Throughput Accounting: Bottleneck Management (#44)

In this podcast, we cover how to spot a bottleneck, as well as how to manage it to maximize throughput. Key points made are noted below.

Locating the Bottleneck

The first step in managing the bottleneck is to figure out where it is.  In a complex environment, it can actually be difficult to find.  Here are some indicators.

First, figure out where there’s a work backlog.  This should be an area that absolutely never catches up with demand.  If it involves a manufacturing process, then there should be a pile of inventory in front of it.  But don’t think that this is an absolute way to find the bottleneck, because it could just mean that the preceding work station is super efficient, and is dumping all kinds of work on the next work station in line – which doesn’t necessarily make it the bottleneck.

Another bottleneck indicator is that the maintenance staff is always hovering around a work center.  This is because it’s being operated at way beyond its normal run rate, so the equipment tends to break down more often.  Or, if the bottleneck is a person, such as a salesperson, look for people who never have any time to take vacation or participate in meetings outside their areas.

And the ultimate indicator of a bottleneck is when it stops working for a while, and company profits sink like a stone.

It’s also possible to deliberately designate a work center as the bottleneck, even if it currently is not the bottleneck.  You might want to do this if the work center requires really expensive equipment, or highly paid staff.  So, you cut back on the investment or headcount in that area, and now it’s your bottleneck.

Managing the Bottleneck

So, let’s assume that you’ve targeted the bottleneck.  So.. what do you do with it?  The main point to remember is that the bottleneck should operate at all times.

With this goal in mind, you can make sure that it operates around the clock, and that all employee breaks are covered by replacement personnel.  Or, if there has to be downtime for machine maintenance, then schedule it during an employee break period, so that you can overlap two potential downtime periods.

Also, there’s usually some downtime when there’s a shift changeover, so schedule the incoming staff to arrive a little early, so that you have two production crews in the work center at the same time.  With the scheduled overlap, there’s no reason for changeover downtime.

This next recommendation is a big one, because it applies everywhere, not just in the production area.  If there’re employees involved in the bottleneck, make absolutely certainly that they’re doing nothing but running that operation.  They should not be doing maintenance, or cleanup, or filling out time reports, or anything.

This is really useful for bottlenecks located elsewhere in the company, such as salespeople or engineers, because they should have administrative support who handle absolutely everything for them.  That means the admin schedules meetings for the bottleneck person, answers voice mails and e-mails, brings in lunch, whatever it takes.  The point is to strip away absolutely every activity that keeps that bottleneck person from processing work.

Another way to improve the bottleneck is to review incoming materials for quality issues just in front of the bottleneck.  This strips away any materials that would otherwise be processed through the bottleneck and then eventually be thrown away anyways.

Also, be sure to reduce employee turnover at the bottleneck operation.  If it’s a boring operation, then raise wages to make sure that people show up for work.  Better yet, cross-train a number of people, so that you can easily drop other employees into the bottleneck on short notice if you need to.

And another point – if you have an under-utilized person sitting around in the bottleneck operation, and the cost accountants tell you they’re costing too much money, tell them to go pound sand.  Chances are, any part-timer in the bottleneck area is still creating so many incremental throughput dollars that it would be foolish to pull them away from the operation.

And I’m not done yet.  You can also off-load excess work from the bottleneck to a backup operation within the company, even if the backup is way less efficient than the main operation.  This is a key point, because everyone focuses on the efficiency of an operation, and not its throughput, so they assume an inefficient operation loses money.  Not true.  In most cases, you can break loose a few employees from other operations to work on a backup work center – and since you were paying them already anyways, there’s no incremental cost to having that extra work center.  So, even though it may appear inefficient, it can create a lot of extra throughput dollars.

This also says something about keeping old equipment lying around.  If you can put an old clunker to work as a bottleneck backup, then do it – don’t scrap the equipment.

Another option is to outsource the work.  As long as the throughput generated from outsourced work exceeds the incremental outsourcing cost, then this is a viable option.

You can also improve the bottleneck just by changing work rules.  For example, the upstream work station might have a batch sizing rule which says that it must fill up a crate with parts before sending it on to the bottleneck, where they may already have run out of work.  Instead, install a conveyor belt between the two operations, and send parts over one at a time.  Or, cut the size of the crate in half.  Just do whatever it takes to reduce the artificial buildup of inventory before it moves to the bottleneck.

Another work rule may be to never pay for rush delivery of parts.  Tough.  Always pay for a rush delivery, because the cost of the delivery is usually way lower than the throughput you’d otherwise lose by shutting down the bottleneck.  And the same goes for overtime.  If it takes overtime pay to run the bottleneck, then pay the overtime.

You can also focus on the operations in front of the bottleneck.  For example, if the upstream workstation sometimes falls behind and doesn’t deliver inventory to the bottleneck in time, then invest in an extra upstream work center, so that you have tons of sprint capacity.  And once you have it, run it like crazy for a few days, so you build up a nice inventory buffer just in front of the bottleneck operation. 

That way, even if all of the operations feeding the bottleneck crash and burn for a while, the bottleneck operation can keep chugging along, feeding off that buffer.

Obviously, there are a lot of ways to manage a bottleneck. This also means that, as a manager, you need to spend a really large chunk of your time reviewing the bottleneck operation over and over again.  If you find that you’re spending most of your time monitoring non-essential operations, then you need to re-evaluate your priorities – because you’re not improving company throughput.

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Throughput Accounting: Basics (#43)

In this podcast, we cover the basic concepts of constraint management, including the bottleneck, inventory buffer, sprint capacity, and throughput. Key points made are noted below.

This is the start of a five-part series on throughput accounting.  This is a nifty topic that’s rarely covered in school.  Partially, I think, because it goes against the grain of a lot of the other accounting methodologies.  One bad rap it gets is that it only applies to manufacturing, which is absolutely not the case.  So, if you were about to delete this podcast because you don’t do manufacturing, you might want to wait a little bit longer.

