TOCICO WEBINAR

The Ultimate Constraint:

Time
A simple way of thinking about Business and financial reporting that
everybody can easily understand

© TOCICO. All Rights Reserved.

Can you go back in time and try something again, if you don’t like how you did? No?
Oh, heck, then like any constraint, it is use it or lose it. In recognition of this bit of
obvious fact, Eli Goldratt suggested the five focusing steps. <CLICK>

1
 TOCICO Webinar

Five Focusing Steps

Step 1: Identify the Constraint

Step 2: Decide how to exploit it
Step 3: Subordinate everything to the above
Step 4: Elevate the constraint
Step 5: If the old constraint ceases to be
what holds the system back the
most, start at the top right away!

© TOCICO. All Rights Reserved.

After identifying the system’s goal, we look for the resource that can’t keep up.
It can be internal or external.
Constraints have the characteristic of being infinitely variable,
meaning every extra little second it produces adds to the bottom line by the flow of
Throughput it allows.
I said “flow of Throughput.”
In communicating, we often truncate what we mean, when we think the other
person gets it.
Flow of Throughput produced over some period of time.
There’s time.
Flows only make sense in the context of some period of time.
A primary spring where I go fishing in Florida produces water at the rate of around
50,000 gallons per minute.
We think of orders as so many dollars of sale per day, week or month.
That is what I want to build on in this presentation.
It’s a ridiculously simple idea but I find people truncate its use.
(We are in such a hurry, aren’t we? We keep truncating!) <CLICK>

So, we come to focusing step 2.

What are we doing?
Let me stop truncating and explain it.
We are considering, since we can’t get more time, that we need to find some way to

2
wring more Throughput out of the constraint during each period.
This might be by adding a third shift for the slowest piece of equipment,
it could mean shortening set-up times,
it could be by seeking orders with higher Throughput or
ensuring that raw materials are always available.
Whatever …
all of these examples are simply decisions of how to get more Throughput out of the
sum of a bunch of consecutive periods of time.
It does no good to produce 10% more on your NCX-10 machine for the first 4 hours of
the day only to have something break and maintenance takes the rest of the day to
get it going again.
That’s what I meant by the sum of consecutive time periods.
Want a better result for the year?
Ensure the NCX-10 is available and used for more minutes, assuming you have
enough orders.

So, let’s start looking at your financials through a time lens. <CLICK>

2
 TOCICO Webinar

Let’s talk about TIME

Accounts Receivable: 45 days worth

Inventory: 90 days worth
Total Investment: 135 days worth
Sales: New $12m 365 days worth
Throughput: 90 days worth
Operating Expenses: -41 days worth
Taxes: -22 days worth
Net Profit: 27 days worth

© TOCICO. All Rights Reserved.

I’m going to do some days math on this slide.

It will be somewhat new.
Please put your questions in on the chat line and I’ll stop at the end of this slide to
address them.

You commonly use time to express the size of pools of money.

Perhaps, your company offers payment terms of Net 30.
A scant few customers pay early.
A few pay on time.
Most pay a little late and a few pay as late as they can. <CLICK>
The average might be 45 days.

The same thing applies to Inventory.

“How much inventory does your company hold?”
“Oh, we have about 4 months of inventory on hand, plus or minus.”
Four months of inventory is 120 days.
However, that’s days of Truly Variable Costs – what the rest of the world calls Costs of
Good Sold.
Days of Accounts Receivables are days of Sales.
A day’s worth of inventory is not as valuable as a day’s worth of Sales.
(Again, I’m assuming!)
In other words, to put Inventory into the same terms, days of sales, we must discount

3
those inventory days by the percentage that Truly Variable Costs are of Sales.
For this company, TVC is 75% of Sales.
So, 120 days of inventory multiplied by 75% is <CLICK> 90 days of Sales

That gives a total of 135 days.

That is how we think of the pools of cash sitting on our balance sheets.

I call them pools because, like a lake, they remain at a certain size.
After a storm of new orders, A/R naturally increases and Inventory is pulled lower.
Following a dry spell, Inventory rises and A/R falls.
When supply chains get clogged up, Inventory first declines to a point that shortages
block sales, followed by a reaction to hold Inventory at a new higher level. <PAUSE>
The opposite is also true.
Faster resupply means inventory increases, until a decision is made to lower
inventory levels. <PAUSE>
Speaking more generally, which means more simply, due to the complexity of nature
and its chaotic variation, both pools, inventory and accounts receivables vary over a
range.

