% 1.3% 0.3%0.0%

20.0%

40.0%

60.0%

80.0%

100.0%


Beltline

Average Demand as a %



OTIF (On Time In Full)



To maintain “service” we can buffer with capacity or inventory. WIP and Finished Goods give us a good idea about how well capacity is being deployed.



What are the cash consequences of current flow practices?



Working Capital Relationships Current State

September End Inventory of $211m

Finance days

111

Inventory Pipeline in Days

Raw WIP Fin Gds

24 100 7

Debtor days

30

Payables days

50



What is the pareto of the real money being spent?



Pareto Works……….. Use it!!

Key Drivers Sensitivity Analysis

P&L Actual 2010 Eur 000’s

Sales 30899

Material Cost 11810

Throughput 19089

Labour 6387

Staff 2967

Depreciation 1566

Energy 1438

Purch Servs 1181

Freight 1090

Consumables 1029

Maintenance 748

Other variable 652

Toolcrib 495

Loss prevention 373

Op Profit/(Loss) 1163

A 5% Change for better effects the bottom line by: -



Key Performance Indicators and Policies drive behaviour



?????



Cause and effect analysis (speculation for feedback)

Medium to strong negative correlation of -0.64. Bonus Incentives (25%) to make volume of parts over the right mix of parts could be a contributory factor (If Null

were true a correlation as great as this would occur by chance alone with a probability of less than 2.5%)





A Case Study example “It’s too expensive to stop”



Big Picture Financial Mapping

ControlCooled

Heat Treatment

Finish –North Line

Finish –South Line

Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast

Draw with a logical flow in mind considering the major dependencies. Do NOT trying to show real movements which might come out as a “spaghetti” diagram.

This is not the objective of a Big Picture Financial Map




ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast

Add the main routes of products flowing through production to final customers




ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast

We only MAKE money one way so let’s record on our BPFM how much money different parts of the

process generate for us

Con. Cooled £000’s

Sales 9263

Material costs(4179)

Throughput 5084

Heat Treated £000’s

Sales 2738


Throughput 1715

OTIF 82% by week




Where is the inventory tied up in the system?

OTIF 82% by week

ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290




How do we turn the inventory into time? Days of sales cover?

OTIF 82% by week

ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290



Big Picture Financial Mapping…….How

can we convert the production units

into days of sales cover?

Month Accounting days

Opening

Jan 20

Feb 21

Mar 23

Apr 19

May 22

Jun 20

Jul 17

Step 1 find the accounting data and decide on the alignment i.e. the inventory opening position is to be compared with future sales

£000's £000's £000's £000's £000's £000's £000's £000's £000's

Raw Materials Inventory FG Inventory WIP Working Inventory Sales Mat Cost D Lab Variable Fixed Overhead Cost of Sales

419438 348769 1048765 1397534

421,804 365,010 1,103,376 1,468,386 846,293 366,758 146,987 115,865 270,987 900,597

420,478 352,350 1,073,247 1,425,597 1,089,873 472,838 150,236 117,834 274,900 1,015,808

411,332 369,041 1,150,408 1,519,449 1,174,546 509,388 152,673 119,874 281,009 1,062,944

461,278 375,689 1,009,595 1,385,284 950,220 412,148 141,682 113,351 264,981 932,162

430,780 360,554 1,107,902 1,468,457 964,689 418,710 148,999 115,923 230,931 914,563

476,068 361,049 1,083,007 1,444,057 1,067,380 460,462 148,765 112,347 260,432 982,006

530,740 353,199 1,075,086 1,428,285 871,243 376,754 140,354 111,946 249,870 878,924



Big Picture Financial Mapping…….How

can we convert the inventory in tonnes

into days of sales cover?

Step 2 perform “smoothing” to reduce the impact of different accounting days in each period and restate the sales, material cost of sales, and full cost of sales

£000's £000's £000's

Month Accounting days Smoothed Sales

Smoothed

Cost of Sales

Smoothed

Material

Cost of

Sales

Smoothed

Raw

Material

Days

Smoothed

MLT in

Days

Smoothed

Finished

Goods in

Days

Smoothed

Working

Inventory

Days

Smoothed

Total

Inventory

Days

Opening

Jan 20 846293 900597 366758 34.31 34.94 11.62 46.55 80.86

Feb 21 1037974 967436 450322 28.10 34.22 11.32 45.53 73.63

Mar 23 1021344 924299 442946 28.48 34.83 11.44 46.27 74.75

Apr 19 1000231 981223 433840 28.44 35.17 11.28 46.46 74.90

May 22 876990 831421 380645 36.35 36.43 13.56 49.98 86.34

Jun 20 1067380 982006 460462 28.07 33.85 11.01 44.86 72.93

Jul 17 1024992 1034028 443240 32.22 31.42 10.48 41.90 74.12



Big Picture Financial

Mapping…….How can we convert

the inventory in tonnes into days

of sales cover?