First, I’ll give an overview of the main throughput concepts, and then in later episodes, I’ll describe how you apply it.

The Theory of Constraints

Throughput accounting is based on the theory of constraints, which says that one percent of all events causes 99 percent of the results.  That one percent is the bottleneck operation, which controls the profits of the entire company.  The bottleneck is also called the drum, because it sets the pace for the entire company.  If the bottleneck is well managed, then profits are high.  If not, then profits drop.  If you focus all of your resources on making the bottleneck as absolutely efficient as possible, then you will make more money.  On the other hand, if you invest dollars anywhere else in the company but leave the bottleneck alone, then you’ve essentially just burned all of those invested dollars.

For example, if you implement a massive company-wide efficiency improvement campaign, only the portion that impacted the bottleneck will actually improve the company’s total output, even if the entire company became more efficient.

Let’s continue with the example.  Let’s say that the efficiency campaign was extremely effective in improving the processing speed of a machine located ahead of the bottleneck operation, so that it can now produce twice as many parts.  That’s just great.  The trouble is that the bottleneck cannot handle all of the extra parts, so the new production just piles up in front of the bottleneck.  The net result is that you’ve now invested in more inventory than you had before.  Or, to look at it another way, you would have been better off not to have improved that upstream operation.

Now, I already mentioned that throughput does not just apply to manufacturing, so let’s look at it from the perspective of the sales department.  The CEO wants more sales, so he authorizes the hiring of more sales people.  The new employees are very effective in obtaining customer interest in the product, but now the sales technician who conducts the demos is completely swamped.  And customers won’t buy the product until they’ve been through the demo.  So once again, we have a bottleneck – it does not allow sales to be completed, and it’s not even in the manufacturing area.

The Buffer

That was the drum, or bottleneck, and it’s the central part of throughput accounting.  However, you also need to know about the buffer.  There needs to be a buffer in front of the bottleneck operation, because you maximize profits if the bottleneck is always running, and you need on-hand inventory to ensure that it always runs.  If there’s no buffer, then the bottleneck may sometimes run out of work, and that loss in productivity drops straight to the bottom line.  So, this is the one place in the company where inventory is good.  Most accountants are trying to eliminate inventory from their companies, because it’s a waste of working capital.  But if you do that to the inventory in front of the bottleneck, you’ve just cost the company a pile of money.

The same concept applies in my earlier example with the sales technician.  If someone cancels a demo, then someone should immediately reschedule a demo into that time slot.  Otherwise, the sales technician’s time has been permanently wasted.

The Rope

There’s one more concept to address, which is the rope.  The rope is the method used to release inventory into the production processes ahead of the bottleneck.  The trick is release inventory just in time to ensure that the bottleneck and its buffer are fully supplied with the correct amounts of work-in-process inventory.

If the rope releases inventory into the system too late, then the bottleneck will be starved of work, and the company loses money.  Conversely, if it releases too soon, then you choke the system with too much inventory.  The rope has a lot of similarities to a just-in-time manufacturing system.

Once again, you can use the rope concept outside of the manufacturing area.  Getting back to the sales demo scenario, it’s the job of the sales personnel to keep a steady stream of fully qualified customers lined up, ready and waiting for their product demos.

Taken together, these three concepts are called the drum-buffer-rope system in the theory of constraint management.

Sprint Capacity

In addition, there are two more terms to be aware of.  The first is called sprint capacity.  This is the ability of upstream work centers to generate a lot of output fast when the buffer in front of the bottleneck is used up.  This happens when you have a machine failure or a labor shortage that reduces the flow of inventory to the bottleneck.  If you have enough resources to scramble and rapidly fill that pipeline before the bottleneck operation runs dry, that you have excellent sprint capacity.

Once again, the accountant is usually trained to screw up the sprint capacity system.  To the accountant, there appears to be too much production or labor capacity sitting around, which – they think – is costing the company too much money.  In reality, you have to look at where the capacity is located.  If it’s ahead of the bottleneck, you may very well want to keep it, whereas if it’s after the bottleneck, it might be a good idea to sell it.

Throughput

And the final term – you may have noticed that this podcast is about throughput accounting, but I never defined throughput.  Throughput is the margin that’s left after you subtract the totally variable cost of a product from its selling price.  This usually means that the variable cost is strictly the cost of materials that go into a product, and nothing else.  It does not include overhead, it does not include direct labor.

In a throughput costing environment, our job is to maximize throughput dollars.  Since the bottleneck drives the amount of product that we can produce, the key factor is the minutes of time required to get a product through the bottleneck operation, in relation to the amount of throughput dollars you earn from the product.

That sounded a little too theoretical, so here’s an example.  You can earn $100 of throughput from the sale of one unit of Product A.  That product requires 10 minutes of processing time at the bottleneck operation, so you can earn $10 per minute of bottleneck time used.  On the other hand, you can earn $60 of throughput from the sale of Product B, which requires 4 minutes of bottleneck processing time.  So for Product B, you can earn $15 per minute of bottleneck time used.  This means that the company will earn more money in total if it can push more of Product B through the bottleneck, even though Product A appears to make more money per unit.

This last concept is the whole key to throughput accounting – you have to identify the bottleneck, which is not always an easy thing to do, and then make sure that the right product flows through it.  Pretty obviously bottleneck management is key, and that’s why it’ll be the topic of the next episode.

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PDF Invoices (#42)

In this podcast, we cover how to create a PDF invoice, and the advantages of doing so. Key points made are noted below.

