So, You’re Going on the Lean Journey?
You’ve read the books on lean manufacturing principles and done the exercises, and it all makes sense. You’ve heard all the great stories about the successful transformations of companies into profit monsters pumping out earnings and quickly shipping out fabulous products before customers even know they want them. You’re amped up and ready to begin your lean journey.
Well, my advice is to STOP. Stop right now. Press the pause button. If you’re a middle manager, senior manager, or the owner of a company, you could very quickly lose everything in your quest to undergo the lean transformation.
Here’s a story for your consideration: A good friend of mine was brought in to do just this for a major manufacturer of point-of-purchase displays. In no time, he ran into a wall and subsequently ended up being fired for the very thing he was hired to do. (*Brutal Disclaimer: The company never made the transformation and proceeded to bleed to death over the coming few years after my friend left their graces.)
Sorry to put a total kibosh on your romantic lean manufacturing dream. So what happened to my friend and the display manufacturing company?
The Problem with a Lean Transformation
Here is the big problem with a lean transformation and where you can get into real financial trouble with your lender. In one word: Inventory. Your inventory, especially work in process (WIP or partially finished goods) and finished goods inventory, is where people tend to hide problems that occur throughout the organization.
One of the lean manufacturing principles and part of the lean training you received talks about the 5S methodology of cleaning and organizing your plant. (The term 5S is the name of a workplace organization method that uses a list of five Japanese words: seiri, seiton, seiso, seiketsu, and shitsuke.) You’ve heard about the costs related to inventory. You agree that it’s vastly expensive to count, manage, store, and possibly pay taxes on all that stuff. Not to mention the shrinkage, obsolescence, and damage to the inventory that also occurs throughout the year. Getting rid of all the stuff that has collected over the years is supposed to maintain efficiency and effectiveness in your shop.
But in your enthusiasm to do this are the seeds of your destruction. Before you chuck anything, wait! Don’t chuck anything until you really understand what’s going to happen. Build a plan to deal with the results of these actions before, not after, you go to war.
Managing Different Types of Inventory
Let’s start with your raw material inventory. It can include a great deal of things that shouldn’t be there. In a lot of cases, it’s just a matter of getting off your keister and sending those materials back to the suppliers.
But when it comes to WIP (work in process) and finished goods inventory, it’s not so simple. Here lies the first monster that can really destroy you: cleaning up that WIP inventory. (*Note: Some companies use an accrual of costs to value WIP goods. Every time you process this material or add value in any way, it’s accruing costs.) Take a hard look at this inventory. You probably have a pretty big investment in it that shows up on your balance sheet. How much of it hasn’t moved an inch in years?
For example, remember the time your guy misread the order and produced 1,200 parts that went down the line some distance before he realized he only needed 12 parts? Your sales team hasn’t sold one in years, but you keep holding on to them. Yes, it’s time to throw those out or send them to the recycler.
Next, you tackle your finished goods inventory. But this is the second monster that can destroy you.
Yes, you can discount some of it and derive some value from your finished goods inventory, but let’s be honest, something that hasn’t sold in three or four years won’t likely command a great deal of money when you try to sell it at a discount. Are you keeping products for a customer who may want to purchase down the road? Has the customer ordered any in the last couple of years? Hmm, seems to me if the answer is no, then you’re going to need to chuck your finished goods inventory.
Back to Another Story About My Friend
My friend found out that the display company he had gone to work for was still storing inventory and carrying it on the books as assets for companies that had gone bankrupt. Huge problem here! We all now know the inventory being held wasn’t actually assets at all. The dollars spent to store it, count it, trip over it, you name it, cost the company a great sum of money. The company needed to get rid of all the inventory ASAP!
No good deed goes unpunished, however. When you do the right thing and get all that junk out of the plant, it’s going to show up as a cost on your balance sheet. And if you’re working with a bank and have loans with them, you can bet that you have a covenant in your loans that requires your balance sheet to have certain ratios of retained earnings to the outstanding loan. Or, more simply, your bank probably requires that you have adequate assets in the company to provide them reasonable assurances that if things go south, they will get their money back. What does all this mean?
Your enthusiasm for cleaning up coupled with thinking that all of the piled-up inventory has value will most often lead you to disaster with your lender and other stakeholders.