Raw material £430780 x 30.5 days =

Smoothed raw material cost of sales £460462

Work in progress £1107902 x 30.5 days =

Smoothed cost of sales £982006

Finished goods £360554 x 30.5 days =

Smoothed cost of sales £982006

Step 3 apply the “smoothed” figures to the inventory balances at the start of the month (or end of the prior month).




Who is responsible for what?

OTIF 82% by week

ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290

Raw material

28.10 days

Finished goods

11.30 days

Work in Progress

34.70 days




If responsibility followed flow it would look like thisOTIF

82% by week

ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290

Raw material

28.10 days

Finished goods

11.30 days

Work in Progress

34.70 days




What are the operating expenses of running the production system per annum?

Overheads £3048k

OTIF 82% by week

ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290

£2255k£366k

£628k

Raw material

28.10 days

Finished goods

11.30 days

Work in Progress

34.70 days




ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM12670

1610

616

3760

1574

1489

786

1759

1707

2009

Fgds604

Fgds416

Fgds1290

Overheads £3048k

£2255k£366k

£628k

What about looking at the due date performance & inventory lead times by the

distinctive streams (Jan Sales Dec Inventory)

Raw material

28.10 days

Finished goods

11.30 days

Work in Progress

34.70 days

The second level of inventory analysis; the average is broken down into its constituent parts

OTIF 82% by week




ControlCooled

Heat Treatment



Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast


Sales 9263


Throughput 5084


Sales 2738


Throughput 1715

RM30.8d

3.9d

1.5d

11.4d

19.2d

4.5d

9.6d

5.3d

5.2d

24.5d

Fgds1.8d

Fgds1.3d

Fgds15.7d

Overheads £3048k

£2255k£366k

£628k

What about looking at the inventory lead times by the distinctive streams (June results)

Raw material

28.07 days

Finished goods

11.01 days

Work in Progress

33.85 days

What does this tell us….. It is “screamingly” obvious where the biggest issue is at present

CC OTIF 90% by week

HT OTIF 72% by week



Big Picture Financial Map information output

We are looking for Trends and Relationships which may not have been explicitly analysed before linking

commercial considerations to operations and financial information

Sales over time in units and value.

Inventory over time broken down into: -

– Raw materials days

– Work in progress days

– Finished Goods days

Hours worked

Dependencies

Rules about production organisation

Policies

– Obsolete or slow moving inventory

– Planned level of utilisation of resources

– How do we decide on the number of work centres

Working Capital

– Debtor days

– Creditor days

– Buffering

The list is not exhaustive………………….



Quantifying the Big Picture Financial Map

We can now complement our sales and operational map with financial data we have analysed:

–Sensitivity to making money

–Working capital profile

–Inventory in terms of days of sales cover

–Stock age profiles at different parts of the system

–Trends on labour hours and work in progress

–Trend lines for performance overall

The data helps us quantify the judgements we have made whilst compiling the material and information flows.

By contrasting these measures with the desired level of business performance, we can begin to understand the scope for improvement necessary to achieve the goal – and whether improvement must be attempted in stages to ensure success.



Big Picture Financial Mapping…….What other financial

information can we develop that helps us focus on the

most important aspects of the business?

Step 6 choose a reasonable period of time like the last 12 months and get hold of the data regarding what the company really generated in terms of sales and what it really spent its money on. Arrange it in terms of impact a bit like this: -

Step 6 Now apply a factor to each of the headings and ask yourself what is the impact on the bottom line if this figure was to improve by “X” %?

Pick a low number like 5%, we want people to understand that relatively modest real improvements can make a big difference to the bottom line.

Step 6 check out the completed sensitivity slide on the next page, what does it say to you about where to focus to make the most impact on the bottom line?

