Operating in difficult times Featured

8:00pm EDT April 25, 2009

In these difficult times, many companies are striving to become leaner.

But to do so, you can’t just make random cuts. Instead, running lean requires you to take a hard look at all areas of your company to assess how changes will affect your operations.

Whether you’re looking to cut costs by improving efficiencies, renegotiating contracts or reducing your work force, it is important to consider the big picture. You also have to involve those at the highest levels of your company.

“It is essential that the directors become more involved in the day-to-day operations of the firm,” says Adam Wadecki, manager of operations, Cendrowski Corporate Advisors LLC.

Doing so is important, Wadecki says, because the directors bring a different perspective than the management team and can help the firm’s members see issues from another angle.

Smart Business spoke with Wadecki about how to become a leaner company and streamline your operations.

How do you define a lean organization?

A lean organization is one that can quickly convert its resources into cash. The time it takes to convert resources into cash is equivalent to the time it takes the firm to convert raw materials into finished goods, finished goods into receivables and, finally, receivables into cash.

An organization becomes lean by decreasing the time between each of these steps. Many organizations track the average time spent in each of these conversion processes; however, a more thorough analysis will look at not only the mean time spent in each process but also at the distribution of the time spent in each process.

This should be included in an organization’s risk management strategy. Decreasing this time will help the organization improve its working capital management.

What steps can an organization take to start becoming leaner?

With respect to production processes, lean manufacturing and Six Sigma are probably the most widely used tools.

Each of these has gained in popularity in the last 20 years. Accountants also have developed tools to use when assessing operations, generally under the guise of internal control. For a long time, the accounting profession largely concentrated on what it called internal accounting controls within a business.

However, the profession has since moved to a broader definition of what it labels internal control, emphasizing that operations are indeed a part of an internal control assessment.

What types of analyses can management perform to improve a company’s operations?

Historically, managers in crises have placed great emphasis on cash management at all levels of the organization. This emphasis is underscored by the need of management to understand the day-to-day finances of the firm’s operations and also the ability of the firm to service any outstanding debt obligations. However, it also is important to quantify the risks to these cash flows based on the probability and magnitude of potential events. This should be an essential part of the organization’s risk management process.

How can an organization quantify risks to cash flow?

This is a process that both management and the board of directors must be involved in. Cash flow risk assessments must be performed with accurate and timely information.

It’s also important to consider the human element in the risk assessment process. For instance, when directors receive risk assessments from management, they should consider management’s track record in providing these assessments.

Are risks generally understated? How tolerant is management of low-probability risks? How does management test its risk assumptions? How are probability and magnitude estimates quantified? Management can pose similar questions to the company’s support staff.

By understanding risks, organizations can identify with a laser focus operations in need of improvement. This process is especially important for organizations that have lean operating strategies or those that are attempting to improve their leanness; such organizations often rely on steady, predictable operations to maintain high profitability.

What are some mistakes organizations make when proceeding toward lean?

Organizations need to ensure that they are, in fact, ready for change before they begin implementation. To borrow a phrase from the accounting profession, a proper tone at the top needs to be set, and employees must buy in to the process.

This tone is set not only by management but also by a firm’s directors. If these individuals are not able to garner worker support, any initiative is likely to fail. Where possible, it may be advantageous to tie employee performance with company profitability in order to make sure everyone is properly incentivized; workers must believe the benefits of their activities will exceed the costs.

However, organizations must be careful not to create incentives for workers to optimize myopically, rather than over the long term. This was a central problem at the heart of the current fiscal crisis — improper incentives that led to socially suboptimal decisions. Remember the adage, ‘What gets measured gets done.’

ADAM WADECKI is manager of operations for Cendrowski Corporate Advisors LLC. Reach him at aaw@cendsel.com or (866) 717-1607 or visit the company’s Web site at www.cca-advisors.com.