yellow belt process improvement training and certification module

(C) The School of Continuous Improvement

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Yellow Belt– Process improvement Training and Certification Module

Disclaimer


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This Yellow Belt – Process Improvement Training and Certification program is being offered free of charge to the interested individuals who wish to learn more about Process Improvement.

Reproducing this module or distributing or selling it to achieve financial benefits will invite stringent action under the concerned law of jurisdiction by the institution facilitating this module.

With the end-objective/ deliverable of identifying a process improvement opportunity in your organization, read the module and have fun.

Of course, you would have an assessment at the end of the module based on which you would be certified.

Body of knowledge


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a. How to link strategic goals to process improvement initiatives b. Introduction to Kaizen, PDCA, Lean and Six Sigma c. Pre-requisites to process improvement d. Key financial indicators e. How to choose a process improvement approach f. 7 QC Tools


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How to link strategic goals to process improvement initiatives

Strategic goals to process improvement


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1. What matters the most to the CEOs of a company is their strategic goals and how they are performing against them.

2. The organization can be improved. The business units can be improved. Processes within the business units can be improved.

3. Identification of an improvement opportunity is typically done by the Biggest Bang for Buck approach.

4. Most organizations use the Balanced Scorecard approach to roll down strategic goals to operational objectives.

Balanced scorecard


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As you can see from the snapshot of the Balanced Scorecard of a company, the strategic goal of the company is to have an operating margin of 25% yearly for the next 5 years with the margins increasing 2% every year. A CEO would normally state this when he knows his operating margins are somewhere in the range of 10-15%.

Balanced scorecard


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A key customer complaint is lag in the delivery times. This has led to wastage of time and money and importantly also led to customer attrition.

Balanced scorecard


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How can you meet the company’s and the organization goals – Well by optimizing the manufacturing and warehousing processes. These processes are critical to delivering products on time.

Notes


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1. You don’t necessarily need to have a Balanced Scorecard approach to identify process improvement initiatives that are linked to strategic impact areas.

2. You though need to work with your top bosses (May not be the CEO all the time) to identify the strategic goals.

3. The drill-down to the customer impact and finally the process linkages to the customer impact is equally as important.

4. Having numbers/ data around what you write is not mandatory at this stage.


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Introduction to Kaizen, 8D, lean and six sigma

What is Business process improvement?


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1. Business Process Improvement is about improving the performance of an operational metric from its historical state(As-is) to a new level (Future state).

2. This improvement can be slow and incremental or breakthrough.

3. Business processes are improved to impact strategic indices like:

a. COGS: Cost of Goods Sold

b. Customer Satisfaction

c. EBITDA: Earnings before Interest, Taxes, Depreciation and Amortization

d. COPQ

e. Operating Margins


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BPI Journey

framework

Standardization

Characterization

Optimization

Improvement

Business process improvement journey


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Business process improvement journey

1. Standardization – This should be the first step of any improvement journey. Set the procedures correct. Have the processes mapped. Remember – No standards, no improvement.

2. Characterization – Once the processes are standardized, map the input and process output variables. Set/ Define the targets for the variables.

3. Optimization – Funnel down the many input variables which impact the output variable to the few critical input variables which have a major impact on the output variable.

4. Improvement – Improve the state of the metric of interest from the as-is level to a future state level.

Pre-requisites for business process improvement


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1. Top management buy-in is mandatory.

2. Processes should be standardized in documentation.

3. Data should be readily available from the process.

4. Trained resources.

5. Established communication channels

With these 5 basic pre-requisites, any one can improve a business process in an organization.

Improvement and Innovation are two different things altogether. A Business may want to innovate at first, or they may want to improve and then innovate.

Business process improvement approaches


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1. Global 8D: An easy to understand and an effective problem solving technique used for complex problems.

2. Kaizen Blitz: An easy to deploy mechanism used for relatively simpler problems intended to drive small improvements.

3. Theory of Constraints: A scientific approach to improvement that focuses on the weakest link in the chain and looks at improving.

4. Lean Six Sigma: An interwoven set of approaches combining statistical tools and techniques to help identify causes of variations and wastes in the process and reduce them.

