“Doing more with less” is one of those paradigms of traditional Lean, the logical conclusion being “doing everything with nothing.” This doesn’t make much sense with regards to Lean Manufacturing resources, but when applied to Working Capital it’s an achievable ideal.
Releasing quite large quantities of cash embedded in “redundant inventory” for investment elsewhere in the business instead of borrowing sounds more sensible – and it is. Even Zero Working Capital can be achieved with Lean 4.0, the latest “release” of Lean that helps manufacturers be more Industry 4.0 compliant.
The principles of flow, now incorporated into Lean 4.0, were developed by our founder John Costanza, nominated for a Nobel Prize in Economics for his work in this area.
Industry 4.0 (the 4th Industrial Revolution) and Lean 4.0
Just to back up a little, the 1st Industrial Revolution, otherwise known as Industry 1.0, began in Manchester, here at Royal Mills on Cotton St. Water and then steam-powered production of cotton began on an industrial scale. Because there’s so much rain and humidity in Manchester they could spin much finer yarn without it breaking. Yes, really.
Electrically powered mass production of cotton and many other products drove the 2nd Industrial Revolution or Industry 2.0. Computerised automation and IT, the 3rd Industrial Revolution.
This historical journey is described in our blog http://www.maestro-business.co.uk/the-4th-industrial-revolution-industry-4-0-and-lean-4-0-what-might-they-mean-for-you/
Lean 4.0 and Working Capital Efficiency
So, while Lean was revolutionary in its day, it has since evolved into flow as in Lean 4.0 – for greater Productivity, more Profitable Growth and better Cash Flow. All of these drive more efficient Working Capital Management.
This tangible, sustainable bottom-line benefit of Lean 4.0 is measured while tracking Working Capital Efficiency = Working Capital/Revenue, where the lower the percentage the greater the efficiency.
The efficiency with which cash is converted to product and back to cash is referred to as the Cash Conversion Cycle. It determines how much can be achieved with how little cash, an underlying criterion of many business decisions.
Working Capital is defined as the Cash difference between Receivables (cash due to be received from customers) and Payables (cash due to be paid to Suppliers) plus Inventories (Raw, In-Progress and Finished.)
Materials purchased from suppliers is converted into product which is then sold to Customers for cash. That cash in turn is used to pay Suppliers for those materials. This is known as the Cash Conversion Cycle as cash is converted from cash to product and back to cash.
These cash quantities can be denominated in the number of days that Customers are given to pay manufacturers’ invoices, and the number of days Suppliers have to wait for their invoices to be paid. Likewise, the amount of inventory held within a business can be represented in days on hand at average rates of consumption, as illustrated here.
Cash can be released from Working Capital by a) requiring Customers to pay sooner (e.g. in 30 days instead of 60 days) thereby decreasing the amount of cash embedded in unpaid customer invoices – and b) Suppliers having to wait longer (e.g. 60 days instead of 30 days) before they’re paid – decreasing the amount of cash embedded in unpaid supplier invoices.
In this example the average Working Capital has been halved down to 60 days. However, customers would be asked to pay in half the time and suppliers would have to wait twice as long to be paid. Neither would be very happy.
Tightening the Customers’ payment terms can have a negative effect on sales and on prices customers are willing to pay to off-set these negative payment terms. Lengthening Supplier payment terms can impact both reliability and timeliness of supply as well as quality.
The amount of cash embedded in the “redundant” inventory portion of Working Capital can be reduced with Lean 4.0 with much faster lead-times (shorter inventory investment pipeline) instead of reducing Payables or increasing Receivables. Not only is cash released into the business, customer satisfaction, and more profitable sales are both increased.
Payment terms to Customers and Suppliers can both be improved for more and more profitable sales and a more flexible and responsive Supply Chain.
In this example the same result has been achieved by reducing lead-time or Inventory Conversion Cycle time to an average of 30 days without disturbing either Customer or Supplier relations.
Further, by dramatically shrinking the Inventory Conversion Cycle (ICC) down to 10 days, both Customer and Suppler payment terms could actually be improved by 10 days each while still releasing 60 days of cash from Working Capital.
Finally, the shorter lead-times and better on-time delivery facilitate better negotiated payment terms, thereby reducing Receivables as well.
Much shorter lead times and faster ICCs are achieved by linking and synchronising the output of each Process in a flow, as illustrated in the following 2-minute audio-visual. Click here.