Sales 12001200Material costs 5202000Throughput 6799200Overheads 2160000Wages 1722864Consumables 1236000Sales Org 450000Depreciation 380000Warranty 120012Head Office 208000Freight Out 20000Profit 502324



Key Drivers Sensitiv ity Analysis

Sept YTD Profit and Loss Actual

£’s

A 5% Change for better effects the bottom line by: -

Sales 12001200Material costs 5202000Throughput 6799200Overheads 2160000Wages 1722864Consumables 1236000Sales Org 450000Depreciation 380000Warranty 120012Head Office 208000Freight Out 20000Profit 502324

1000

10400

6001

19000

22500

61800

86143

108000

339960

260100

600060

Freight Out

Head Office

Warranty

Depreciation

Sales Org

Consumables

Wages

Overheads

Throughput

Material costs

Sell Price



Working Capital Relationships Current State

June Inventory of £1.4 million

Finance days

63


Raw WIP Fin Gds

28 34 11

Debtor days

50

Payables days

60



Measure of Improvement

Manufacturing Lead Time as Measured by Days Inventory in WIP

28.129.0

26.3

29.1

18.420.1 20.0

22.9

16.7

13.0

8.9

12.4

14.6

9.07.8

0

5,000

10,000

15,000

20,000

Period

No. of

Piece

s

0

5

10

15

20

25

30

35

Days

Closing WIP (Pcs) 10409113441250712693 8812 9360 7336 8739 7633 6781 6159 5136 7352 4945 4207

Sales (Pcs) 111071174814275130851440113945110101144013700156002075912476151041647316216

WIP Days 28.1 29.0 26.3 29.1 18.4 20.1 20.0 22.9 16.7 13.0 8.9 12.4 14.6 9.0 7.8

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar



Working Capital Relationships Future State

June Inventory of £1.4 million

Finance days

63


Raw WIP Fin Gds

20 7 5

Debtor days

50

Payables days

60

ThroughputOperating Expense

InventoryOTIF

95% by week



Summary Flow Accounting

Current Cost AccountingActively works against flowLead us to the wrong decisionsAre confusing and complex to people

Flow Accounting Analyses and Interprets accountancy data in an different way resulting in Flow:Improved customer serviceReduced lead timesFocus on Throughput and total costClearer understanding of the operating expenses of current capacityImproved bottom line results



Next Steps for Flow Accounting

49



P Q

D15 min

PurchasePart

£5/unitD

5 min

C10 min

C5 min

B15 min

A15 min

B15 min

A10 min

RM1£20/u

RM2£20/u

RM3£20/u

Many TOC people will recognise P & Q





P Q

SALES 240000 2000 600

COGS 207734

STANDARD MARGIN 32266

Sell Price 90 100

Standard Material COG 114000 90000 24000

Actual Material Costs 114000

Material price variance 0

Direct Labour 40000

Labour Recoveries 31912

Labour Under Recovery -8088

Depreciation 8000

Salaries 56000

consumables 10000

Rent and Rates 6000

total 80000

Overhead Recoveries 63823

Overhead Under Recovery -16177

ACTUAL PROFIT/LOSS 8001

PROFIT & LOSS ACCOUNT FOR WEEKS 2 TO 22

LABOUR

OVERHEAD

Work in Progress 17125 Creditors 65250

Raw Material 15200 Bank Account 52400

Finished Goods 0 Accruals 7200

Purchased Part 1250 Accumulated Depreciation 8800

Debtors 107800 Reserves 7725

141375 141375

BALANCE SHEET AS AT END OF WEEK 22

ASSETS LIABILITIES

PROFIT/(LOSS) 8001

NON CASH ITEMS

DEPRECIATION 8000

ACCRUALS

MOVEMENTS

DEBTORS -89400

CREDITORS 23500

INVENTORY

WIP -2000

RM 4000

FG 0

PP -500

CASHFLOW -48399

CASH FLOW STATEMENT FOR WEEKS 2 TO 22

OPENING RAW MATERIAL STOCK 19200 OPENING PP STOCK 750

PURCHASES 100000 PURCHASES 10500

SUB TOTAL 119200 SUB TOTAL 11250

CLOSING RAW MATERIAL STOCK 15200 CLOSING PP STOCK 1250

RAW MATERIAL COG 104000 PP COG 10000

RECONCILIATION OF COST OF GOODS SOLD (COGS)

Documents

03 - John Darlington_21 TOCPA_UK_11 Nov 2015_for Web