financial growthWe know that deploying lean tools improves our performance indicators. We see employee engagement rise when improvement activities are successful.

But how do you convince the managers who hold the purse strings of the financial benefits?

The answer lies in talking to them in their language – money and more specifically profit. Improvement initiatives can help your business to make more profit in two ways; by:

  1. Making more product without additional cost
  2. Making the same amount of product for less cost

So work out the monetary benefits of your activities and communicate them.

Both of the following examples are from actual MasterClass events (identifying information removed).

Additional product made – calculate the marginal contribution

The marginal contribution is the additional sales value minus the material, labour and overhead costs of producing additional quantities.

There are three steps involved in the calculation:

  1. Develop a Profit and Loss (or contribution) account based on the current state of the area you are working in.

Include reference to the measures that will be used to monitor the progress of the improvement.

Use the previous twelve months’ activity. If data is only available for a shorter period it should be extrapolated to produce an annualised figure. This gives a fair comparison.

  1. Recreate the account using the improved measures to show a forecast profit or contribution for the next twelve months.
  2. Compare the bottom line figures calculated in the two columns.

Marginal contribution example

Application of the Line Balance technique resulted in improved People Productivity and reduced Not Right First Time. The additional output is sold and the cost of scrap is reduced.

Measure Before Improvement After Improvement
Not Right First Time 28,476 ppm 25,234 ppm
People Productivity 268 ppoh 277 ppoh

Benefit Calculation

Before Improvement After Improvement
Sales volume A 32,000,000 35,200,000
Sales price/unit B £0.16 £0.16
Total sales C C = B X A £5,120,000 £5,632,000
Direct material cost/unit D £0.0386 £0.0386
Total direct material costs E E = D X A £1,235,200 £1,358,720
Scrap cost/unit F £0.0098 £0.00814
Total scrap cost G G = F X A £313,600 £286,528
Contribution H H = C – (E + G) £3,571,200 £3,986,752
Additional contribution I I = H after – H before £415,552

 

The increase in sales volume, material used and the reduction in scrap will show in those lines of the Profit and Loss account.

The additional contribution calculated in the table, is the overall increase that will show in the profit line of the Profit and Loss account.

Reduction in a cost item – calculate the total impact

Cost savings may result from the reduction in the amount of labour required, the amount of scrap generated, the amount of consumables, materials or power used, the loss of material, fluids, oils, coolants or compressed air used, special freight charges or late delivery penalties.

Again calculate the saving over a fixed period of a year. The figures you need are usually found in accounts.

Total impact example

The Set Up Improvement technique was deployed resulting in reduced set up time. This allowed an additional number of set ups to be done, resulting in reduced batch sizes, less work in progress and finished goods being held. The financial benefits are calculated as follows:

Before Improvement After Improvement
Stock A From stock check £375,077 £201,121
Stock cost % B Between 10 & 50% organisation dependent 30% 30%
Stock holding costs C C = A x B £112,523 £60,336
Savings D L = C before – C improved £52,187
Cash generated E E = A before – A improved £173,956
Interest % F 10%
Interest saved G G = E x F £17,396
Total annual savings H H = D + G £69,583

The reduction in stock holding cost is seen in various line items in the Profit and Loss account depending on what costs are incurred in your business.

The reduction in stock and increase in cash generated will show as changes on the Balance Sheet.

The total annual saving is seen as increased profit in the Profit and Loss account.

Using the financial benefit

If the activity results in making more for less and reducing cost items you can add both the calculated benefits together.

Remember though, when you communicate the benefits you need to include the cost of the improvement activity!

Finally, you mat want to make sure somebody revisits your costing system to translate the savings made into a reduced price for the customer.

If you have found other ways to show the impact on your bottom line, share it with us.