How to act in times of uncertainty?22.03.2020
“In times like these, it’s helpful to remember that there have always been times like these.”
Everything that has happened in recent weeks has put us all in a whole new situation. It is probably a fundamental change in people’s future lifestyles. But it happens in people’s destinies often. This is probably the biggest stress the world economy has experienced in the last 70 years. However, the economic system is very viable and sooner or later this crisis will pass, unfortunately not all companies will survive. Survival is not guaranteed for anyone…
These days, we are approached by several colleagues, whose companies I consult, or whose teams we have trained. The questions I hear are definitely relevant to many.
So I decided to share some recommendations in this situation.
First of all, the methodology we call Theory of Constraints (TOC) provides the most effective answers to all current questions in this situation. I am pleased to work with companies that have started working according to the principles of TOC in the past and now solve new challenges much more easily and successfully.
Managers today have to make decisions that may affect the fate of their companies (as well as their own and their employees)…
On the one hand, these decisions must be taken lightning fast, on the other hand, they pose great risks…
How to combine speed and risk reduction?
For colleagues who have some basic knowledge of TOC, or who want to use this powerful tool in today’s real situation, I offer some solutions.
- This is a time when classical accounting calculations cannot provide management with the data to make the right and quick decisions. Moreover, the information provided may lead to erroneous decisions.
- Product profitability and cost calculation currently make no sense (a company that produces only a super-profitable product may go bankrupt in a few weeks)
- Even an operational profit loss calculation (how much can it be “operational” at all?) does not do anything, because, for example, large stocks of finished products and materials for some companies would probably be valued at “0”, not all as defined by them or purchase prices…
On the other hand, TOC management decision technique (Throughput accounting -TA) – works perfectly in this situation. Moreover, it is very easy to gather all the information needed to make TA decisions. In any company, it can be collected in a few minutes every day!
These are operational S (Sales) and TVC (Truly variable cost) data collection and T (Throughput) calculated accordingly. It is also much easier to keep track of current (and projected) OE (Operation expenses) levels relative to the previous period.
In turn, it allows the management to receive all the necessary up-to-date data for decision-making every day!
The situation of companies is different, it can look like this:
- The business is closed or unable to operate due to external circumstances (bans, radical restrictions on customer flow)
- The business has serious market constraints (customers withdraw or seriously reduce orders; the company’s customers are in group “A”)
- The business does not have a sharp decline in the volume of orders, but there are constraints due to the slowdown in the supply of materials, raw materials, a serious constraint on transport services or other services, illness or self-isolation of employees.
- The business is experiencing a sharp increase in orders and this is difficult to deal with due to internal capacity problems, possibly due to the problems of point (c).
The simplest recommendations for companies with a type D situation (I know several such Latvian companies!):
- Enable the 5FS (5 Focusing Steps) technique, immediately increase the Throughput of System Constraints and, as a result, maximize sales (Throughput – T). Accelerate flow and shorten internal cycle time (LT).
- Follow but do not worry about rising raw material and related service costs (Delta TVC), adjust T if necessary, possibly turning on market segmentation. You can look at a possible reduction in payment terms for materials against a discount (for many suppliers, cash flow is critical, but probably not for you at moment?)
- Follow the level, but surely go for the necessary increase of Operation Expenses if it generates a positive difference between Delta T and Delta OE (and in such cases, it is usually very positive!)
- In a crisis situation FCF (Free Cash Flow) – must always be followed, but it is important to analyze the state of the supply chain. In case your FCF is at a good level, look at the possible increase of payment terms for materials against the discount (cash flow will be critical for many suppliers). If you have strategic suppliers for whom your company is a “big customer” – do not destroy it by “cutting cash flow, worsening payment conditions “due to cost reduction”, it may cost more for you in the long run!
- IMPORTANT: Analyze the state of the entire supply chain and the size of the Buffer (BM fulfillment)
“The rebound will come” This means that if the consumption of your product has risen sharply recently, all the players in the chain, seeing the empty shelves, tend to increase their regular orders several times (Peter Senge’s “Bear game” principle), which multiplies as they reach the manufacturer. The size of the “rebound” depends on the length of the “shelf life” of the product and the capacity of the supply chain.
For example, if you are a “lucky” producer of something which was out of the shelves in the first days of crises, then there may be a time when 2-3 or more months later no wholesaler will need this product at all. Also, the situation is exacerbated by other manufacturers’ “special offers” with large discounts.
You can prepare an action plan to reduce the “rebound force” today!
“B” situation companies:
Cash flow – is your main problem, the main daily measurement of free cash flow – FCF (Free cash-flow).
We measure this as FCF = T – OE – Delta I, or S – TVC – OE – Delta I,
where (in each measurement period) S – all income (money entered in the account), TVC – money physically paid for basic materials, Delta I – money actually paid for Investments, increase of inventories, or (with “-” sign ) obtained from the sale of inventories or property, plant, and equipment.
OE – Operation expenses (all money paid for the operation of the company – rent, utilities, administrative payments, total salary payments and taxes, external services). OE in this situation can be calculated in two ways.
Classic – one part of the planned OE for the respective period (1/21 of the monthly OE if the period is one day; 1/4 if the period is a week), respectively following the budget execution.
Operational path – physically made OE payments in the respective period are calculated, but also following the budget, but already with the link to the calendar. OE reduction – daily work!
In case the FCF decreases, the time remaining until the need to raise additional external money or to decide on the other “A” situation can be calculated.
Note: A separate article should be devoted to the technique of reducing Operation expenses (OE) and describing the potential risks.
“A” situation companies:
The company is down. But the question of cash flow is still relevant, because if a company has no revenue, then it is necessary to understand how long this company can withstand the “freeze”. In this case, the company likely has no revenue (S), no direct costs (TVC), and no investment (I).
It is possible that stocks are still being sold (- Delta I) and Operation Expenses will definitely have to be covered.
FCF = Delta I – OE.
In this case, a negative free cash flow is likely to be generated and the issue is:
How long will there be enough money until the insolvency (or sale of the business) and based on this, strategic decisions must be made.
Here, of course, all possible mechanisms must be used, which will be offered by the government in times of crisis, to reduce the current repayment of OE (downtime compensation for employees, freezing of loan repayments, granting of financial assistance, and so on).
“C” situation companies:
The company is in a more or less “normal” situation. You have experienced similar problems several times. However, the external situation is different, it also applied to your competitors.
This means you have both new features that you can use or run and “rakes you can climb on”. What to do – is your choice.
You will find answers to the question – how it can be used – in the TOC principles (especially in the TA, TP and URO sections)
This material is addressed to professionals with at least minimal knowledge of TOC. But if they are not enough yet, we offer to turn to www.toc.lv.
“If there is no wind, start rowing”
– Latin proverb
“When nothing is clear, anything is possible”
– Margaret Drable