5. PDCA: Plan, Do, Check and Act is a reiterative process for improvements where closing of one project drives another.


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Approach Time Cost intensive

Resources

Other conditions

Global 8D 1 month Yes 2-3 Process experts’ involvement must

Kaizen Blitz 14 days No Entire process team

Simple problems, quick to fix and small improvements

Lean Six Sigma 3-6 months Yes 3-4 Root cause not known, other pre-requisites

Theory of Constraints 2-3 months Yes 3-4 Dependencies clearly mapped, system improvement

PDCA 1-2 months No 1-2 Need for iterations to improvement

Business process improvement approaches

Choosing the right bpi approach


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Answer the following questions in form of a check list and send to the Trainer of the module to help understand how to choose the right approach to the problem: 1. Does your organization want a quick fix to the problem? 2. Can your organization spend 1-2 hours/ resource for every resource for 2 weeks? 3. Does your organization care about long term improvement? 4. Do you want to improve the entire system or just one process in the organization? 5. Does your organization permit you spending 1-2 hours every day for 3-6 months on

process improvement work? 6. Does your organization believe in the principle of continuous improvement? 7. What is the Strength of your company and how many departments do you have? 8. Which sector does your company belong to (Services, Manufacturing)? 9. Which sub-sector does your company belong to (Warehousing, Distribution etc)?

Case Studies


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Example 1 An organization wanted to improve a key process metric Cycle time for products that it had identified for improvement. Improving this metric was critical as the company had relatively high cycle time resulting in customer waiting and some times also moving to competitors. The organization wanted a solution to the problem within a month as a temporary fix. Once the “bleeding” stopped, the organization was also willing to invest resources to improvement initiatives. Which improvement initiative/ approach combination should the organization choose to work with?

Case Studies


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Example 2 An organization wanted to improve the efficiency of its distribution system. This distribution system involved taking in products from 6 different companies and supplying it to the customers. The reasons for inefficiencies in the distribution system were well known and the company had data to back up the reasons. The company was in a very competitive sphere and wanted to reduce the inefficiencies, which resulted in high cost of services provided resulting in lowering their profit margins. The team had 50 FTE and the company was willing to allow 1 hour per day for every resource for 2 weeks to fix the problem at hand. Which improvement initiative/ approach combination should the organization choose to work with?

Case studies


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Example 3 An organization wanted to improve the OEE (Overall Equipment Effectiveness) of its operating factory. The OEE was measured at 61% daily and one of the main reasons why the OEE metric was down was due to frequent downtimes due to knife change. The organization wanted to fix specifically the knife change issue doing which they would have resulted the OEE to go up to 75% for which they had one week. Which project initiative or approach should they use?

Case studies answers


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Example 1 8D: 8D has one discipline step which is called Interim containment action. This talks about the bandaid approaches. Implementing 8D for a month will get the temporary fix. Another discipline speaks of Permanent Corrective Action. To implement permanent corrective actions, the organizations need to invest money. Thus, a simple 8D implementation will do the trick. Example 2 Kaizen Blitz/ Theory of Constraints: The fact that the organization wanted to address the issue quickly and was also ready to commit resources to the project with the reasons being known, you could either take the Blitz approach or Theory of Constraint Drum – Buffer – Rope approach. Example 3 Shortage in time means Kaizen Blitz is the only possible approach that can be taken.

By now, you should know


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Which process improvement approach should you choose for your problems?


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8D and Kaizen Blitz

8D


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1. 8D or Global 8D Method of problem solving is a scientific approach to solve problems.

2. This method constitutes 8 steps or 8 disciplines arranged in a chronological order.

3. The problem solving closely resembles the y = f(x) approach.

4. Practitioners should use 8D when they have about 1-2 months to solve the problem and if they can have a team of 3-4 working on the project.

5. 8D is also used to find temporary actions that will help taking care of immediate concerns.

8D


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Example A manufacturing company has been producing a lot of defective products over the last 3 months. It has reported loss of $200,000 for the last 3 months alone due to re-make of the defective products. Defective products also mean loss in customer satisfaction. The company CEO has allocated 3 resources and wishes to fix this problem within a month.