PDF Creation Software

Today’s topic is PDF invoices. What this is all about is converting your customer invoices into electronic files.  This is not scanning, which requires a little too much time, and also a flatbed scanner.  What I’m talking about is buying a copy of Adobe’s Acrobat software, which you can get at adobe.com for $300.  I also just checked on eBay, and you can get there for somewhere in the range of $200 to $230.  Or, you can buy it on Amazon for $250.

Once you install it, the software creates a new printer called Adobe PDF.  Then, when you want to create an electronic version of an invoice, just select the Adobe PDF printer, and the software creates an electronic version in .PDF format.  This is a really common format, and most everyone has Acrobat Reader software that can access the file.

Advantages of PDF Invoices

Now, what’s the big deal with having PDF invoices?  There are a couple of things.  The primary one is that you can send PDF attachments in e-mails to any customers who haven’t paid their bills on time.  When you do this, you avoid the time delay of mailing or Fedexing the invoice to the customer, and you avoid the risk of someone losing a fax.  Instead, the customer has the invoice in their hands right away, and they usually forward it straight to their accounts payable staff, with an authorization for immediate payment.

When we first implemented PDF invoices, we had a major decline in overdue receivables, and also – maybe more important – we found that at least half of all overdue receivables could be handled with just a single e-mail, as long as they had that PDF attachment.

OK, that was the main item in favor of PDFs.  But also, what if somebody in your company wants to include a cover letter with an invoice?  This usually happens with really complicated invoices, where the customer is probably going to call you back for clarification before they pay.  Now, you could just print the invoice and hand it over to the person who’s supposed to write the cover letter.  The trouble is, people don’t like to write cover letters, so they may park the invoice in their IN boxes, and you’ve just lost the invoice.

But, by sending out a PDF invoice by e-mail, you can still keep track of the original, which is also a good reminder to follow up with the letter writer, to make sure that the cover letter is completed fairly soon.

So, there are some reasons in favor of PDF invoices.  How about the mechanics of the creating them?  I already said that the basic process flow is to select the Adobe PDF printer, and you’re done.  But - there are a couple of other issues to be aware of.  First and foremost, some accounting systems already have a feature built in where you just press a button, and it creates a PDF invoice.  So, before you buy Adobe Acrobat, check your software to see if it has this feature.  If it does, you’ve just saved a couple of hundred dollars.

Also, if you’ve already printed the invoice and now you want to create a PDF version, the accounting software may insist on printing the word “Duplicate” on the invoice.  This may present a problem if customers don’t want to pay from duplicate invoices.  A good way to get around this problem is to always create a PDF invoice on the first printing.  And then, if you want a paper version too, then just access the PDF file, and print it from there.  To make this approach easier to remember, set your printer default to Adobe PDF, so the system will automatically create the PDF file as soon as you hit the print button.

As you may have noticed from previous episodes, I will mention accounting products on this podcast, but I don’t specifically recommend them – you can figure out for yourself if a product will work for you, and you can decide for yourself if you should buy it.  But in this case, I can’t state strongly enough that this is the one piece of accounting technology that has helped me the most – and it’s incredibly simple to use.  And no – Adobe has not paid me to say that.

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Remote bank deposits (#41)

In this podcast, we cover the process flow associated with using a remote bank deposit system. Key points made are noted below.

How Remote Bank Deposits Work

Today’s topic is remote bank deposits.  This is when you use a check scanner to extract information from incoming checks and send the information on the checks over the internet, to the bank.  There’s no need to send the physical checks to the bank at all. I just acquired a check scanner, and I’ve been tooling around with it for a couple of weeks, so I can give you some first-hand knowledge of how this nifty piece of technology works.  And by the way, what I’m about to tell you is based on the Key Bank remote deposit system, so systems used by other banks may vary a bit.

First, you order the check scanner from your bank.  Then, you arrange for about an hour of training time over the phone with a bank employee.  Of that hour, about half is used up while you download and install software to use with the scanner.  I don’t know why it takes this long, since we have a pretty massive T1 line, but it does take some time.

The rest of the training is a hands-on training session where you run actual checks through the scanner.

The Check Scanning Process

The basic scanning process is to separate all of your checks into different piles for each company being paid.  For most companies, their customers are just paying them, so all of the checks would go into a single stack.  In our case, we own four companies, so we end up with four piles of checks.  Then, we add up the dollar amounts of the checks in each pile, so that we have batch totals for each one.

After that, we log in, and click on the account number that corresponds to a company.  Then we enter the deposit total, and we’re ready to scan.  To do so, we sort the checks for a specific company by physical size, so the smallest checks are in front, and the largest in the back.  This usually means that those cheap little $5 rebate checks end up in front.  Then, we put them in the input tray of the scanner, and it scans the batch at the rate of about one check per second. While it does a scan, the scanner automatically prints a scanner endorsement on the back of each check.

If the scanner can’t read the amount of the payment shown in a check, then the software shows a scanned image of the check, and we enter in the correct amount.  We’ve found that the system can read typed checks quite well, but it has issues with handwritten ones, or checks printed in reverse, where the text is in white, on a black background.  Key Bank tells me that the system’s ability to correctly read the dollar amount on checks is about 65%, but I find that it’s way higher than that, as long as the checks are typed.  I’d say the rate is more like 98% for typed checks.

Then, the system adds up the checks that we’ve scanned into it, and creates a deposit total, which it compares to the expected deposit total that we originally entered.  If it’s correct, then we press a button to submit the deposit and print a receipt, which we file by date.  Key Bank also tells us to retain the originals of all checks for 15 business days, after which we can shred them.  The total time to submit a daily deposit is just a couple of minutes.

Now, a couple of extra items that you might be interested in.  First, what about bad scans?  Well, so far, we’ve never had one, which says something about the reliability of the scanner.  If we were to have one, we would delete the scanned image and run the check through again.  If the scanner has already printed a scanner endorsement on the back of a check that we need to scan again, then we put some white-out tape over the endorsement before doing another scan.

