In today’s competitive manufacturing landscape, measuring and optimizing performance is crucial for success. This white paper outlines the essential key performance indicators (KPIs) that manufacturing companies should track and provide strategies for effective implementation. By focusing on these metrics, manufacturers can enhance productivity, quality, and profitability while driving continuous improvement across their operations.
Introduction
Manufacturing companies face increasing pressure to improve efficiency, reduce costs, and maintain high quality standards. To achieve these goals, it’s critical to implement a robust system of performance measurement. This paper will explore the most important KPIs for manufacturing and provide guidance on how to effectively measure and leverage these metrics.
KPIs in manufacturing have a significant impact on both profitability and cashflow.
Key Manufacturing KPIs
1. Overall Equipment Effectiveness (OEE)
OEE is a comprehensive metric that measures the overall efficiency of manufacturing equipment and processes. It combines three critical factors:
- Availability: The percentage of the time scheduled the equipment is available for operation
- Performance: The speed at which the equipment operates compared to its designed speed
- Quality: The percentage of good units produced out of the total units started
OEE = Availability x Performance x Quality OEE provides a holistic view of production efficiency and helps identify areas for improvement across multiple dimensions
Profitability Impact:
OEE directly affects profitability by influencing:
- Production output
- Operating costs
- Quality rates
- Revenue potential
A manufacturer improving its OEE from 65% to 75% could see a substantial increase in production output without additional costs, directly boosting profitability. For instance, if a production line typically produces 1000 units per day at 65% OEE, increasing to 75% could result in an additional 154 units daily, potentially increasing revenue by 15.4% without proportional cost increases
Cashflow Impact:
Higher OEE leads to more efficient use of resources, reducing the need for overtime or additional shifts. This efficiency can lower labor costs and improve cashflow by reducing operational expenses
OEE impacts cashflow through:
- Reduced downtime costs
- Lower repair and maintenance expenses
- Improved inventory management
- Faster cash conversion cycles
Example: Electronics Manufacturing Company
Consider an electronics manufacturer producing widget:
Initial Scenario:
- Daily production target: 1,000 units
- Actual OEE: 65%
- Cost per unit: $200
- Selling price per unit: $300
- Daily production: 650 units (due to 65% OEE)
Financial Metrics:
- Daily revenue: 650 × $300 = $195,000
- Daily cost: 650 × $200 = $130,000
- Daily profit: $65,000
Improved Scenario:
The company implements strategies to improve OEE to 85%
New Financial Metrics:
- Daily production: 850 units
- Daily revenue: (850 × $300) = $255,000
- Daily cost: (850 × $200) = $170,000
- Daily profit: $85,000
Impact Analysis:
1. Profitability:
- Profit increased by $20,000 per day (30.8% improvement)
- Annual profit increase: $6,000,000 (assuming 300 working days)
2. Cashflow:
- Increased daily cash inflow: $60,000
- Reduced repair costs due to better equipment performance
- Lower inventory holding costs due to improved production efficiency
3. Additional Benefits:
- Improved on-time delivery rates, potentially leading to better customer satisfaction and repeat business
- Reduced stress on equipment, potentially extending its lifespan and reducing long-term capital expenditure needs
By improving OEE from 65% to 85%, the company has significantly enhanced both its profitability and cashflow position. The 30.8% increase in daily profit, combined with the improved cash inflow, demonstrates the substantial financial impact of improving OEE performance.
It’s worth noting that even small improvements in OEE can lead to significant financial gains. For instance, a 1% improvement in OEE for a high-volume producer can result in hundreds of thousands of dollars in additional annual revenue.
To maximize the benefits of OEE improvements, companies should focus on:
- Reducing unplanned downtime
- Optimizing equipment performance
- Minimizing quality defects
- Implementing predictive maintenance strategies
- Continuously monitoring and analyzing OEE data for ongoing improvements
By leveraging OEE as a key performance indicator and continuously striving for improvement, manufacturing companies can significantly enhance their profitability and cashflow positions, ultimately leading to increased competitiveness and long-term success.
2. Production Volume
This basic metric measures the total output of a manufacturing facility over a specific time period. It helps benchmark manufacturing efficiency and determine whether production targets are being met
Profitability Impact:
Increasing production volume often leads to improved productivity due to economies of scale and better resource utilization.
Example:
Consider a manufacturing company that produces widgets.
