Calculating Project Savings in a Lean Six Sigma Program

Posted by on Dec 7, 2019 in Lean Six Sigma, Project Savings | 0 comments

Nothing speaks louder than saving money for most organizations.  Owners, CEOs, and top executives want to know that employees are working on projects that are going to make customers happy and make a difference to the bottom line.  They want to see a return on investment for the training expense and the time teams spend working on projects.  Nothing works better when it comes to accomplishing this than a robust Lean Six Sigma process that is well managed.

In order to accomplish your cost savings objectives you need to standardize how project savings are calculated and how you define the difference between hard and soft dollars.  These definitions must come directly from you finance department and be communicated to all employees.  Financial impact must be calculated for every project.  At a previous employer, we used a template provided by finance where every project was evaluated with the help of department accountants so there was no dispute on the amount saved and what were hard savings versus soft savings.

The discussion of what constitutes hard and soft savings is a long-standing debate.  Generally speaking, hard savings are understood as tangible bottom-line reductions resulting in saved money that could be removed from budgets or reinvested back into the business.  Hard dollar savings can occur from three sources:

  • Cost taken out
  • Revenue growth
  • Working capital / cash flow

For a project to impact revenue growth, the project may identify and remove a production bottleneck or constraint.  Because of this the organization is able to accept new orders that it was previously not able to do or work off backlogged orders it wasn’t able to get to previously..

Projects that affect working capital and cash flow may fall into those that address invoicing processes, lowering accounts receivable, or reduce inventory requirements through increased process efficiencies.

For hard savings to occur, three criteria must be met:

  1. A prior baseline of spending must be established, typically 12 months.
  2. The dollars must have been planned and in the budget.
  3. The cost savings must affect the bottom line, i.e., the profit and loss statement or balance sheet.

Soft dollar savings, on the other hand, are cost avoidance savings and are everything that is not hard dollar savings.  They fall into two categories:  budge impacting and non-budget impacting.

Budget impacting cost avoidance eliminates or reduces items in the budget marked for future spending.  Examples are efficiency improvements that eliminate the need to spend planned expenses on machinery and equipment.

Non-budget impacting cost avoidance results from productivity or efficiencies gained without a head count reduction.  If a project reduces the process cycle time of employees by ten percent and results in a total of four hours saved per week, these four hours are allocated to other tasks.  This cost avoidance area is one of the most abused, because it is easy to assume that you can aggregate these small time slices into a sufficient “time saved” and generate huge savings when the time will simply be absorbed into other work activities.

The following offer more clarity on these differences:

  • Avoidance is a cost reduction that does not lower the cost of products/services when compared against historical results, but rather minimizes or avoids entirely the negative impact to the bottom line that a price increase would have caused.
  • When there is an increase in output-capacity without increasing resource expenditure, in general, the cost avoidance savings are the amount that would have been spent to handle the increased volume/output.
  • Avoidances include process improvements that do not immediately reduce costs or assets but provide benefits through improved process efficiency, employee productivity, customer satisfaction, improved competitiveness, etc.  Over time, cost avoidance often becomes cost savings.

In closing, it’s important to remember that projects may generate a wide range of savings.  It is therefore important that you involve your finance department and standardize the savings calculation process to ensure all savings are captured and to ensure credibility of the savings calculation.

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