Exception Conditions

Another issue is, what about foreign checks?  So far, you can’t scan them, so you still have to send in the originals.  The problem is apparently not in the scanning system, but just that the laws have not been passed that allow the bank to process these types of checks.  If you happen to run a foreign check through the scanner, it’ll notify you, and not accept the scan.

Also, what if you mistakenly send the same check through twice?  The system keeps track of all checks scanned for the past ten days, and will notify you when a duplicate check goes through.  It shows you images of both the first and second checks, so you can see if there’s really a duplication.  Then, you just cancel the second check.

Scanner Maintenance

Also, the maintenance on the scanner is quite minimal.  We’re supposed to wipe down the scanning hardware with a Q-Tip about once every three months, and there’s also a Hewlett-Packard inkjet cartridge for printing the scanner endorsement, for which we keep a backup on hand.  Other than that, there’s really no maintenance to speak of.

System Pricing

The price of the system is about $100 a month.  We’re doing it mainly for the convenience, since no one wants to deliver checks to the bank, and mailing checks can sometimes result in checks that are lost in transit.  There’s also a one to two day reduction in check clearing time.  For us, the system is not really economical, but it sure is convenient.

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Biometric Time Clocks (#40)

In this podcast, we discuss the advantages of using biometric time clocks, as well as how they function. Key points made are noted below.

Today’s topic is biometric timeclocks.  Before I get started on this topic, I’d like to point out that I receive no compensation to talk about the suppliers in this podcast.  I only mention specific manufacturers, because I think you might be interested in what they produce. So, getting back to the topic - The main questions are, what is a biometric timeclock, and why would you want to use one?

What is a Biometric Time Clock?

A biometric timeclock can theoretically use any unique feature on your body to verify that you’re the person who is entering time information.  Though this could involve a retina scan, your voice, or facial features, the timeclocks currently on the market that are cost-effective only use either fingerprint scans or the shape of your hand to verify who you are.

The only company putting out a biometric clock that measures the shape of your hand is Recognition Systems, which is a division of Ingersoll Rand.  For this clock, which is called the HandPunch, you have to initially record the geometry of your hand in the timeclock.  To do this, you place your hand on a template and hold it there for about 30 seconds.  The clock uses a built-in digital camera to take about 90 measurements of the length, width, thickness, and surface area of your hand and four fingers.  The measurements don’t include your fingerprints, which I’ll get back to in a minute.

Once someone is registered in the system, they then clock in and out by punching in their employee number and putting their hand on the template for verification.  The verification process takes about one second.

There are several versions of the Handpunch on the market.  The small business version is the HandPunch 1000, which has a capacity of 50 users.  You can buy a new one on eBay for $850.  You can also add memory capacity to bring the number of users up to 100.

A more advanced version is the HandPunch 4000, which has a capacity of several thousand employees, depending on the amount of memory you buy for it.  It retails for $3,600, but you can buy it on eBay for about $2,700.  This version presents up to 24 information fields for employees to view.  For example, they can view their work schedule, or total hours worked so far in the pay period, and unused vacation time.  It also includes a bar code reader, in case employees want to scan in their access codes instead of punching it in by hand.

Another variation on the biometric timeclock is the fingerprint scanner.  In this case, an employee places their finger on a template, which scans the fingerprint and matches it against a stored record.  Kronos sells the Kronos 4500 TouchID terminal, for which there’s a limited market on eBay.  The pricing I found for an essentially new terminal was $600.  InfoTronics also makes a couple of versions of a fingerprint scanning timeclock.  Your best bet with them is the IDpunch 5, which can be used by up to 250 employees.

Now, there are scenarios where fingerprint scanning may not work.  If you have a rugged industrial environment where people can get dirt or grease on their hands, this may obscure their fingerprints, and result in rejected scans.  In this type of environment, you may be better off using a hand measurement system, such as something in the HandPunch product line.

When to Use a Biometric Time Clock

So, to get back to the second question, why would you want to use a biometric timeclock?  There are two reasons.  First, it eliminates buddy punching.  This is when one employee punches in or out for another employee who isn’t actually on the premises.  The result is that a company pays an employee for work that was never performed.  With biometric technology, the actual employee really has to be present in order to punch in or out.

The second reason is that there’s no need for employees to swipe their employee badge into the machine.  This is a really neat feature, because lots of employees forget or lose their badges, and the company then has to go through the effort of issuing new badges.

So, in short, you use biometric timekeeping to save money by eliminating buddy punching, and by eliminating the administration of employee badges.

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Timekeeping by Telephone (#39)

In this podcast, we discuss the benefits of entering time data through employee phones. Key points made are:

• Time cards, time clocks, and time entry through a website are the traditional time collection methods.

• A telephone time clock allows employees to enter their time into a central system via any phone, including their cell phones.

• A telephone time clock works well when employees are engaged in field service, construction, or agricultural activities, or when a business has many locations but few people in each one (which makes the investment in local time clocks too expensive).

• Basic process is to call an 800 number, enter the employee ID, enter the clock code for the type of activity, and either enter a time stamp, start/stop time, or elapsed time. There is also a provision for answering a series of yes/no questions. The entire process takes 20-30 seconds.

• Benefits of timekeeping by telephone include the elimination of time cards, no data entry work, immediate data validation, immediate visibility into the hours being worked on projects, and the immediate availability of hours worked for clients that can then be billed to those clients.

• The underlying time database should be integrated into the company’s payroll processing system.

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Automatic Cash Application (#38)

In this podcast, we discuss the characteristics of an automatic cash application system, and the circumstances under which it works best. Key points made are:

• There are four steps in the automatic cash application process, which are:

  • 1: Import data from the bank, or customers, or engage in manual data entry. Need to link up payment information from the bank with the invoice detail in the company’s accounting system.