As we just discussed Throughput is a flow, not a pool.

The same is true of Sales, Truly Variable Costs, Throughput and Operating Expenses.
They are all flows.
We talk about them in terms of money not time.

“I got a new $12,000,000 customer!”

That means you got a new customer who buys, on average, one million dollars per
year.
(Truncating again, you assume that is good news. The first part is the assumption
that the added Truly Variable Costs will be less than $12 million per year and, if so,
the annual required additional Operating Expenses are also less than the Throughput
produced by enough to make it worth it to undertake the numerous risks involved.)

Back to my point, Sales, TVC and OE are all flows of money over time.
What if you discussed these flows in terms of time instead of money?
Then, you can compare the way you think of your pools with those of your flows.
I expect I have totally lost you now.
In fact, I hope so!
“What a weird presenter! He wants to lose us.”
No, I want to give you a new tool – one that others don’t use – one that will allow you
to understand your business more fully, so you make better decisions.
In other words, wake up!
Stop looking at your email on your second screen.

3
I’m about to reveal the main point here on slide three! <PAUSE>

You got the new 12 million dollar customer. How many days does that 12 million
represent? <PAUSE>
It’s 12 million per year right? <PAUSE>
The new Sales come in over 365 days, right? <CLICK><PAUSE>
If your Truly Variable Costs for the goods you need to buy and any commissions you
might pay the salesperson are a little bit more than 75%, <CLICK>
then the Throughput is about 90 days worth. Does this make sense? <PAUSE>
A quarter of the year is about 90 days.
You only have even a chance of retaining that 90 days worth of the new customer’s
sales.
Yet, you must invest 135 days worth of Sales to adopt this new customer.
Oops!
Getting a new customer doesn’t help your cash position.
It hurts it.
Over time, your cash situation will improve.
How long will you have to wait?
That is a very good question you just asked. <PAUSE>
Let’s see.

For a small additional customer your system’s capacity may be sufficient, as is.
To handle such a big customer, you’ll usually need to add some new Operating
Expenses.
You need some new people in the warehouse and a new delivery truck.
Rent, utilities, customer service, accounting, marketing, sales, HR, purchasing and
management you judge have enough capacity and require no new OE … good.
How much does all that cost?
One million dollars per year.
That’s one 12th of the 12 million in sales.
One 12th of a year is a month – 30 days.
Oh, that was easy.

Is that all the added operating expenses?

Nope.
What about interest on the Total Investment?
If you had to borrow the money on your line of credit which costs you 8%, in today’s
inflationary times, that’s 8% of 135 days or about 11 days.
That means that the total new OE is 30 days plus 11 days. <CLICK>

Then, don’t forget taxes.

The IRS certainly won’t!

3
Either the company pays them directly or sends some cash out to the owners so they
can pay the taxes for the company. <CLICK>
Either way the cash disappears.

<CLICK> That leaves the company with an additional Net Profit of 27 days worth of
the new sales.
Thinking back to the size of this new customer, those days are equal to almost
$900,000!
Whoo hoo!
That’s most of a million bucks! <PAUSE>

Back to the question I asked you earlier.

When does the company see some cash from these profits? <CLICK>
The good news is, after one year, 27 days of the new customer’s sales flowed in.
How much flowed out? <PAUSE>
We calculated it at the top.
135 days of the new customer’s sales flowed out to fill up the Inventory and A/R
pools. <PAUSE>
Remember, I asked how long until we see some cash from this new customer?
<PAUSE>
The answer is 5 years!
You’ll wait 5 years to see the first dime back! <PAUSE>
You get back 20% per year on your investment.

Let me give you a couple of asides.

In inflationary times, the 135 days worth of new investment you get back five years
later will not buy what the $4,438,356.16 you invested up front could have bought
back then but we can ignore that, since you borrowed the money you invested and
get to pay back in depreciated dollars too.
So, your return on your investment is 20% even after the 8% you pay in interest.
A net 20% return.
Not bad, unless …
Unless what?
Unless the customer declares bankruptcy or you can’t raise the price when your TVC
or OE go up. <PAUSE>
Now, if you are investing your own cash, subtract the inflation rate from the return
and reduce the OE for the interest not paid.
It will be a little better that way.

To keep it simpler, I assumed that the interest is the same as the first year.
Actually, interest payments would decline as you use the 27 days of Net Profit each
year to pay off the 135 days of Investment.