8D


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D1: Form the Team 1. The team had 3 members. One of them was the project leader,

and one was a quality engineer with the other being a production line supervisor.

2. The total experience in the process amongst the 3 individuals was about 15 years.

3. The team was first briefed about the problem, and were asked to study symptoms of defects found in the defective units.


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D2: Problem Description 1. The team conducted a 5 WHY analysis on the defects noted.

2. Reasons for populated under categories in a tool known as

Affinity Diagram.

3. Pareto Charts were drawn to understand the reasons and also to help the project team freeze to the root cause of the problem of high number of defects.

8D

8D


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D2: Problem Description

Nails

rust w

ithin

10 d

ays

Str

ength

of

nails

is b

ad

Nail

bre

aks

Nail

tip is n

ot

sharp

Nail

head is n

ot

round

Nail

is n

ot

centr

ed

0%

20%

40%

60%

80%

100%

0

10

20

30

40

50

60

Cum

ula

tive %

Defe

cts

Causes

[Pareto Chart for Defects]

Vital Few Useful Many

75% of defects happen due to Nails rusting quickly and nails breaking earlier than expected.

8D


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D2: Problem Description 1. 5 WHY Analysis was used as a Root Cause investigation technique.

2. Prior to using 5 WHY, the team may decide to use Affinity Diagram to understand major causes contributing to the two prioritized defects from Pareto Charts.

3. It was found out that 75% of nails were being found defective due to two main reasons:

a. Nail raw materials were not being picked in a FIFO mechanism. b. Variations were found in the finishing powder quantity used to polish

nail raw materials before passing on to nail machines.

8D


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D2: Problem Description The company had incurred a loss of $200,000 due to defective nails being

produced. About 40% of the quantity of the nails had been returned back by customers. 75% of defects causing defective nails were due to nails rusting and breaking earlier than the expected 2 months timeframe. The root causes of this problem are:

a. Nail raw materials were not being picked in a FIFO mechanism. b. Variations were found in the finishing powder quantity used to polish

nail raw materials before passing on to nail machines.

8D


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D3: Interim Containment Action

1. The team proposes two quick solutions to fix the issue:

2. Solution 1 – One operator from the pool of 8 operators will be devoted to checking the quality of raw materials. Only passed materials will move to production. He would use Acceptance Sampling logic and reject the entire lot if he finds more than 2% of the weight not proper.

3. Solution 2 – A bucket of finishing powder would be kept near to nail polishing machine and will be replenished every 1 hour. The replenishment individual will keep providing feedback to the polishing operator if adequate quantity of polishing powder is not used.

8D


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D3: Interim Containment Action Deal with change resistance

1. In an 8D project and in fact in any improvement project, change

management is important. 2. Any attempt to improve the process, step 1 for that being an Interim

Containment Action, will need to have the backing of the employees of the process.

3. Possible resistance questions are: a. Why should I do it this way? b. What benefit would I get? c. Are you sure this is the right way?

8D


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Deal with change resistance Explain to the operator 1. The fix is a temporary fix, to ensure we deliver to client expectations as we are

defaulting on it by approximately 40%. 2. With your proactive participation in our next activity in the project, we shall

be able to find a permanent solution to the problem at hand, which will alleviate this present work.

3. As the permanent solution may take some time coming, these temporary fixes will ensure we reduce the percentage of defective nails.

8D


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Validating effects of Interim Containment Action 1. Statistical tests like a Paired t test or a 2 Sample proportions test can be used

to validate the effects of Interim containment action.

2. These effects can also be validated by shop floor observations or checking the daily defective report.

8D


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D4: Root Cause Analysis and Escape points The 5 – Why analysis along with data validation led to the below causal factor

charting:

Nails rust (46%)

Nails break (29%)

Raw materials improper(

100%)

Raw materials of varying

thickness (50%)

Polishing process not done properly (50%)

Polishing powder not

added (100%)

Operator missing to add polish powder

Lack of thickness tester

8D


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D4: Root Cause Analysis and Escape points

1. The detailed root cause analysis included shop floor visits to ensure facts are collected.

2. The root cause analysis reveals that if this issue of defective nails need to be fixed to 75%, the company needs to purchase a hardness tester and also think of a way to automate the gun powder addition process.