  • 2: Make corrections for keying errors with rules engines; there may be an AI-based learning process incorporated into the system.

  • 3: Manually fix those issues that cannot be automatically corrected by the system; a good result is automatic application of 90% of all payments.

  • 4: Export the cleaned data to your ERP system.

• Problems could be caused by underlying procedural issues.

• The success rate usually begins quite low; use the Pareto principle to fix the 20% of problems causing 80% of the problems, which rapidly improves the situation.

• Automatic cash application is a good solution when the transaction volume is high, or where cash receipts processing is prone to error, or when there are large spikes in cash receipts transaction volume, or when the system can be used to segregate cash receipt duties from other positions in the company.

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Forensic Accounting Investigations and Logistics Metrics (#37)

In this podcast, we discuss the nature of forensic accounting investigations, when they are needed, and who may be involved in investigations. In the second part of the podcast, we also discuss logistics metrics. Key points made in regard to forensic accounting investigations are:

• The forensic accounting investigator is called in which a client suspects that fraud has occurred.

• The investigator gathers documents, examines them, and reports findings to the client. This work involves looking for anomalies, checking on the existence of suppliers, investigating disbursement spend, reviewing contracts, and so forth.

• The investigator follows the money in asset misappropriation cases. This includes the examination of records and emails.

• Nonprofit entities tend to be quite trusting and have few employees, which places them at a higher risk of fraud.

• The investigator may need to look into conflicts of interest (such as business dealings with friends and family), corruption, and bribery. This may involve reviewing the existence of any payments to government officials.

• Insurers may pay for the fees of the investigator.

• May end up talking to the SEC, FBI, and other regulators and law enforcement agencies.

• Forensic investigation skills may not be present in every Big Four office; tends to be concentrated in offices located in larger population areas.

Key points relating to logistics metrics are:

• Percentage of certified suppliers; focus is on production suppliers.

• On-time inbound delivery percentage; there is a penalty for both early and late deliveries.

• Raw materials inventory turnover

• Cost of rush freight services; too high a number indicates excessively low raw materials inventory.

• Picking accuracy; focus is on parts shortages.

• Order fill rate; can depend on the number of line items in an order.

• Percent of products damaged in transit; can help to calculate on a quarterly basis, to smooth out short-term anomalies.

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The Universal Payment Identification Code, and Sales Metrics (#36)

In this podcast, we discuss the advantages of using the universal payment identification code (UPIC) for payables transactions, as well as the best sales metrics to use. Key points made in the podcast are:

• The Clearing House Payments Company does payment clearing; it is an alternative to the Fed.

• UPIC is a pseudo account number, to which customers can send their ACH payments. The Clearing House Payments Company then looks up the linked account account, and forwards each ACH payment to it.

• UPIC is portable, so it stays the same when you change bank accounts.

• UPIC avoids the need to contact customers when the underlying bank account changes.

• UPIC does not allow the use of ACH debits or demand drafts.

• Can ask your bank if they offer UPIC.

Key points relating to sales metrics are:

• Sales per salesperson; use it to measure nonrecurring sales.

• Customer cancellation percentage; use it to monitor the loss of longer-term customers.

• Sales productivity; can use it to measure productivity for individual salespeople, or the entire department.

• Sales effectiveness ratio; want to maximize gross margin per hour of bottleneck time.

• Quote to close ratio

• Pull-through ratio; useful when have large initial group of prospects.

• Days of backlog; only at a gross level, so it may hide constraint issues for individual products.

• Customer turnover; need to factor in which customers need to be dropped.

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Recovery Auditing and Accounting Metrics (#35)

In this podcast, we discuss the reasons why recovery auditing can improve profits, as well as the measurements to use in the accounting department. Key points made in the podcast are:

• Profit leaks come from the accounts payable and purchasing streams.

• There tends to be more leakage as headcount declines, since there are fewer people watching transactions.

• Need staffing overcapacity to plug all profit leaks.

• Hire a recovery auditor to do the analysis work for you. This will require a specialist in each area to be examined, such as payables, advertising, freight, sales and use taxes, and health care billings.

• A recovery auditor can bill an hourly rate, or a percentage of the cost savings.

• The hiring person can look bad if too many mistakes are found by the auditor.

• The first recovery audit tends to find the most savings, with diminishing returns thereafter. Still makes sense to bring in recovery auditors on a regular basis.

• Useful for isolating where the problem areas lie within a business.

• Recovery auditing tends to work better with large to mid-sized companies, but can still make sense when sales are as low as $20 million.

• A good recovery auditor will provide advice, as well as spot specific instances of waste.

Key points relating to accounting metrics are:

• Error tracking is essential within the department.

• Average expense report turnaround time; turnaround time can be delayed when supervisors do not forward expense reports to the payables staff in a timely manner.

• The total number of transaction errors requiring a payroll adjustment.

• The proportion of purchase discounts taken; should focus on those discounts that are the most economical to take.

• Average time to issue invoices; should be as fast as possible.

• The total payroll transaction fees charged by the payroll supplier.

• The percentage of dates on which tax filing dates are missed.

• The time required to produce financial statements.

• Borrowing base usage; warns when the amount of available debt is getting close to zero.

Related Courses

Business Ratios Guidebook

Fraud deterrence (#34)

In this episode we discuss the issues relating to fraud deterrence, to keep instances of fraud from ever happening. Key points made in the podcast are:

• Fraud deterrence involves conditions and procedures analysis to keep fraud from taking place.

• Could include the use of detection systems to spot fraud before it worsens.

• The cost of fraud deterrence is a fraction of the cost of the fraud being prevented.

• It avoids the loss of business reputation by a business, which might otherwise impact its contracts and loans.

• A robust, bottom-up budget is a good fraud deterrence control.

