CHAPTER # 05

THE CONVERSION CYCLE

Introduction
The conversion cycle is a recurring set of business activities and related data processing
operations associated with the manufacture of products. A company’s conversion cycle
transforms (converts) input resources, such as raw materials, labor, and overhead, into
finished products or services for sale.

5.2 The Traditional Manufacturing Environment

The traditional conversion cycle consists of two subsystems: the production system, and
the cost accounting system. The production system involves the planning, scheduling,
and control of the physical product through the manufacturing process. This includes
determining raw materials requirements, authorizing the release of raw materials into
production and the work to be performed, and directing the movement of work-in-
process through various stages of manufacturing. The cost accounting system monitors
the flow of cost information related to production. Information produced by the cost
accounting system is used for inventory valuation, budgeting, cost control, performance
reporting, and such management decisions as “make-or-buy” decisions.

The Production System

Depending on the product being manufactured, a company will employ one of the
following production methods:

Continuous processing produces a homogeneous product through a continuous series

of standard procedures. Cement and petrochemicals are produced by this
manufacturing method.

Batch processing produces discrete groups (batches) of product. Each item n the batch
is similar, requiring the same raw materials and operations. To justify the cost of setting
up and retooling for each batch run, the number of items in the batch is usually large.

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This is the most common method of production. It is used to manufacture such
products as automobile, household appliances, and computers.

Make-to-order processing involves the fabrication of discrete products in accordance

with customer specification. This process is initiated by sales order rather than depleted
inventory levels.

Documents in the Batch Processing System

The most common documents in the batch processing system are:

1. The sales forecast: It shows the expected demand for the firm’s finished goods
for a given period. The marketing department usually produces a forecast of
annual demand by product.
2. The production schedule: Is the formal plan and authorization to begin
production. This document describes the specific products to be made, the
quantities to be produced in each batch, and the manufacturing timetable for
starting and completing production.
3. The bill of materials (BOM): It specifies the type and quantities of raw materials
and subassemblies used in producing a single unit of finished product. The raw
materials requirements for an entire batch are determined by multiplying the
BOM times number of items in the batch.
4. A route sheet: Shows the production path that a particular batch of product
follows during manufacturing.
5. The work order (production order): Draws from BOMs and route sheet to
specify the materials and production (machining, assembly, and so on) for each
batch. These together with the move tickets (described next), initiate the
manufacturing process in the production department.
6. A move ticket: It records the work done in each work center and authorizes the
movement of the job or batch from one work center to the next.
7. A materials requisition: It authorizes the store keeper to release materials (and
sub assemblies) to individuals or work center in the production process.

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The Batch Production Process

The typical batch production process has 3 phases:

1. The production planning and control phase

2. The manufacturing phase, and
3. The inventory control phase.
1. The Production Planning and Control Phase

The production planning and control phase involves two main procedures:

A. The specification of materials and operations requirements, and

B. Production scheduling.

Establishing the raw materials requirements for a batch of any given product entails
analyzing what is needed versus what is available in the raw materials inventory.
Operations requirements are determined by examining the machining other
manufacturing tasks needed to produce a unit of finished product. Primary
determinants for both materials and operations requirements are the sales forecast, the
inventory status report, and engineering specifications for the finished product.

The second procedure carried out under planning and control is production scheduling.
The schedule for a production run is prepared by the production scheduling clerk and
is based on the information provided in BOMs and route sheets. The scheduling clerk
also prepares work orders, move tickets, and material requisitions for each batch in the
production run. Before releasing these documents to the various work centers, the clerk
creates an open work order file and sends a copy of the work order to cost accounting.
The work orders, move tickets, and materials requisitions prepared by the scheduling
clerk flow through the various work centers in accordance with the route sheet.

2. The Manufacturing Phase

The manufacturing phase begins when workers obtain raw materials from storekeeping
in exchange for materials requisitions these materials as well as the machining and the

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labor required to manufacture the product, are applied in compliance with the work
order. When the task is complete, the supervisor or other authorized person fills out
and signs the move ticket for that work center. The completed move ticket authorizes
the batch to proceed to the next work center. As evidence that this stage of production
has been completed, a copy of the move ticket is sent to production and control to
update the open work order file.

Upon receipt of the last move ticket, the open work order file is closed. The finished
product along with a copy of the work order is sent to the finished goods warehouse. A
copy of the work order is also sent to inventory control to update the finished goods
inventory records.

3. The Inventory Control Phase

The inventory control phase has three main functions in the production process. First, it
triggers the entire process by providing production planning and control with an
inventory status report of raw materials and finished goods. Second, inventory control
personnel are continually involved in updating the raw materials inventory records
from materials requisitions. Finally, upon receipt of the work order from the last work
center, inventory control records the completed production in the finished goods
inventory records.

5.3 The World-Class Manufacturing Environment

The world-class company is a company that has achieved high standards and has
undergone fundamental changes from traditional forms of organization and
management. This type of company continuously pursues improvement in all aspects
of its operations, including its manufacturing procedures.

A world-class company profitably meets the needs of its customers. Its goal is not
simply to satisfy customers but to positively delight them. This is not something that
can be done once and then forgotten. With competitors aggressively seeking new ways
to increase market share, a world class firm must continue to delight its customers.