3. While the project team thinks of permanent corrective actions, the interim containment actions are already taking care of temporary corrections.

8D


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D5: Installing Permanent Corrective Actions

1. A solution, if a well planned one, will always work.

2. With the issue of adding hardness testers and automating the polishing machine process needing possible financial investments, present a quote and get necessary approvals.

3. Obviously, this financial investment needs to be backed up by good ROI.

4. For our reference, we will use the simple ROI Calculation shown in next slide.

8D


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Solution point How to Cost Yearly benefits

Time to install and pilot

Purchase a hardness tester and ensure hardness readings are captured

Senior Operator will sample hardness of raw materials on receipt and reject if rejections > 2% on weight

$ 1,000 $ 165,000 15 days

Install a pull mechanism from the polish powder container

A pull filter will be added to the container that will pull the polish powder and add to the main polish gun

$ 5,000 $ 500,000 15 days

8D


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1. The solutions need to get an approval from the top management.

2. Once approval received, the project team must ensure a proper plan is formed (Solution Deployment Plan). This plan will chalk out the roles and responsibilities of individuals participating in the deployment.

3. Finally, the project team must add these actions into the process.

4. After adding these actions into the process, the project team must monitor the performance of these actions. Question is --- Are they together able to bring about a reduction in percentage of defective nails?

8D


40 D6: Validation of results After one week of monitoring and collecting data, the below results were observed: 1. Out of 100 batches of raw materials, 20 were rejected and supplier asked

to re-supply. 2. 80 batches of raw materials produced 25 tons of nails. 3. Ad-hoc inspection of nails and quality inspection revealed 3% defectives

from 22% observed earlier. 4. Customer returns went down from 40% to 10%.

8D


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D7: Standardizing the procedure

1. The project team wrote the new standards for inclusion of hardness testing mechanism and also prepared guidelines for container replenishment for polish powder and automation maintenance.

2. These new standards were then communicated to all employees to ensure change resistance points are handled.

3. The top management team was apprised of the results and inclusion of new standards and a signoff was obtained.

8D


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D8: Celebrating the milestone

1. The final step of “Celebrating the success of the project” is an important one, often not to be undermined.

2. An open hall meeting to be conducted with all the employees where the role of all employees and project team members should be acknowledged by the Project Leader.

3. Monetary incentives may or may not be provided, but a formal recognition by means of certification should be provided as a motivation tool for line workers.

8D


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Problem

1. Identify an opportunity to improve in your organization.

2. Ask the below questions: a. Should the problem have a temporary fix first? b. Should the problem be solved in a maximum time frame of 1 month? c. Should the problem have a long-lasting solution? d. Should the problem need the involvement of at least 3-4 team members? e. Will the organization be able to commit 3-4 resources for 1 month for at least 3-4 hours

a day? f. Will the organization be able to commit to spending money on installing solutions? g. Are we equipped to handle change in our company?

8D


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Project Task

D1: Identify the team members D2: Collect data on the problem, quantify the problem and present the problem description. D3: Identify and implement temporary fixes to the problem. Present cost impact if any. D4: Conduct a thorough Root Cause Study on failure points. D5: Develop and implement permanent actions. Present cost impact and deal with change resistance issues. D6: Validate results of D5. D7: Standardize the new procedures by integrating them into your SOPs

Kaizen Blitz


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Kaizen stands for “Modify to make things better”.

Any act of improvement is known as Kaizen. Kaizen Blitz or “Conventional Kaizen” are known as “Quick Win” projects.

Other forms of Kaizen are Line Kaizen, Cube Kaizen, Teian Kaizen etc.

Kaizen events run for at the most 14-21 days.

The entire process team along with the top management participates in the Kaizen event.

A Kaizen event may or may not fetch direct financial impact.

A Kaizen event may only result in at the most 10-15% in the performance of the operational metric.