• Just the act of reviewing accounts is a deterrent, since employees see that you are looking over their shoulders.

• The worst frauds tend to go on for an extremely long time, building in size as they get older.

• It is rare to see an excessive level of control in a business.

• Focus on all aspects of the business when engaged in fraud deterrence.

• Conduct an operational review to identify control issues and also increase the efficiency level. Requires lots of interviews.

• Difficult to do an in-house fraud deterrence review, due to the fear of recrimination.

• Should do deterrence reviews about every two to three years.

Related Courses

Accounting Controls Guidebook

Fraud Examination

Fraud Schemes

Acquiring a Public Shell Company (#33)

In this episode, we discuss the considerations involved in buying a public shell company. Key points made in the podcast are:

• A public shell is a public company that has no business activity, and which is no longer filing periodic reports with the Securities and Exchange Commission (SEC).

• A private company buys a public company in order to go public through a reverse merger transaction; this can be done in as little as three months.

• A key risk is that the shell may have undocumented liabilities, which the new owner may have to pay.

• Securities attorneys usually manage a group of shells, which they preserve for sale to others. This involves letting them lie fallow for several years, with no activity, while continuing to have their books audited. It costs about $25,000 per year to operate a shell in this manner.

• Once a private company buys a shell, it swaps the shares of its own shareholders for those of the shell, and then has to register these shares with the SEC. The shares cannot be sold until they have been registered. A key problem is building trading volume, or it will be quite difficult to sell the shares.

• The pre-existing shares of the shell are more likely to be sold at this point by their owners, since the share price will likely have increased.

• The new owner has to issue a Form 8-K to the SEC as soon as the acquisition is completed, which is a time-consuming chore.

• Estimate $15,000 per month to maintain a public company once the shell purchase has been completed.

Related Courses

Mergers and Acquisitions

Public Company Accounting and Finance

Metrics (ROI) and Accounting Run Charts (#32)

In this episode, we discuss how run charts can be used within an accounting operation, as well as the different types of metrics relating to the return on investment. Key points relating to accounting run charts are:

• Accounting run charts are used to track transaction volume by activity. They can be assembled with Excel, or through an accounting system custom report.

• Run charts can be used to justify changes in employee headcount.

• Run charts can also be used to monitor employee performance, especially when processing volumes per person decline.

• Run charts can be useful for deciding whether to use temps or hire full-time workers, depending on the transaction pattern observed over time.

• Run charts can be used to monitor the seasonal elements of transaction volumes.

Key points relating to return on investment metrics are:

• ROI metrics are needed for the analysis of investments.

• Return on assets; includes all assets, to give a better picture of the total investment in assets.

• Return on operating assets; only includes those assets actively being used to generate revenue.

• Return on equity percentage; used by investors. Can be enhanced by using more debt to buy back shares, which can cause leverage problems.

• Return on common equity; subtracts out the effects of preferred stock dividends.

• Equity growth rate; shows how the equity balance is being impacted by inflows and outflows.

• Economic value added; incremental rate of return in excess of the cost of capital.

Related Courses

Business Ratios

Lean Accounting Guidebook

Metrics: Operating Performance (#31)

In this episode, we discuss the most essential operating performance metrics for a business, with a emphasis on how to discern the performance of an organization’s core operations, how changes in fixed expenses will alter profits, and whether financial reporting fraud may be present. Key points are noted below.

Operating performance is all about the net results of your company.  Examples of operating performance are the gross margin and net profit measurements, which pretty much everyone uses.  The trouble is that no one uses anything else, and there are some other ways to look at operating performance.

Sales to Operating Income Ratio

A good alternative measurement is the sales to operating income ratio.  This is the same thing as the net profit measurement, but you strip out any income or expense that’s unrelated to your core operations.  This means removing gains or losses from asset sales, as well as any changes in reserves, and also take out any interest income or expense.

The intent of this measurement is to strip out all of these non-operational items that muddy the waters and keep you from seeing how the company is actually performing.  If you don’t have large amounts of these non-operational items cluttering up your income statement – then don’t bother with it.  But if you do, this really should be the preferred measurement to use instead of net income.  Obviously you can’t use it for external reporting, but it’s a good one for internal management reports.

Core Operating Earnings

Now, here’s a much more complicated version of the same concept, which is called core operating earnings.  Standard & Poor’s came up with this one.  They start with the income figure, and then modify it to arrive at the earnings of a company’s core operations.  Here’s how it works:

You begin with net income, then add back stock option expenses, and restructuring charges, and pension expenses, and purchased R&D expenses, and asset write-downs.  Then, you subtract out any goodwill impairment charges, and gains or losses from asset sales, and pension gains, and merger and acquisition expenses, and litigation expenses, and any gains from hedging activities.  That’s eleven different changes to the net income figure, which may seem like a lot.  On the other hand, as I go down that list, I can see that five of them would have applied to my company in just the last few months.  So you may want to try it, and see if you get a more realistic view of how your company is doing.

Sales Margin

Here’s a measurement you can use to replace the gross margin, and it’s called the sales margin.  This one is the gross margin, minus all sales expenses, divided by sales.  Basically, it dumps all of your sales expenses into the cost of goods sold, so the only expenses not included in the cost of goods sold are administrative.  This is a good measurement if you want to track margins by product line, and if your sales expenses are fairly easily traceable to those products.  It’s also useful if most of your sales expenses vary with sales volume – which can happen if the sales people are paid mostly on a commission basis.

The sales margin is really useful when you have a product line where customers require lots of intensive hand holding by the sales staff.  In this case, it makes a great deal of sense to charge the sales expense directly to that product line, just to see what your margins are really like.  And they could very well be negative.