3
However, do you only get one new customer every 5 years?
I hope not!
For most companies, like the one I showed here, even if they make plenty of profit,
their growth requires increased debt.

Another consideration:
I assumed you had enough room on your line of credit to borrow the whole amount.
Banks, require collateral.
I assumed your total collateral of all your assets could cover the investment for this
new chunk of business.
“What does he mean by that?”
Well, how much could you borrow on the investment above alone?
Usually, half of the Inventory.
That’s 45 days worth.
It is better for receivables.
Something like 34 days of the 45 days.
Total borrowing: 79 days worth.
If my assumption is wrong, you’ll have to come up with the rest of the 135 days
yourself.
That’s 56 days or $1,841,095.89.
The “Oh goody, we got a whopper of a new customer!” now requires you to look off
into the distant and uncertain future to decide to be happy about it.
Isn’t business life a stinker?

Remember, this was an additional customer.

They contribute a much higher percentage to the bottom line than the company’s
total Net Profit as a percentage of Sales.
This customer contributes 27 days out of 365 days or 7.4% return on Sales.
Your average Net Profit for the whole company will usually be less than half of that.

First off, before I go on, do these calculations for your own company.
Your numbers will be different.
This example is for a distributor, broker, importer or some other type of reseller.

For a manufacturer, recognize that your inventory will be in three buckets:

-Raw materials
-Work in process and
-Finished goods
The sum of the three is typically many more days than a reseller but the discount to
get it into the same terms as A/R is usually much larger.
To produce the 12 million of new product may require an investment in capital
equipment.

3
If so, convert that into days of the newly added Sales and add that to the A/R and
Inventory, increasing the total investment.
As I mentioned, your Truly Variable Costs of Sales will typically be much less than 75%
of Sales.
Don’t forget sales commissions. Your TVC should include those.

If yours is a retail company, you typically won’t have Accounts Receivable.

However, you may have to add 2-3% of Sales to your TVC percentage to recognize
credit card fees.
The rate of Throughput to Sales is typically much higher than this example but so is
OE.

Feel free to ask me if you are having trouble.

In fact, let me pause here to respond to any of your questions.
Who has a question?

“What can I do with this, Henry?”

Good question.
Let’s see. <CLICK>

3
 TOCICO Webinar

With ignorance, comes limitations

Overconfidence à Poor ROI!

© TOCICO. All Rights Reserved.

Many business owners are knowledgeable about their Income Statements.

“I know I am going to make a 7.4% return on Sales on my new 12 million dollar
customer.”

However, fewer of them understand how much cash that uses up.
The common symptom is that their companies and their debt grow to a certain size
and stagnate there.

Is you company pressing up against a glass ceiling that restrains your growth?
What can you do?

4
 TOCICO Webinar

With knowledge, comes power

Raise Prices à Better ROI!

© TOCICO. All Rights Reserved.

- Raise prices
Too often, we feel disempowered on pricing.
Knowing how much not raising them holds your company back ought to make you
braver.
A small price increase on your product is hardly noticeable to your customer but
makes a disproportionate difference to you.
This is truer the smaller a proportion you are of your customers total annual
purchases.
Nobody likes a price increase but, after all, if you are only half a percent of the
customer’s total buy, will a 5% price increase really make a material difference to
them?
That’s a trivial 0.025% increase to their TVC.
Nobody has time to sweat such a small amount.
Their cost of replacing you is far more, because it takes their time away from buying
better and not running out.
Don’t believe that the supply and demand curves applies to you.
You may have learned it in school but it seldom applies in real life.
You usually can’t stimulate demand by lowering prices, unless you sell commodities.
The same thing happens on price increases, they typically don’t lower the demand for
your products.
The customer needs the amount they are buying.
Be brave.

5
Pay down your debt and grow your company faster.
By the way, a 5% price increase on the calculations above improves the ROI from 20%
to almost 30%.

5
 TOCICO Webinar

With knowledge, comes power

Faster Payment à Better ROI!

© TOCICO. All Rights Reserved.

- Offer discounts for faster payment

If you can negotiate a faster payment, please do it.
It may not cost anything.

If you must offer a 2% discount to get paid in 15 days instead of 45, your ROI
improves from 20% to 23%.
It works better, if you only have to pay 1% or ½%.
Even though Net Profits go down, the investment and interest on that investment are
down proportionately more.
This allows you to grow faster and break through the glass ceiling that holds so many
companies back.
Remember we are not trying to increase the profit per customer.
We are trying to increase the company’s total profits.
Pulling some cash back in allows you to go from 100 customers to some larger
number.
If you want to know how, find my video on my YouTube page on how to construct
Decisive Competitive Edge offers.