Kaizen Blitz


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Stages for Kaizen Blitz

Identification of opportunity

Team formation

Strategic communication and involvement

Solutions prioritization –

Teian Kaizen

Causal Factor Charting

Current state mapping and

Genchi Genbutsu Results validation

Risk Analysis

Planning for next Kaizen

Kaizen Blitz


47 Stages for Kaizen Blitz

1. An opportunity qualifies for Kaizen Blitz, if the top management supports with involvement of themselves and the process team. 2. The project has to be completed within 14-21 days of commencement.

3. The project is considered relatively simple to complete. Complexity of a

project can often be determined by votes from the process experts.

Let us now go through each step for a Kaizen Blitz project for an identified opportunity in a manufacturing company.

Kaizen Blitz


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Sample case

The company manufactures chairs, which are then sent to the customers for use. The customers pay $150 per chair. The company incurs a total cost of $110 per chair which includes labor cost, administrative costs and shipping costs. The top management identified an opportunity of saving $10 from the cost of the chair. Thus, by the end of the project, the operational costs intend to go down from $110 to $100 per chair.

Kaizen Blitz


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Identification of Opportunity

1. The strategic goal of the Kaizen project is savings of $10 per chair or 10% saving in operational costs.

2. The project team draws a simple Tree Diagram to illustrate the impacting factors to operational costs.

3. This tree diagram will help the project team understand which area to focus on. This decision can be taken based on complexity of the focus area.

Kaizen Blitz


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Operational costs

Labor Administration and overheads

Raw material inspection

Final Quality Inspection

Shipping

The project team identifies administration overheads and shipping costs as two focus areas that need to be improved. Of the two, they choose to focus on administration overheads for this Kaizen event, with another Kaizen event on reducing costs for shipping to commence after completion of this Kaizen event.

Kaizen Blitz


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Problem statement The reported administration overheads costs for producing chairs for our customers is at $50. With other costs contributing to $60, the goal of this project is to reduce the administration overheads costs by $10. By reducing the administration overheads costs by $10, the company will be able to reduce the cost per chair from $110 to $100, resulting in a saving of $10 per chair = 10% cost savings. A variability check can be done using Regression Analysis.

Kaizen Blitz


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Team formation and Strategic communication

1. The team for a Kaizen event should include the below mentioned

individuals:

a. Project team leader b. Process Owner c. Process Manager or supervisor d. 2 – 3 Level 1 employees

Once the team has been formed, the process owner/ CEO of the company should announce the Kaizen event with the purpose of it, either by email or by an official communication to all employees of the functional unit.

Kaizen Blitz


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Current State Mapping

In order to improve anything, you need to know where to start. Knowing your current process is the perfect start. 1. Kaizen would not work if your processes are not standardized. 2. Thus, if the process is not standardized, standardize them first. 3. A standardized process may have variants. 4. If so, the variants must also be captured in the process document.

In our case, we need to do the process mapping of all the tasks done in the administration department. The core function of the administration department is to prepare the paper work for all deliveries and ensure all electrical connections are being utilized properly.

Kaizen Blitz


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Current State Mapping

Product preparation

Electricity and machine utilization

Print invoice Take finance

team signature

Add Ok to system to generate barcode for shipment

Shipping process

The project team didn’t want to disturb the harmony of the system by cutting down on electricity consumption.

Kaizen Blitz


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Genchi Genbutsu

1. The project team now conducts shop floor visits for a week to identify the entire chain of activities that happen from printing of invoice to bar code generation.

2. This is known as Genchi Genbutsu in Lean.

3. Observations from the Genchi Genbutsu can be used to build the Current State Value Stream Map.

4. By knowing the Current State Value Stream Map, one can easily identify areas of improvement.

Kaizen Blitz


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Current State Value Stream Map

Production Shipping

Item carried to invoicing

department

Item checked against order

Invoice printed

Invoice signed off to bar code generation

2 min 2 min 2 min 1 min 10 min

Kaizen Blitz


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Causal Factor Charting

1. The project team uses the Current State Value Stream Map to do the

causal factor charting. Causal factor charting is a technique used in all improvement projects.

2. This is a critical thinking tool, which helps project teams map the causes that contribute to the problem.

3. Here is the causal factor charting for the problem at hand: High wait time of invoices to be signed off Delay in invoice signing and return for bar code generation Delay results in finance team waiting for invoices to return after signing off Higher administrative costs.