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Since the mid-1970s, the factors that govern competitive advantage have shifted away
from an emphasis on costs alone to an emphasis on customer satisfaction, product
diversity, and the ability to respond rapidly to changing consumer demand. Hence,
nowadays, manufacturers are responding to the changes that they can no longer ignore
by achieving manufacturing flexibility.

Manufacturing Flexibility

Modern consumers want quality products, they want them quickly, and they want
variety of choice. The demand profile imposes a fundamental conflict on traditional
manufacturers, whose structured and inflexible orientation renders them in-effective in
this environment.

In contrast, world-class competitors meet the challenges of modern consumerism

through flexible manufacturing system.

Achieving manufacturing flexibility incorporates four operational characteristics: (1)

physical reorganization of the production facilities, (2) automation of the manufacturing
process, (3) reduction of inventories, and (4) high product quality.

1. Physical Reorganization of the Production Facilities

Traditional manufacturing processes tend to evolve in piecemeal fashion over years into
snake-like sequences of activities. Products move back and forth across shop floors, and
upstairs and downstairs through different activities. The inefficiency in the layout of
traditional plants adds handling costs, conversion time, and even inventories to the
manufacturing process. Furthermore, because production activities are usually
organized along functional lines, there is a tendency for parochialism among
employees. This “us versus them” mentality is contrary to the team attitude and creates
bottlenecks in the process.

A flexible manufacturing system is a much-simplified process. The flexible

production system is organized into flows. Computer controlled machines, robots, and

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manual tasks that constitute the flow activities are grouped together physically into
factory units called cells. This arrangement shortens the physical distances between the
activities, thus reducing setup and processing time, handling costs, and inventories in
the flow.

2. Automation of the Manufacturing Process

Automation is at the heart of a well-functioning environment. By replacing labor with

automation, a firm can be more efficient and therefore more competitive. Automation
also contributes directly to the other operating characteristics of inventory reduction
and increased quality.

3. Reduction of Inventories
The hallmark of world-class manufacturing firms is their success in inventory
reduction. Such firms often experience annual inventory turnovers of 100 times per
year. While other traditional firms carry weeks and even months of inventories, world-
class firms have only a few days or sometimes even a few hours of inventory. Why is
this important? What is wrong with maintaining inventories?

The Disadvantages of Inventories:

There are three main reasons it is advantageous for a company to reduce inventories:

A. Inventories cost money. Inventories represent an investment in materials, labor,

and overhead that cannot be realized until they are sold. Also, there are other
costs associated with inventory that are often hidden. Inventories must be
transported throughout the factory. They must be handled, stored, and counted.
In addition, inventories lose their values through obsolescence.
B. Inventories hide production problems. If machine capacity imbalances in the
manufacturing process are causing bottlenecks, work-in-process inventory builds
up at the bottlenecks. If customer orders and production are out of sync,
inventories build up.

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 C. Willingness to maintain inventories can precipitate overproduction. Because of
setup cost constraints, firms tend to overproduce inventories in large batches to
absorb the allocated costs and create the image of improved efficiency. However,
the true cost of this dysfunctional activity is hidden in excess inventories.

These inventory-driven problems promote inefficiency, reduce profitability, and

erode a firm’s competitiveness. Many manufacturing problems can be solved by
reducing inventories.

How can firms reduce their inventories?

Firms have successfully reduced their inventories by adopting the Just-in-time (JIT)
manufacturing model. However, JIT is more than an inventory reduction technique.

JIT is a philosophy that attacks the manufacturing problems through process

simplification as well as inventory reduction.

Under the JIT approach, raw material inventories arrive in small quantities from
vendors several times per day “just in time” to go into production. JIT supports a pull
manufacturing process. As production capacity upstream becomes available, the
manufacturing process pulls small batches (or a single item) of product into the next
work center. Rather than periodically taking in large batches, JIT promotes a continuous
flow of production through the process pulled along by idle capacity. Unlike the
traditional push process, JIT does not create batches of semi-finished inventories at
bottlenecks. In fact, under this philosophy, the firm eliminates bottlenecks and reduces
the distances between cells and work centers. Hence, fewer inventories are in transit at
any point in time. The JIT concept rests heavily on the following assumptions:

Zero Defects: continuous processing requires raw materials, work-in-process, and

finished goods with the zero defects. Some world-class manufacturing firms define this
as fewer than 200 defects per million parts produced.

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Zero Setup Time: long machine setup procedures add cost and delays to the process.
Firms should arrive to reduce setup time to less than five minutes.

Small Lot Sizes: to achieve a machine utilization of about 95% and a continuous flow
of product through the process, lot sizes must be small. Some should be no more than
one day’s worth of inventory in the production cycle.

Zero Inventories: JIT is not simply an inventory reduction technique. Rather, JIT
depends upon inventory reduction. A successful JIT firm may achieve inventory
turnover of 100 times a year.

Zero Lead Times and Reliable Vendors: A JIT firm must have established and
cooperative relationships with vendors. Late deliveries, defective raw materials, or
incorrect orders will shut down production immediately. There are no inventory
reserves to draw on in a JIT system.

Team Attitude: JIT relies heavily on the team attitude of all employees involved in
the process. This includes those in purchasing, receiving, manufacturing, shipping
everyone. Each employee must be vigilant of problems that threaten the continuous
flow operations of the production line. JIT requires a constant state of quality control
along with the authority to take immediate action.