Operating Leverage Ratio

Here’s another measure to consider – the operating leverage ratio.  This one compares the amount of fixed expenses to operating income.  It’s really useful when you’re considering getting rid of variable expenses and substituting fixed expenses instead, such as when you replace manufacturing workers with a robot.

The measurement is sales, minus variable expenses, divided by operating income.  If the ratio goes up, then you’re adding to your base of fixed expenses, which probably means that your breakeven point just went up, and that means you’re more likely to lose money if sales decline.

Quality of Earnings Ratio

And let’s do one last measurement, which is the quality of earnings ratio.  This one compares the reported earnings level to cash flow from operations.  If the two numbers are fairly close, then the reported earnings level is a fair reflection of how the company is actually doing.

To calculate the quality of earnings, subtract cash flow from operations from net income, and then divide by your average assets for the reporting period.  If the net income and cash flow numbers are about the same, then the result should be close to zero – which is good.  Any number higher than about 6% indicates a low quality of earnings.

On this measurement, keep in mind that there may be a good reason for a difference between net income and cash flow – but, that different should be a one-time event.  So if the ratio is fairly large for multiple reporting periods, there’s probably some accounting trickery going on.

Related Courses

Business Ratios Guidebook

Metrics (Asset Utilization) and New 2007 Accounting Standards (#30)

In this episode, we review upcoming new accounting standards, as well as some of the better metrics relating to asset utilization. Key points discussed concerning new accounting standards are:

• Conceptual Framework Project; could be at the top of the GAAP Hierarchy

• Business Combinations; acquisition method

• Fair Value Option

• Earnings per Share; to converge with IFRS standards

• Income Taxes; to converge with IFRS standards

• Nonprofit Accounting

• Post-Retirement Benefits; implementation guidance

• Subsequent Events; cleanup issues

• Emerging Issues Task Force; changes to its approval process

• Securities and Exchange Commission; Staff Accounting Bulletin 108

Key points relating to the metrics for asset utilization are:

• Sales per person; can be adjusted by using outsourcing or part-time employees

• Need to look at asset utilization on an individual basis to see impact on bottleneck operations

• Repairs to fixed assets ratio; fixed assets are stated at gross, and intangible assets are excluded

• Accumulated depreciation to fixed assets ratio; increasing trend shows preponderance of old assets; might also still have old assets on the books that have already been dispositioned

• Breakeven point; useful for understanding maximum possible profitability, as well as the margin of safety; can be used to view the impact of new fixed asset purchases on the breakeven point

Related Courses

Business Ratios Guidebook

GAAP Guidebook

Metrics (Cash Flow) and Excel Risk Mitigation (#29)

In this episode, we review the ways in which Excel spreadsheets can fail and how to mitigate these risks, and also discuss the essential metrics relating to cash flow. Key points discussed concerning Excel risk mitigation are:

• Excel is useful for rapid system construction.

• It is possible to set up data validation in Excel, but this feature is rarely used.

• A general failing is the high degree of company-wide access to Excel spreadsheets.

• A user can have a false sense of security when using Excel, not realizing the ways in which it can issue false results.

• The best risk mitigation approach is to identify the most critical spreadsheets in the business and focus on improving them; review for complicated formulas that are likely to fail.

• There are spreadsheet problem detection products on the market that can be applied to Excel.

• Use the Excel feature to view all formulas; makes it easier to peruse them.

• Look for hard coded figures within a range of formulas; more prone to error.

• Investigate cells containing high-dollar values.

• Conduct data analyses for large data sets within a spreadsheet.

Key points relating to the metrics for cash flow are:

• Always use a few cash flow measurements as a basis of comparison to other metrics.

• Cash flow return on sales; shows the amount of cash generated as a percent of sales.

• Cash flow return on assets; less subject to manipulation than return on investment metrics.

• Fixed charge coverage; use it to see if most of a firm’s cash flow is used to pay for its fixed expenses.

• Cash to current assets ratio; a high proportion of cash indicates a high level of liquidity.

• Cash to current liabilities; provides a very conservative view of cash requirements.

• Cash flow to debt ratio; see if there is sufficient cash flow available to pay down debt obligations.

Related Courses

Business Ratios Guidebook

Introduction to Excel

Excel Formulas and Functions

Metrics (Liquidity) and a Review of Accounting in 2006 (#28)

In this episode, we review the key accounting events during the past year, and also discuss the key metrics for liquidity. Key points discussed concerning accounting events are:

• Enron and Worldcom jail terms were handed down.

• There were a series of stock option manipulation frauds.

• The SEC issued new compensation disclosure rules.

• FIN 46 was issued, involving off-balance sheet reporting requirements.

• Issues with the existing lease and pension accounting standards were discussed.

• The industry dealt with ongoing complaints about the requirements of Sarbanes-Oxley section 404, pertaining to systems of control.

Key points relating to the metrics for liquidity are:

• The current ratio is not a useful indicator of liquidity, since it includes inventory, which is not liquid.

• The quick ratio is better, since it removes inventory from the calculation.

• A comparison of sales to assets can be plotted on a trend line; the proportion should be about the same over time.

• The days of working capital ratio indicates the amount of working capital needed to support one day of sales.

• The accounts receivable collection period indicates the average number of days during which an invoice is outstanding, before it is collected.

• A comparison of sales to inventory can be plotted on a trend line, to indicate the ongoing investment level of a business in inventory.

• The accounts payable days measurement can be plotted on a trend line to highlight any changes in payables duration.

• The risky assets conversion ratio shows the percentage of low-value assets on a company’s balance sheet.

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Business Ratios Guidebook

Metrics (Inventory) and the Risk Assessment Suite, Part 2 (#27)

In this episode, we delve further into the risk assessment suite, and also describe the most useful metrics for inventory. Key points discussed relating to the risk assessment suite are:

• It was created in response to high-profile audit failures.

