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Justifying MRP
Part 3 of 4

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Perhaps the easiest part of the justification exercise is calculating the financial benefits where predicted results are generally accepted and calculations are essentially straightforward. There are two varieties of these dollarized benefits. The first is direct day-to-day savings affect­ing the company's bottom line. The second is increased working capi­tal (cash availability) gained by minimizing temporary assets such as inventory and accounts receivable and by better cash management.


Probably the most common and also the most dangerous cost sav­ing projections come from the dreaded headcount reductions. While upper management can get very excited about hearing that a more streamlined system will allow them to run the operation with 20 fewer employees, the effects of stating this as part of the justification can have debilitating effects. There has been so much negative press about downsizing in the past several years that the majority of employees harbor a frequent fear of losing their jobs. What kind of an enthusiasm level can they maintain when asked to help install a new system that is destined to eliminate their jobs or the jobs of their friends? Ironically, even the best planned new system installations rarely have a direct bearing on headcount reduction. In fact, installation of a new system has often led to an increase in staff. What is more common is a rede­ployment of the labor pool. People do different jobs under the new system than under the old one. If planned and executed properly, mi­gration to a new and improved information system will lead to an in­crease in business, and this increase will create internal work. So rather than projecting a headcount reduction as a justification item, many companies approach it from the productivity angle. They place the value on being able to achieve higher sales and profits without a correspond­ing increase in labor costs.

Profit increases usually have the biggest impact when justifying major expenditures. While higher profits through increased sales typi­cally falls into the gray area outlined above, increased profitability resulting from the lowering of costs ranks much higher on the man­agement acceptance scale. Cost reduction has both time and material components. Shortening the production cycle time or reducing the unit cost and/or the amount of materials consumed for a given output will lower the cost of sales, and thus increase profits. There are many ways in which improved information systems can generate such cost efficiencies. Reduced purchasing and manufacturing lead times can be realized with planning and simulation tools. Reduced material waste and labor inefficiency can be gained from tools that aid more accurate scheduling and provide early warning signals of pending problems. Purchase price reductions can be achieved through better planning for bulk buys and just-in-time scheduling. Costs attributed to material obsolescence can be lowered by shortening the time be­tween purchase and use, again a result of improved planning and scheduling systems.

While not as visible as the reductions in operating costs, the often-overlooked financial benefits of reducing the amount of working capi­tal needed to run the business are very real. Improved inventory man­agement results in fewer raw material and in-process inventories needed for a given output volume. Reducing inventory investment increases profit and optimizes working capital in several ways. The most obvi­ous is the lowering of interest payments on the inventory sitting on the shelves. In addition, lower inventory levels naturally lead to reduced obsolescence and lower storage facility expenses. In general, the cost of carrying inventory is much higher than most people believe it to be. Bringing this issue to the surface and then showing how to reduce the corresponding costs can be a real eye-opener.

Improving the information system can easily lead to better cash management, which in turn lowers the company's interest costs. Work­ing capital can be optimized through more effective handling of ac­counts receivable. Timely customer invoice processing brings cash in quicker. Better-managed credit controls reduce bad debts. Proper man­agement of accounts payable—taking discounts, avoiding early pay­ment, etc.—makes more cash available to the business. Cash itself should be managed like high-value inventory—cash sitting idle does no good, and hitting a cash shortage at a critical time can have serious ramifications.

To Be Continued


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