Initially, they produce 1,000 units per month with the following metrics:
- Fixed costs: $10,000 per month
- Variable costs: $20 per unit
- Selling price: $50 per unit
At this production level:
- Total costs: ($10,000 + (1,000 × $20) )= $30,000
- Revenue: (1,000 × $50) = $50,000
- Profit: ($50,000 – $30,000) = $20,000
Now, let’s increase the production volume to 1,500 units per month:
- Fixed costs remain $10,000
- Variable costs decrease to $18 per unit due to bulk purchasing
- Total costs: $10,000 + (1,500 × $18) = $37,000
- Revenue: (1,500 × $50 )= $75,000
- Profit: ($75,000 – $37,000) = $38,000
The profit per unit increased from $20 to $25.33, demonstrating improved productivity.
Cashflow Impact:https://www.projectmanager.com/blog/manufacturing-kpis
Increased production volume can have both positive and negative effects on cashflow:
Positive impacts:
- Increased sales: Higher production typically leads to more sales, generating more cash inflows
- Improved overhead absorption: Fixed costs are spread over more units, potentially increasing profit margins and cashflow
- Economies of scale: Bulk purchasing of raw materials can lead to cost savings, improving cashflow.
Negative impacts:
- Increased working capital needs: Higher production requires more investment in inventory and raw materials, potentially straining cashflow
- Longer cash conversion cycle: If sales don’t keep pace with increased production, it may take longer to convert inventory into cash
Cashflow Management Strategies
To optimize cashflow while increasing production volume:
- Negotiate better terms with suppliers: This can help manage the increased working capital needshttps://www.volopay.com/in/blog/how-to-improve-cash-flow-in-manufacturing-business/.
- Implement efficient inventory management: Use just-in-time principles to minimize excess inventory
- Offer early payment discounts to customers: This can accelerate cash inflows.
- Monitor and optimize the production-to-sale cycle: Regularly review the time it takes to convert raw materials into cash from saleshttps://www.volopay.com/in/blog/how-to-improve-cash-flow-in-manufacturing-business/.
- Use real-time cashflow forecasting: This helps anticipate and manage cashflow challenges associated with increased productionhttps://www.bench.co/blog/accounting/cash-flow-statements.
By diligently managing these factors, manufacturers can increase production volume while maintaining healthy cashflow, ultimately driving growth and profitability.
3. First Pass Yield (FPY)
FPY measures the percentage of units that pass through the entire production process without any defects or need for rework. It’s a critical indicator of both quality and efficiency.
FPY = (Total Units Produced – Defective Units) / Total Units Produced
FPY has a significant impact on both profitability and cashflow in manufacturing operations.
Profitability Impact
A high FPY directly contributes to increased profitability by:
- Reducing waste and scrap costs
- Minimizing rework expenses
- Lowering labor costs
- Improving overall productivity
Example:
Consider a manufacturing company producing widgets:
- Daily production: 1,000 units
- Cost per unit: $50
- Selling price per unit: $75
- Initial FPY: 90%
Initial Scenario (90% FPY):
- Good units: 900
- Defective units: 100
- Revenue: (900 × $75) = $67,500
- Production cost: (1,000 × $50) = $50,000
- Rework cost: (100 × $25) = $2,500
- Profit: ($67,500 – $50,000 – $2,500) = $15,000
Improved Scenario (95% FPY):
- Good units: 950
- Defective units: 50
- Revenue: (950 × $75) = $71,250
- Production cost: (1,000 × $50) = $50,000
- Rework cost: (50 × $25) = $1,250
- Profit: ($71,250 – $50,000 – $1,250) = $20,000
By improving FPY from 90% to 95%, the company increases its daily profit by $5,000, representing a 33.3% increase in profitability.
Cashflow Impact
FPY improvements positively affect cashflow by:
- Reducing working capital requirements
- Accelerating the cash conversion cycle
- Minimizing inventory holding costs
- Improving on-time delivery rates
Example: Using the same manufacturing scenario:
Initial Scenario (90% FPY):
- Raw material inventory: $100,000
- Work-in-progress inventory: $75,000
- Finished goods inventory: $50,000
- Total inventory value: $225,000
Improved Scenario (95% FPY):
- Raw material inventory: $95,000 (5% reduction due to less waste)
- Work-in-progress inventory: $71,250 (5% reduction)
- Finished goods inventory: $47,500 (5% reduction)
- Total inventory value: $213,750
By improving FPY, the company reduces its total inventory value by $11,250, freeing up cash that can be used for other purposes or to reduce debt.