• It requires a more robust understanding of the client, its risk management practices, operating environment, strategy, and competitive factors.

• The client will likely be required to complete a questionnaire pertaining to the preceding items.

• There is a new focus on auditing the financial statement presentation and disclosures.

• The auditor will need to ask more questions about a client’s internal controls.

• It requires consideration of a client’s internal controls as part of an audit.

• More attention must be paid to the risks of material misstatement of financial statements.

• Link the audit program to an increased need to address the risks of material misstatement.

• Work by the client to assist the auditor can reduce fees; it may also be possible to reschedule the audit to assist the auditor.

Key points discussed related to metrics for inventory are:

• Inventory turnover is useful for seeing how much inventory is needed to support sales.

• The proportion of old inventory on hand is needed to call attention to the need to eliminate inventory. The percentage of returnable inventory is a more specific variation.

• Inventory accuracy is needed by the purchasing and picking staffs, and reflects inventory record accuracy.

• Inventory availability is needed to see if there is a problem with delivering to customers on time.

• The percentage of warehouse utilization is needed to plan for additional investments in warehouse space.

• The cubic volume of warehouse space used is useful for adjusting the warehouse racking systems to accommodate more inventory.

Related Courses

Business Ratios Guidebook

How to Conduct an Audit Engagement

Inventory Management

Metrics (Payroll) and the Risk Assessment Suite, Part 1 (#26)

In this episode, we give an overview of the risk assessment suite, and also describe the most useful metrics for the payroll function. Key points discussed relating to the risk assessment suite are:

• The cost of audits for a public company can be three times the cost of audits of privately-held companies.

• There is a disparity between the need for higher levels of assurance arising from audits and the pressure on auditors to keep their prices down.

• The risk assessment suite revises auditing standards to make audits more comprehensive.

• As a result of the risk assessment suite, audit planning will likely start sooner, so audits will also start sooner, and auditors will be more inclined to finish all audit work while still in the field.

Key points discussed related to metrics for payroll are:

• Use the number of manual paychecks cut per 1,000 payees

• Use the number of W-2c forms issued per 1,000 payees

• Use an error summarization system to self-report payroll errors, and then issue an aggregated report by error type.

• Use payroll outsourcing costs by month, divided by the number of payees; track on a trend line.

• Use the total payroll department cost divided by the total number of payees; track on a trend line.

• Use the number of W-2 forms downloaded by employees, divided by the total number of payees; useful when posting W-2 forms on a central site, where employees can readily access them.

Related Courses

Business Ratios Guidebook

How to Conduct an Audit Engagement

Payroll Management

The Fast Close, Part 10 (#25)

In this episode, we cover improvements to the billing process, and make final comments about the fast close. Key points discussed concerning billing are noted below.

The Closing Issues with Billing

I’ve saved billing to be the last item I cover in these discussions on the fast close, because most people tend to leave it for last.  When you start a fast close project, billing is not usually considered a problem area, because it doesn’t really take that long to complete.  Instead, people like to focus their attention on the really massive issues, like improving inventory accuracy.  But once they get past all of those other problems, billing is still waiting there, totally unimproved and hogging a large chunk of the closing day.

The main issue with billing is that you really can’t eliminate it entirely on closing day.  More than likely, there’s been a fair amount of shipping right through the end of the preceding day, and that’s just going to take some time to process.  However, there are some ways to improve the situation.

Issue Invoices Early

First, issue invoices as early as possible.  This means completely flushing out every other invoice related to shipments made earlier in the month.  There’s absolutely no excuse for waiting until closing day to complete invoices that could have been handled a few days before.

Also, issuing invoices as early as possible also means having someone stay late on the last day of the close in order to create invoices based on any shipping documents sent in by the shipping department up to that point.

First thing the next morning, send someone down to the shipping dock to verify everything that was shipped the day before, and to bring back any remaining shipping documents.  Get someone working on these last invoices as soon as possible.

Put Resources on Invoice Issuance

However, even being organized like this is not enough.  There may be such a volume of invoices to be created that it still takes a bunch of hours.  If so, you should assign practically everyone to do invoicing during the morning of the close.  In addition, give each one of them their own laser printer, so they can more efficiently create invoices.  Not having them walk to a central printer can save a surprising amount of time.

Do Not Retype Information

Another time-saving trick is to not retype a lot of information from supporting documentation onto an invoice.  Instead, enter on the invoice something like, “See attached” or “As per the attachment,” and then staple the supporting documentation to the invoice.  Or, if you’re copying from an electronic document, try to cut and past the information into the invoice, rather than manually retyping it.

Use Special Invoice Templates

Also, we’ve all run across those painful customers who want invoices issued to them in a very specific format – or else they’ll reject the invoice.  The slow and painful approach is to manually create exactly what they want, no matter how much time it takes.  However, if the customer is going to be around for a while, consider creating a special customer invoice template for them, so that the special formatting becomes a routine billing issue.

Additional Comments

In addition, don’t keep waiting to create an invoice if there’s a chance that its contents may change in the near future.  If you wait around for more accurate information, it may not arrive for weeks.  A better alternative is to at least create the invoice, so the revenue is booked, and then modify it after the fact – if that’s even necessary.

And finally, if you send out month-end statements, don’t do it right in the middle of the close.  That’s something that can easily wait a day or two, so just schedule it for some other time.

So, some final comments on the fast close.   Your primary goal is to shift work out of the closing day, so the most effective change you can make is to shift closing work forward into the preceding month.  Another comment is that the fast close does not require much money – you don’t need fancy accounting or workflow management software.  In fact, you don’t really even need a consultant.  But if you do hire a consultant, get one with a good industrial engineering or process analysis background.  That kind of skill is useful, because the fast close is entirely about process improvement, and not at all about accounting.

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Closing the Books

The Soft Close

The Year-end Close