Cycle Time Reduction
and Ratio Analysis
Table 2 compares the
ratio analysis before cycle time is reduced to the ratio analysis
after cycle time reduction has been achieved. Again, this is a real
case. In a situation where sales remain flat, the inventory
reduction results in lesser assets being employed for the same
sales. This causes the Sales to Total Assets ratio to increase. Not
withstanding the textbook answers, this means we can increase this
ratio with cycle time reduction without major
increases. Often what happens is that assets remain flat hut sales
actually go up as customers respond to better response times and
lower costs. The revelation comes when we realize that cycle time
reduction affects the entire organization. The largest definition
for cycle time reduction I have seen is the time spent between the
expression of a customer's need and the fulfillment of that need. I
will go one step further and lengthen it to include when the cash is
collected. As quality improves and the customer has a greater
tendency to get what was ordered, when ordered, collection problems
start going away. Greater speed means fewer misunderstandings and
better collections. This has the effect of reducing the trade
receivables, which means even less assets are being deployed for the
same volume of sales. There is a positive double impact.
Average Collection Period begins to go down and the collection
manager begins to look like a hero. He or she may get the bonus but
the real reason may be the improved manufacturing cycle time. Next
time you go to the collection department, tell them they owe you a
as the cycle time reduction reduces cost of goods sold, the Net
Profit Margin is increased. The same volume of sales with a reduced
cost results in a higher Net Profit Margin. Of course, this
improvement goes down only to the gross profit line. The overhead
costs remain the same. The cycle time reduction opportunity in
overhead areas is much larger than on the manufacturing line but
this is the subject of another paper. At least the manufacturing
people can spearhead the way.
Inventory Turnover ratio is directly effected by cycle time
reduction. Inventory reduction is really a manifestation of cycle
time reduction. A decreased inventory results in a greater Inventory
Turnover ratio. For years, financial people have known this was a
good sign without knowing, perhaps, all of the ramifications. Most
focus was placed on the concept that high inventory turns indicated
little obsolesce. In fact, cycle time reduction not only decreases
the likelihood of obsolescence as problems are noted and corrected
sooner but also decreases inventory on hand. Again, there is a
positive double impact.
the average payment period. There are financial people within your
company staying awake nights looking for ways to increase your cycle
time. This is not their intention but it is a result of focusing on
one aspect of the business instead of the business as a whole. It is
a truism in finance that everything costs something in some way.
Financial people are looking for ways to keep cash so they can
invest it. Often I hear of the Very Important Company that requires
payment terms of 45 days from its vendors. Regardless of intentions,
sometimes the financial realities dictate a momentary change. If a
small company is facing a payroll next week and is short of cash,
the harsh fact is that the company has to ship to a customer with a
shorter payment period. The company may want very much to satisfy
the Very Important Company but payroll is payroll and cash is cash.
A variation on the theme is the company that makes payments on
stated points of the month.
example is a company that cuts checks Friday for invoices received
by the previous Wednesday. The vendor has a much greater incentive
to ship and bill on Tuesday than it does to do it on Friday. The
point is, cycle time reduction has to take place from the vantage
point of the business as a whole instead of the individual parts.
One solution is to pay within a short period of receipt of the goods
with amounts deducted for each day a shipment is late and each day a
shipment is early.
mentioned earlier that the Return on Total Assets is the product of
the Sales to Total Assets ratio and the Net Profit ratio. Take care
of the latter two and the first will be taken care of.
interesting to note that the financial people squirreled away in the
dark may never have heard of cycle time reduction. All they may know
is that something right is going on. Fortunately, the ratio analysis
is giving the correct answer.
Cycle Time Reduction
and the Venture Capitalists
about those venture capitalists. How does cycle time reduction show
up in the valuation? The answer is: it doesn't, not directly. There
are basically six reasons why a VC wishes to invest in a company.
They are: management, management, management and market, market,
market. Inherently, good management has always sought out short
cycle time, even way before the phrase was coined. A market is
usually good because of a lack of competition. This is probably
because the enterprise had a short research and development cycle
time. Short cycle time has been there all along.
cycle time probably results in increasing revenue, high earnings and
correspondingly increased book value. All of these factors lend
themselves to an increased valuation but because the iffyness of the
calculations it is hard to break their impact out. In successful
emerging companies, short cycle is such an integral part of the
whole business it can't be broken out. Large companies are trying to
implement short cycle time; successful emerging companies start out
So there it is. We have
examined the impact of cycle time reduction on the financial
analysis. The discounted cash flow calculation demonstrates the
impact of a cycle time reducing capital expenditure. Ratio analysis
is used to evaluate entities ranging from large divisions to
companies. We have also seen how venture capitalists value cycle
time reduction. Note that in each case the financial analysts
secluded away in their dark, remote towers have little direct
knowledge about the details of the operations involved but are
drawing conclusions and interpreting them for the big boys.
Ultimately, their decisions will impact the directions a company and
your career (paycheck) take. You may ignore their tools if you wish.
To be Continued
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