Additionally, with higher FPY:
- The company can fulfill orders faster, potentially reducing the average collection period.
- There’s less need for safety stock, further reducing inventory costs.
- Improved on-time delivery rates may lead to better payment terms from customers.
These factors combine to create a more efficient cash conversion cycle, improving overall cashflow for the business.
In conclusion, improving First Pass Yield from 90% to 95% in this example led to a 33.3% increase in daily profit and freed up $11,250 in cash through inventory reductions. These improvements demonstrate the significant impact FPY can have on both profitability and cashflow in manufacturing operations.
4. Cycle Time
Cycle time measures the average time it takes to complete one unit of production from start to finish. Reducing the cycle time can lead to increased throughput and improved responsiveness to customer demand.
Profitability Impact:
Reducing cycle time from 10 days to 8 days allows a manufacturer to produce more units in the same timeframe. This increase in output can lead to higher sales volume and improved profitability, especially if fixed costs remain constant.
Similarly, reducing the cycle time can improve profitability by:
- Increasing production output
- Reducing labor and overhead costs
- Enhancing customer satisfaction, potentially leading to more sales
- Allowing faster response to market demands
Cashflow Impact:
Shorter cycle times mean faster conversion of raw materials into finished goods and ultimately into cash. This acceleration can significantly improve cashflow by reducing the time between spending on inputs and receiving payment for outputs
Cycle time is a critical metric that significantly impacts both profitability and cashflow in manufacturing and other business operations. Let’s explore these impacts with an example:
Shorter cycle times positively affect cashflow by:
- Accelerating the cash conversion cycle
- Reducing working capital requirements
- Decreasing inventory holding costs
- Improving on-time delivery rates, potentially leading to faster customer payments
Example: Electronics Manufacturing Company
Consider an electronics manufacturer producing widgets:
Initial Scenario:
- Production cycle time: 10 days
- Daily production: 1,000 units
- Cost per unit: $200
- Selling price per unit: $300
- Payment terms: Net 30
Financial Metrics:
- Monthly production: 30,000 units
- Monthly revenue: $9,000,000
- Monthly cost: $6,000,000
- Monthly profit: $3,000,000
- Cash conversion cycle: 40 days (10 days production + 30 days payment terms)
Improved Scenario:
The company implements lean manufacturing principles and reduces cycle time to 7 days.
- New production cycle time: 7 days
- Daily production: 1,200 units (20% increase due to efficiency)
- Other factors remain the same
New Financial Metrics:
- Monthly production: 36,000 units
- Monthly revenue: $10,800,000
- Monthly cost: $7,200,000
- Monthly profit: $3,600,000
- Cash conversion cycle: 37 days (7 days production + 30 days payment terms)
Impact Analysis:
1. Profitability:
- Profit increased by $600,000 per month (20% improvement)
- Annual profit increase: $7,200,000
2. Cashflow:
- Cash conversion cycle reduced by 3 days
- Working capital requirement decreased:
- Initial: (40/365) × $108,000,000 = $11,836,986
- Improved: (37/365) × $129,600,000 = $13,130,959
Despite higher revenue, the proportional working capital increase is lower due to faster cycle time
3. Additional Benefits:
- Increased production capacity allows for faster response to market demands
- Potential for improved customer satisfaction due to shorter lead times
- Opportunity to negotiate better terms with suppliers due to increased purchasing volume
By reducing the cycle time from 10 to 7 days, the company has significantly improved both its profitability and cashflow position. The 20% increase in production output led to a corresponding 20% increase in profits, while the shortened cash conversion cycle helps manage working capital more efficiently.
5.Down Time
Tracking both planned and unplanned downtime is essential for identifying inefficiencies and optimizing equipment utilization. Minimizing downtime directly impacts productivity and profitability.
Downtime in manufacturing has significant impacts on both profitability and cashflow.