When the company my friend went to work for realized it would have to write off a 650,000-square-foot warehouse full of stuff that they knew would never sell, they panicked. If their lenders got wind that their collateral had no value, that the only value was in terms of boiler fuel, they would very quickly put the company out of business. Not only that, the lenders could have claimed fraud in this case and made a compelling argument that the company was aware of this. This would have left the company officers open to a major personal liability, not to mention possible criminal charges for fraud. The company had every reason to panic.
Making Your Lean Journey Battle Plan
Back to you and your lean journey now.
So, what should you do? Yes, you must make the lean journey, but you’re going to have to make some hard decisions up-front, and you need a battle plan.
Take a look at your balance sheet. Can you support the loss of a significant amount of your equity? Do you have an equity and cash position that will allow you to do this without raising alarms with your lenders?
Sit down with your accountant and discuss how much of your equity is about to be sent to the landfill and the recyclers. Does your accountant believe you can support this? If not, you have some very hard choices to make. If you’re going to be upside down or in default of your loan covenants, your next step is to plan how you should go forward.
First, get the help of your accountant. You can put more money into the business. You can raise capital to do this, either from an investor or from yourself, your family, and your friends. But only do this if you and your accountant feel confident that you’re making significant profits or have a fighting chance to recover. This is a tough thing to be honest about with yourself. You need to listen carefully to your advisors at this point and rely on their opinions. Most owners have a hard time with being honest about the prospects of their baby, a.k.a., their company.
The next step is to sit down with an attorney and have him or her look over all outstanding loan agreements and any other relevant documents, such as leases. Some leases become void if you go into bankruptcy or your balance sheet doesn’t maintain a certain equity level. Yes, your landlord is also one of your lenders in terms of planning and moving forward. If you have other investors in your company, these agreements will also need review.
What does your attorney think? Will you be able to meet the covenants moving forward in all of your agreements? You will still need to have a strategy. You need to inform your lenders and other stakeholders in advance before they open your financial statements and see a significant loss. This is where using your accountant and other advisors to help you lay out your plans for stakeholders comes into play. As the old saying goes, “Forewarned is forearmed.” People don’t like surprises, especially when it comes to money.
The Beauty of Bankruptcy
If you and your advisors think that you have a problem that will cause significant upheaval in your business, and you don’t think you can raise adequate equity to satisfy your lenders and other stakeholders, then you need to talk with a bankruptcy attorney.
At this point, you’re going to have to make some hard decisions. Do you want to continue the business or should you recognize that it’s on life support and the time has come to pull the plug? Say a prayer, take your licking, and move on. Most lenders require personal guarantees. So putting the company into liquidation under bankruptcy will impact you both personally and professionally.
But, wait, all is not lost. The beauty of bankruptcy, if you choose to go the reorganization route, is that it gives you both a way forward and a way to restart. In the case of moving forward with your company and the lean journey, it gives you a plan and the ability to make the hard decisions. It gives you room to understand what your inventories are. Under reorganization, you will present a plan to the courts, and if it’s reasonable, your creditors are held at bay. In some cases, you can even negotiate additional financing. At this point, you need to sit down with a good attorney that specializes in this area. An attorney can give you a much better idea of what is possible and how you’ll need to proceed.
Transparency, Transparency, Transparency
However, most who set off on the lean journey can sustain the costs. Not all of them will appear on your balance sheet and in your profit and loss statements starting out. Hopefully, your increased profits and transparency in running your organization will far outweigh these costs. No matter how you proceed, planning is key and will help you understand both the costs and how to recognize the benefits of your lean journey.
As that old adage goes, “A failure to plan is a plan to fail.” No matter how you decide to start your lean journey, you need to do it with eyes wide open. When following the lean manufacturing principles, you need to know the costs and have a team and a strategy to preempt your lenders and stakeholders from not just blocking your best path forward, but to win them over. When all stakeholders are on board, you will have your winning team for the lean journey ahead.
By: Spencer Dick, TigerStop
You can read more about how to approach going Lean at “7 Deadly Wastes of Lean Manufacturing.”
And by visiting TigerStops’s blog and case studies.