Kaizen Blitz


58 Solutions Prioritization

1. The project team gets together and identifies possible solutions for solving the problem.

2. The project team understands that the invoice needn’t wait to be signed off after the product is made. The product making cycle time is 75 minutes, and the invoice could be signed off during this time.

3. Thus, the finance team is asked to pull the customer order numbers and generate invoices based on customer orders.

4. Invoice then sent to signoff, and signoff accepted. Production continues in parallel.

5. Once production completed, bar code fixed and sent to shipping directly.

Kaizen Blitz


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Results Validation

1. The project team observes the data for 2-3 days for the improvement suggested in the previous slide.

2. As we can see, the printing of invoice to Bar code generation activities are moved to as parallel processing to production schedules.

3. Additionally, a digital signature of the finance manager is accepted by the ERP system.

4. Due to the digital signature, the invoice needn’t need to wait for the finance manager signature.

5. Thus the 10 minute wait is completely eliminated.

6. Staff in the last step of the production department empowered to generate bar codes.

Kaizen Blitz


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Results Validation

0

2

4

6

8

10

12

Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Day 8 Day 9 Day10

Day 11Day 12Day 13 Day14

Wait time

Wait timeThis drop from approx 10 minutes to 0-1 minutes of wait time is the biggest achievement of the Kaizen event accomplished in 14-15 days.

Kaizen Blitz


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Risk Analysis

1. Production team members may have difficulty in using the ERP Software to generate bar codes.

2. Finance Manager may object to loss of authority in signing off invoices.

3. Incomplete products could get sign off and sent for shipping. The project team may think of possible improvement measures/ mitigation measures which shall alleviate the impact of the risks mentioned.

Kaizen Blitz


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1. Only one Kaizen event may only give a small benefit to the company.

2. If the company wishes to maximize the returns from Kaizen, it should run multiple Kaizen events.

3. This is known as Kaizen after Kaizen, or it is known as the Plan Do Check Act Cycle.

4. The effectiveness of a Kaizen event is determined on the basis of non-occurrences of failures addressed by the Kaizen project.

Kaizen Blitz


63 Planning for next Kaizen

After reducing the invoice preparation costs, the administration costs graph looks like:

$40

$20

$20

$15 $5

Costs

Administrative

Labor

Inspection RM

Quality inspection

Shipping

Kaizen Blitz


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The team identifies reducing raw material inspection costs as the next Kaizen event.

$40

$20

$20

$15 $5

Costs

Administrative

Labor

Inspection RM

Quality inspection

Shipping

Kaizen Blitz


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Project Task

1. Identify an opportunity for improvement where a maximum of 10% improvement in the performance of operational metric is desired.

2. Form the team

3. Map the macro level process and localize the problem.

4. Describe the problem and conduct shop floor visits to understand the contributors.

5. Prepare the current state value stream map or appropriate replacement.

6. Identify NVA steps and identify solutions.

7. Pilot solutions, validate and showcase next Kaizen goals.

Lean, Six Sigma and Lean Six Sigma


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1. Six Sigma is a statistical measure of performance excellence which translates to 2 Defects per Billion products made when the performance is measured on a Gaussian distribution.

2. Six Sigma levels can be achieved by deploying Six Sigma principles at three cascading levels 1. PFSS – Process for Six Sigma 2. DFSS – Design for Six Sigma 3. MFSS – Management for Six Sigma

3. Six Sigma levels can be achieved by using DMAIC for existing processes and DFSS approaches

to re-engineer new processes.

4. DMAIC --- Define, Measure, Analyze, Improve and Control.

5. DFSS – Design for Six Sigma

Lean, Six Sigma and Lean Six Sigma


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1. Lean is a culture and a way of thinking and has taken a lot of learnings from Toyota Production System.

2. As per Lean, where work is done, waste is generated.

3. Thus Lean initiatives relentlessly pursue a waste elimination approach.

4. Any work that doesn’t add value should be removed from the company’s work board.

5. Six Sigma uses a Data approach to solve problems. Lean uses a Process Approach to solve problems.

6. A ‘marriage ‘of Lean and Six Sigma is known as Lean Six Sigma which combine to deliver increased efficiency and effectiveness.