Profitability Impact
Downtime directly affects profitability by:
- Reducing production output
- Increasing operational costs
- Potentially damaging customer relationships
Cashflow Impact
The cashflow effects of downtime include:
- Delayed revenue generation
- Increased working capital requirements
- Unexpected repair and maintenance costs
Example: Electronics Manufacturing Company
Consider an electronics manufacturer producing widgets:
Initial Scenario:
- Daily production: 1,000 units
- Cost per unit: $200
- Selling price per unit: $300
- Monthly production: 30,000 units
- Monthly revenue: $9,000,000
- Monthly cost: $6,000,000
- Monthly profit: $3,000,000
Downtime Scenario:
The company experiences 3 days of unplanned downtime due to equipment failure.
Impact Analysis:
1. Production Loss:
- Lost production: 3,000 units
- Lost revenue: (3,000 × $300) = $900,000
2. Increased Costs:
- Emergency repairs: $50,000
- Overtime wages to catch up: $100,000
- Total additional costs: $150,000
3. Profitability Impact:
- Lost profit from unsold units: (3,000 × ($300 – $200)) = $300,000
- Additional costs: $150,000
- Total profit impact: $450,000
4. Cashflow Impact:
- Delayed cash inflow: $900,000
- Immediate cash outflow for repairs: $50,000
- Increased labor costs: $100,000
Revised Monthly Figures:
- Monthly production: 27,000 units
- Monthly revenue: $8,100,000
- Monthly cost: ($5,550,000 + $150,000) = $5,700,000
- Monthly profit: $2,400,000
The 3-day downtime resulted in a 20% reduction in monthly profit and significantly disrupted cashflow.
Additional Considerations
- Customer Relationships: Delayed shipments may strain customer relations, potentially leading to lost future business.
- Market Position: Consistent downtime issues can damage the company’s reputation and market share.
- Employee Morale: Frequent downtime can lead to stress and decreased productivity among workers.
- Long-term Impact: Recurring downtime can lead to a loss of customer confidence and market position, affecting future profitability.
- Employee Retention: Assuming loss of income to employees due reduced hours, loss of production bonuses, may cause resignations and loss of employee knowledge, should you have to train new employees.
To mitigate these impacts, manufacturers should focus on preventive maintenance, implement robust monitoring systems, and consider adopting predictive maintenance technologies. These strategies can help reduce the frequency and duration of downtime, thereby protecting both profitability and cashflow.
6. Cost Per Unit
This KPI measures the total cost of producing a single unit, including direct materials, direct labor, and manufacturing overhead. It’s crucial for pricing decisions and identifying cost-saving opportunitieshttps://www.mrpeasy.com/blog/manufacturing-performance-indicator/.
CPU = (Direct Material Costs + Direct Labor Costs + Manufacturing Overhead) / Total Units Produced
Profitability Impact:
Cost per unit has a significant impact on both profitability and cashflow for manufacturing businesses:
Costs per unit directly affect a company’s profitability by influencing gross margins and overall profit. A lower cost per unit generally leads to higher profitability, assuming the selling price remains constant.
Reducing the cost per unit from $50 to $45 through process improvements or better supplier negotiations directly increases the gross margin on each product sold. For a company producing 100,000 units annually, this $5 reduction could translate to a $500,000 increase in gross profit.
Cashflow Impact:
Lower production costs mean less cash is required for each unit produced. This reduction in cash outflow per unit can improve overall cashflow, especially during periods of growth when working capital needs typically increasehttps://www.whittakercpas.com/the-best-kpis-for-manufacturing-businesses-to-increase-profit/.
Cost per unit affects cashflow by influencing the amount of cash tied up in inventory and the timing of cash outflows for production costs.
Example: Electronics Manufacturing Company
Consider an electronics manufacturer producing widgets:
Initial Scenario:
- Production: 1,000 units per day
- Cost per unit: $200
- Selling price per unit: $300
- Daily production cost: $200,000
- Daily revenue: $300,000
- Daily profit: $100,000
Cashflow Considerations:
- Inventory value: (1,000 × $200) = $200,000
- Payment terms to suppliers: Net 30
- Customer payment terms: Net 30
Improved Scenario:
The company implements cost-saving measures and reduces the cost per unit to $180.
New Financial Metrics:
- Cost per unit: $180
- Daily production cost: $180,000
- Daily revenue: $300,000 (unchanged)
- Daily profit: $120,000
Profitability Impact:
Increasing the gross profit margin from 25% to 30% through a combination of cost reductions and strategic pricing can have a dramatic effect on overall profitability. For a company with $10 million in annual revenue, this 5% improvement could result in an additional $500,000 in gross profit.