6
 TOCICO Webinar

With knowledge, comes power

Use TOC Buffers à Better ROI!

© TOCICO. All Rights Reserved.

- Use TOC Replenishment

The TOC solution for replenishment builds Inventory Buffers to the size of the most
you expect to consume in the average time it takes to get more plus some extra to
protect against late delivery from your supplier.
You’ll need some automatic way to perform Buffer Management, assuming you have
more than just a few products to manage.
There are lots of folks in the TOC community that offer such software.
I’ve been using TOC- Replenishment for almost 20 years.
For most companies, inventory collapses.
I’ve seen many drops of 80%.

In the case I just presented, assuming the inventory drop is only in half, ROI jumps
from 20% to 32%.

7
 TOCICO Webinar

With knowledge, comes power

Raise Prices à Better ROI

Faster Payment à Better ROI
Use TOC Buffers à Better ROI
All three raises ROI
from 20% to 70%!
© TOCICO. All Rights Reserved.

Nothing precludes you from doing all three.

<CLICK>
Instead of waiting 5 years to pay off the new cash invested, it gets paid back in 17
months.
These were only three examples of what we can do with our new understanding.
I didn’t mention paying the supplier something extra to give you longer payment
terms.
I didn’t mention getting a down payment from the customer on make-to-order goods.
I didn’t mention value added services that earn you money without having to make
any investment.
Please come up with your own.
All I ask is that you please let me know what you come up with.
Maybe we can go into business together.

This raises a last question.

You’ve heard the truism that every dog has his day.
The question is when should you prioritize better ROI?
Let’s check that out before we close. <CLICK>

8
 Recommended Metrics Table TOCICO Webinar

Constraint Identification:
Operations: Overall Equipment Effectiveness (OEE) > 90% for some Equipment on 24hrx365day basis AND On-Time-in-Full (OTIF) <95%

Market: > 50% World Market Share Orders: > 95% OTIF Cash: OEE < 90%, OTIF < 95% AND Shortages due to late payment

Financial Level Constraint Recommended Metrics to Share Measurements to Ignore

Late pay Free Cash Months of Overdue Overdue Sales, T, NP, OE savings, OEE,
1 Cash
interrupts flow Flow Survival Cash Receivables Payables Any ratios
Free Cash On Time Protective Sales, T, OE savings, OEE,
Orders Net Profit
Not making Flow in Full Capacity manpower productivity
2
Net Profits Free Cash On Time Overall Sales, T, OE savings, non-CCR
Operations Net Profit
Flow in Full Equip. Eff. equip. util., manpower prod.
Net Profit Free Cash On Time Protective Sales, T, OE savings, OEE,
Orders
Net Profits Growth Flow in Full Capacity manpower productivity
3
fluctuating Net Profit Free Cash On Time Overall Sales, T, OE savings, non-CCR
Operations T%
Growth Flow in Full Equip. Eff. equip. util., manpower prod.
Free Cash On Time Protective Operational Sales, T, OE savings, OEE,
Net Profits Orders Growth in T
Flow in Full Capacity Productivity manpower productivity
4 continually
Operational Free Cash On Time Overall Sales, T, OE savings, non-CCR
increasing Operations
Productivity Flow in Full Equip. Eff. equip. util., manpower prod.
NP, ROI & Capital Operational On Time Protective Sales, T, OE savings, OEE,
Orders Growth in T
ROCE Productivity Productivity in Full Capacity manpower productivity
5
continually Capital Operational On Time Overall Sales, T, OE savings, non-CCR
Operations Growth in T
increasing Productivity Productivity in Full Equip. Eff. equip. util., manpower prod.
NP, ROI, ROCE
6 & FCF cont. Any Continue current measures without any changes
© TOCICO. All Rights Reserved.
Outside Advice
increasing

This is my last slide.

It violates the rule of not presenting too much all at once!
Oh, well.

It’s the one-page summary from my workshop from the TOCICO in Berlin back in
2017.
These suggested metrics are a contribution from Ravi Gilani.
Please go onto the TOCICO site if you want to understand the full explanation.

For those of you who haven’t seen this before, let me give you a quick overview.
At the top, because you must do this first, are the four possible types of constraints a
company can have.