By now


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With knowledge about the 8D, Kaizen Blitz approaches in the way how they work, use your trainer’s support and you should be able to identify a project opportunity in your organization and implement it using these approaches.


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Key Financial Indicators

Importance of Financial Indicators

1. Top management approval and support is extremely important for Lean Six Sigma initiatives to sustain and give excellent financial benefits.

2. Top management would approve or deny a project only if they see clear financial benefits from the project.

3. Financial benefits are reported with the help of Financial indicators.

4. Thus, it is important for the process improvement practitioner to understand these financial indicators and know how to calculate them.

5. Understanding and showing the financial indicators’ performance is often considered the first step in most process improvement projects.

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COGS

1. COGS is the abbreviation for Cost of Goods Sold and is a popular financial indicator.

2. COGS is the direct cost incurred by the company in producing a product or delivering a service. When services are delivered, COGS moves to an indicator known as COSG (Cost of Service Given).

3. This is also known as COS (Cost of Sales) in some companies.

4. Material costs, Labor costs and Inventory costs are included in the calculation of COGS. Distribution and sales costs are excluded from the calculation of COGS.

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COGS

1. COGS is represented by the mathematical formula (Heuristic):

Beginning inventory + Purchases and WIP Inventory – Inventory Sold

2. Gross profit is then calculated as Gross Profit = Sales – COGS

3. Gross profit % = Gross profit/ Sales * 100%

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COGS

Example

A company sells 2,000 chairs in a year with each chair being sold at $100 each resulting in total sales of $200,000. At the start of the year, it had inventory worth $10,000 carried forward from previous year closing. During this last year, the company purchased materials worth $100,000 with the aim of building at least 2,500 chairs. It closed the year with $50,000 worth in inventory.

Calculate the COGS, Gross profit and Gross profit % of the company.

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COGS

Example

Sales = $200,000

Beginning inventory = $10,000

Purchases = $100,000

Ending inventory = $50,000

COGS = $10,000 + $100,000 - $50,000 = $110,000 - $50,000 = $60,000

Gross profit = $200,000 - $60,000 = $140,000

Gross profit % = $140,000/$200,000 * 100% = 70%

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COGS

Use the Financial indicators worksheet to calculate the COGS for your company, with the sheet shown below:

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COGS Calculation

Item 2013

Sales $2,00,000

Beginning inventory $10,000

Purchases $1,00,000

Less inventory $50,000

COGS $60,000

Gross Profit $1,40,000

Gross Profit % 70.00%

COGS is known as an indicator that computes the flow of inventory through a manufacturer.

EBITDA

1. EBITDA is a financial indicator used by companies and stands for Earnings before Interest, Taxes, Depreciation and Amortization.

2. EBITDA indicates the company’s operating efficiency, but is not the only indicator to do so.

3. EBITDA is a rather controversial financial indicator to be used standalone, as there are many subjective parameters involved in calculation of EBITDA.

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EBITDA

Example

The revenues for a company for a year is at $200,000. Expenses on labor, material and other overheads tune up to $150,000. The tangible assets of the company incur a depreciation expense of $10,000 while the intangible assets incur an amortization expense of $20,000.

Calculate the EBITDA of the company.

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EBITDA

Revenues = $200,000 Expenses = $150,000

Operating profit = EBIT = Revenue – Expenses = $200,000 - $150,000 = $50,000

Depreciation expenses = $10,000

Amortization expenses = $20,000

EBITDA = EBIT + Depreciation expenses + Amortization expenses

EBITDA = $50,000 + $10,000 + $20,000 = $80,000

Thus, the EBITDA of the company is $80,000.

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EBITDA

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3 reasons why EBITDA mislead: 1. EBITDA places importance on assets

(Depreciation and Amortization inflate the EBIT figures).

2. EBITDA indicates the ability of a company to pay debts, but only some kind of debts and not all.

3. EBITDA doesn’t indicate the true health of the company, for example, it doesn’t indicate if products are being made right or not.