- Profit increased by $20,000 per day (20% improvement)
- Gross margin improved from 33.3% to 40%
Cashflow Impact:
By reducing the cost per unit from $200 to $180, the company has significantly improved both its profitability and its cashflow position. The 20% increase in daily profit directly enhances profitability, while the reduced inventory value and lower daily cash outflow for production positively impact cashflow.
- Inventory value reduced: (1,000 × $180) = $180,000
- Working capital requirement decreased by $20,000
- Cash outflow for production reduced by $20,000 per day
Additionally, the improved cost structure provides the company with more flexibility in pricing strategies and better resilience against market fluctuations. It also enhances the company’s competitive position, potentially leading to increased market share and further improvements in profitability and cashflow.
A higher gross margin typically results in more cash generated from each sale. This improvement in cash generation can enhance the company’s ability to fund operations and investments without relying on external financinghttps://arbcpa.com/how-to-glean-meaningful-manufacturing-kpis-from-financial-statements/.
By focusing on these KPIs, manufacturing companies can drive improvements that positively impact both profitability and cashflow, creating a stronger financial foundation for growth and sustainability.
7. On-Time Delivery Rate
This customer-focused metric measures the percentage of orders delivered on or before the promised date. It’s a key indicator of operational efficiency and customer satisfactionhttps://www.optiproerp.com/blog/important-kpis-for-manufacturing-production/.
On-Time Delivery Rate (OTD) has a significant impact on both profitability and cashflow for manufacturing and distribution businesses.
Profitability Impact
A high OTD rate can positively affect profitability by:
- Increasing customer satisfaction and loyalty, leading to repeat business
- Reducing costs associated with expedited shipping and rework
- Minimizing penalties or chargebacks for late deliveries
- Improving operational efficiency
Cashflow Impact
OTD rate influences cashflow by:
- Accelerating the cash conversion cycle
- Reducing working capital requirements
- Minimizing inventory holding costs
- Potentially improving payment terms with satisfied customers
Example: Electronics Manufacturer
Consider an electronics manufacturer producing widgets:
Initial Scenario:
- Monthly production: 10,000 units
- Cost per unit: $200
- Selling price per unit: $300
- On-Time Delivery Rate: 85%
- Payment terms: Net 30
Financial Metrics:
- Monthly revenue: $3,000,000
- Monthly cost: $2,000,000
- Monthly profit: $1,000,000
- Average inventory value: $600,000
Improved Scenario:
The company is implementing strategies to improve its OTD rate to 95%.
New Financial Metrics:
- Monthly revenue: $3,150,000 (5% increase due to improved customer satisfaction)
- Monthly cost: $1,950,000 (2.5% decrease due to reduced expedited shipping and rework)
- Monthly profit: $1,200,000
- Average inventory value: $540,000 (10% decrease due to improved efficiency)
Impact Analysis:
1. Profitability:
- Profit increased by $200,000 per month (20% improvement)
- Annual profit increase: $2,400,000
2. Cashflow:
- Inventory reduction: $60,000, freeing up working capital
- Faster cash conversion cycle due to improved customer satisfaction
- Potential for better payment terms from satisfied customers
3. Additional Benefits:
- Reduced customer complaints and associated handling costs
- Improved market reputation, potentially leading to new business opportunities
- Reduced stress on employees due to fewer rush orders and rework
By improving the On-Time Delivery Rate from 85% to 95%, the company has significantly enhanced both its profitability and cashflow position. The 20% increase in monthly profit, combined with the reduction in inventory value, demonstrates the substantial financial impact of improving OTD performance.
Regularly Review and Refine
Continuously assess the effectiveness of your KPIs and measurement processes. Be prepared to adjust your metrics as business needs evolve or new challenges arise. The devoted monitoring of KPI’s will be one of the first indications of variances, both positive and negative.
Conclusion
Implementing a comprehensive system of KPI measurement is essential for manufacturing companies looking to optimize their operations and maintain a competitive edge. By focusing on key metrics such as OEE, FPY, and cycle time, manufacturers can gain valuable insights into their processes and drive continuous improvement. Success in KPI implementation requires a strategic approach, including clear goal setting, effective data collection, and a culture that embraces data-driven decision-making. Working with a professional Fractional Manufacturing CFO to help put the right metrics and measurement strategies in place, manufacturing companies can enhance productivity, quality, and profitability while positioning themselves for long-term success in an increasingly competitive global market.