A constraint in operations is explained in the green box on top.

If you are running your equipment or people more than 90 percent of the time on a
24/7 basis, you’ll see confirmation that that’s too much in your On-Time-In-Full
shipments percentage.
It will drop below 95% and your customers will suffer.
You’ll suffer too by missing orders from your customers or getting them billed too
much later.

In the black box is the rarest constraint of all, a true Market constraint.

9
This happens when you own the world Market and it becomes progressively more
difficult to win over the last few customers.
Imagine that there is no Apple.
Then, Microsoft might have a market constraint.

Next is an Orders constraint, which some people call a market constraint.

I think it is worthwhile to differentiate between Orders and Market constraints.
I call it an Orders constraint because you’d make more profit if you just had more
customers or your customers’ orders were bigger in terms of Throughput.
You know you have this one when you are getting more than 95% or your orders out
on-time and in full.
You could make more, if you just sold more.

Last in the Red box is a Cash constraint.

This is very rare.
It is a special case where you don’t have the money right now to pay your bills to the
extent that shortages are curtailing your ability to sell more.
In this case, symptoms are you are on credit hold and your equipment or people are
standing around idle, because of that you can’t fill orders on time.

Down the left-hand side of the table is Financial Level.

The higher the number the better.
Level 1 is Cash constrained.
Level 2 is losing money, on average.
Level 3 is making money but the amount of profit fluctuates up and down month to
month.
Level 4 is steadily increasing profits.
Level 5 is improving in both profits and ROI but consuming cash.
Level 6 is improving profits, ROI and building cash – all three at the same time.

For the four middle financial Levels, there are two possible constraints:
Operations and Orders.
Only Level 1 is cash constrained.
You will notice that I didn’t mention Market constraints.
Why not?
First off, they are too rare.
If you think you are market constrained, call me and tell me about it.
I’ve never seen a company market constrained.
It would give me the chance to learn something.
Probably, you just need to expand the scope of the company to give it more room to
grow but I don’t know for sure.
That’s why I ask you to call me!

9
On to the meat of the table.
If you are at financial Level 6, please call me.
I’d like to buy into your company.
Whatever you do, don’t listen to me or anyone else.
You are smarter than I am.
Congratulations!

For financial levels 1 through 5, There is one Prime metric in bold.

That is what you pay attention to, above everything else.
In his introduction to the TOC Handbook, Eli Goldratt said all of TOC boils down to
focus.
The Prime metric is where you should focus.
The secondary metrics are important, because they warn you if your company is in
danger of slipping backwards into a lower Level or changing constraints by mistake.
That often happens because some non-constraint, likely a critical-constraint-resource
is running out or has run out of capacity and you didn’t know it.
Should a CCR become overwhelmed whether permanently or temporarily, these
secondary metrics will reveal it.

Please look through this summary after this webinar.

You’ll find it very important to properly running your business.

If you recall, the previous few slides were about improving ROI.
I asked when do you want to improve ROI? <PAUSE>
When is it?
The answer is at the upper levels, 5 and 6.
If you are at financial Level 3, as most companies are, you should be focusing on your
change in net profit month over month.
At Levels 2, 3 or 4, if you can increase your profits buy offering better terms, you
should do it, even if it means higher Accounts Receivables.
At 2, 3 and 4, if you must increase inventories to avoid running out and missing
orders, do it.
Likewise, at 2, 3 and 4, ditch the credit cards some of your customers pay with to
capture back the credit card fees.

Regardless, of what Level you are, it helps to think of flows in terms of time.
The reasons are because it emboldens you to charge enough more.
Increases T
It keeps you from feeling rich and spending money you haven’t yet seen, except on
your income statement.
Decreases OE

9
It keeps you from slipping back into Level 1 – Cash constrained.

You will find that paying attention to both Flows and Pools together, in terms of time,
pays off nicely.

9
 Questions?
TOCICO Webinar

Henry Fitzhugh Camp

Henry is an entrepreneur who founded a
private equity fund specifically to earn
extraordinary returns using TOC.
He currently owns and operates all or part
of four companies from manufacturing and
supply chain to software development.

He is fascinated by and a student of

business breakthroughs.

His goal is to demonstrate that

uninterrupted improvement is always
possible.

“When in doubt, choose the less efficient

route.”
- Camp’s Law

hcamp@ssco.pro
© TOCICO. All Rights Reserved.

10