Improve business results with Operational Due Diligence

The contribution of operations can be linked to a company's financial performance by focusing on EBITDA and cash flow. The operation influences this from three sub areas; (1) throughput (i.e., throughput), (2) inventory management, and (3) operating costs. Every company has goals on target growth in sales and profits, and this article answers how the operation can best contribute to this by conducting an ODD.

The principles from the book "The Goal" by Eliyahu Goldratt provide the framework to get started. The key concept is the Theory of Constraints (TOC), which states that every system has a constraint that limits its output (i.e., the bottleneck). The goal of any system, including a business, is to maximize throughput while minimizing inventory and operational costs. In a manufacturing environment, throughput is the rate at which finished goods are produced and shipped to customers, inventory is the raw materials and work in progress, and operational costs are the costs of running the production line.

By applying TOC principles to a company, the company can identify and eliminate constraints that limit throughput, optimize inventory levels and reduce operating costs. This allows a company to improve its EBITDA and achieve strategic goals.

A company may have a bottleneck in its production process that limits throughput. The overall throughput of this system is determined by one bottleneck and it is therefore crucial to resolve this bottleneck just until another process step or machine becomes the new bottleneck and determines system capacity. By identifying and addressing this constraint, such as by improving the efficiency of the bottleneck machine or reducing downtime, the company can increase its throughput, leading to higher revenue and EBITDA provided, of course, that this additional output is sold.

Similarly, a company that efficiently manages its inventory levels can avoid shortages and minimize excess inventory, thereby reducing the cost of holding inventory and freeing up cash flow for other investments to achieve targeted growth. In addition, adequate inventory management reduces lead times, increases delivery reliability and supports the establishment of a "pull" process where production is driven by actual customer demand rather than "pushing" inventory into the production process. All factors that influence customer satisfaction and improve throughput (and thus increase sales).

Finally, operational costs that the operation affects, both variable and fixed. This breaks down into personnel, purchasing, rental and lease, energy, transportation, maintenance and repair costs (i.e. excluding administration, R&D and marketing). Often it is possible to extract slack (i.e. potential for efficiency) from existing processes and resources, and an increase in throughput will result in higher variable costs with fixed costs remaining the same. In other words, a lower cost per product and significant improvement in EBITDA. Thoroughly analyzing each cost item and determining where there is still slack is necessary in order not to rush into high CAPEX investments.

In short, it is important to steer on the right KPIs and gain insight into them. What is my actual throughput from inbound logistics to product delivered to the customer? How much cash is tied up in my inventory in the racks and in the production process itself? How much slack is left in the utilization of my current resources?

Operational Due Diligence answers that. Throughput determines revenue, inventory determines cash flow and a focus on operational costs complete the math to better EBITDA

Within organizations, there is often still too little data and/or insight into the actual bottleneck and insufficient attention is paid to identifying this, resulting in delays in the realization of the strategic and financial objectives. Doing an Operational Due Diligence is applicable for organizations that are about to buy another company or for established organizations that want to evaluate their own operation (periodically). Understanding the operational potential is what it is all about and a substantiated roadmap to then get started is the outcome.