COPQ

1. While Cost of Goods Sold and EBITDA remain strictly strategic financial indicators, Cost of Poor Quality or COPQ is a strategic cum operational indicator.

2. Cost of Poor Quality is a price a company pays for making poor quality products or making products in an incorrect manner.

3. Cost of Poor Quality = Visible losses + Invisible (Hidden losses).

4. Only 20% of the losses are visible to the company.

5. And thus, determining COPQ or COPQ% is extremely critical for any operation or any project. This is often considered the first step of most process improvement projects assuming COGS and EBITDA are determined by top level management.

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COPQ

1. The first trigger for COPQ determination is studying the number of returns of the products by its customers.

2. Returns are classified into three categories:

a. Paid for returns’ service

b. Returns’ replacement under warranty service

c. Returns’ service under warranty

The project team must determine with the help of historical data a stratification of each of these three types of returns/ complaints.

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COPQ

Example

In the last one year, 1,000 products were returned by customers out of 3,000 sold by the company. Out of the 1,000 products returned, 300 were out of the warranty period. 500 new products were issued to the customers to replace the defective products. 200 were serviced as only minor faults were reported in the product.

The sale price per unit was $100. Product manufacturing and selling costs added to $50. Service costs were $30.

Calculate the COPQ % of the company.

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COPQ

Returns Classification

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300

500

200

Out of warranty returns

New product returns

Product service returns

Out of warranty returns need not be factored in for Cost of Poor Quality calculations. Why?

Thus, calculation of COPQ% will be centered only calculating the costs for 700 units.

COPQ

COPQ Calculation

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COPQ = ($50* 500) + ($30 * 200) = $31,000 COPQ % = COPQ due to returns/ Sales = $31,000/ $300,000 = 10.33%.

Thus, the COPQ % due to returns of the product is 10.33%. The company loses 10.33% of its sales numbers due to poor quality of the product.

COPQ

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Broadly, Cost of Poor Quality is a summation of Internal and External Failure Costs. Two more costs, Prevention and Appraisal costs make up Cost of Good Quality. Thus, Cost of Quality = Cost of Poor Quality + Cost of Good Quality.

COPQ

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COPQ as a starting point for most projects 1. COPQ represents the financial opportunity for the project.

2. COPQ can be determined on an organizational level just by looking at the

returns of the products, as that is the first customer interface.

3. Some companies estimate Cost of Poor Quality for their supply chain and don’t really limit themselves to product returns.

4. In such a scenario, we may have multiple COPQ numbers for the organization and then the project team may use a prioritization index to identify a project opportunity.

COPQ

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How process improvement helps in reducing the COPQ%? 1. Every customer product or need has its own set of expectations/

specifications. These are known as Critical to Customer Quality Requirements or CTCQR, or simply CTC.

2. Variation in these CTCQRs result in customers returning the products purchased.

3. Process improvement approaches like Six Sigma DMAIC work to reduce these variations resulting in less complaints from customers.

4. Less complaints mean companies incur less loss.

COPQ

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COPQ Problem A company sells 100 units of chairs in a month to its customers operating on a B2C model. Every chair is priced at $100 each. Every month about 10 customers come back with complaints for chairs they bought the same month. The company has a 3 month warranty clause under which they replace the defective chairs with new ones. The old chairs are scrapped and not used any further. Historical data for the company shows monthly a 5% attrition in client is seen. Calculate the COPQ % for the company, which can be used as an improvement opportunity for a project.

7 QC Tools

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Read the summary case study of application of 7 QC Tools to understand the importance and the usage of the 7 QC Tools.

Assessment

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We have 3 levels of assessment for the Yellow Belt Certification: 1. Objective questions assessment – Trainees will answer 25 objective

questions. 2. Project Identification – Trainees will need to present a project case

from their companies.

Trainees completing both the steps above will be awarded with a Yellow Belt – Process Improvement: Functional Certification.

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(C) The School of Continuous Improvement 91

Thank you….

yellow belt process improvement training and certification module

Business

improvement c

process improvement

balanced scorecard c

process linkages

notes c

balanced scorecard approach

business process improveme

organization goals