Six Sigma – Financial Overview

Roles and Responsibilities of the Finance Support Team Define Savings/Benefits Provide Financial Support Project Selection and Review Project Evaluation Track Savings/Benefits Validate/Audit Financial Results Management Reporting

Finance Team Being Developed An analyst from the appropriate functional area will be assigned to each project team. The analyst will provide modeling support, budget information, and savings guidance. - For example if I’m a BB doing a project in Nuclear - LD Wade is who I need to talk to. Being Developed

Roles and Responsibilities Black Belt vs. Financial Analyst Data Collection Original Analysis Cost Analysis Financial Analyst Provide Budget Information by Cost Center Cost/Benefit Analysis Review / Validation Budget Adjustment

Project Process Map Project Consideration Project Assignment Measure & Analyze Improve & Control Close Project Project Champion Enters High Level Estimate of Cost Savings Finance Sign-Off Establish Budget and Savings. Enter Data into Tracking Model Finance Sign-Off by Project Team Financial Analyst. Sign-Off by Functional Deployment Champion - Finance Sign-Off by Project Team Financial Analyst Sign-Off by Director-Level Deployment Champion - Finance. Sign-Off by Functional Deployment Champion - Finance. Appropriate Budgets Adjusted. Six Sigma changes our approach to work. It focuses on our customer / supplier relationships – internal and external. It’s a different use of metrics.

Finance Sign-Off Before an Opportunity becomes a Project High-level “sanity check” The Project Champion should have already entered numbers and attached the model spreadsheet The spreadsheet should contain values, in thousands of dollars, on the Input and Output tabs only Questions to ask: Are there hard savings? Are the savings categorized correctly? (ie hard versus soft) Are there any other possible sources of savings? Is there an opportunity to save $250,000 or more? 2. Before the Process Improvement Takes Place The Black Belt should have already entered numbers and attached another copy of the model spreadsheet The spreadsheet should contain values, in thousands of dollars, on the Input and Output tabs as well as the detailed business unit tab How do these estimates compare with the previous estimates? Are the correct cost centers numbers used? If there are multiple cost centers, is the Multiple Cost Center tab completed? Do these savings look realistic for the proposed improvement? Are there any errors in the data entry? How do the savings estimates compare with current budget numbers? 1. Hard savings are measurable - doesn’t necessarily mean we’ve already got the data, but we could get if if we needed to. We can quantify them. They are things we can control. They contribute directly to earnings. 2. They include - reducing operating expenses (labor, materials, supplies), lower expenses due to Capital Expenditure reduction (depreciation, interest, property tax) 3. Soft savings - are less measurable or are not tied directly to earnings. 4. Includes - Customer satisfaction, safety or regulatory compliance, Capital Expenditure cash impact

Finance Sign-Off After the “Cooling-Off” Period Detailed audit of savings The spreadsheet should contain values, in thousands of dollars, on the Input and Output tabs as well as the detailed business unit tab. Questions to ask: Did the process improvement take place? Does the process improvement result in the reported level of savings? Are the correct cost centers numbers used? If there are multiple cost centers, is the Multiple Cost Center tab completed? Verify Financial results Time required to validate financial benefits Budget Adjustment Adjust budgets to realize financial benefits 1. Hard savings are measurable - doesn’t necessarily mean we’ve already got the data, but we could get if if we needed to. We can quantify them. They are things we can control. They contribute directly to earnings. 2. They include - reducing operating expenses (labor, materials, supplies), lower expenses due to Capital Expenditure reduction (depreciation, interest, property tax) 3. Soft savings - are less measurable or are not tied directly to earnings. 4. Includes - Customer satisfaction, safety or regulatory compliance, Capital Expenditure cash impact

Savings Definition “Hard” Savings Measurable, controllable and contribute to earnings Sources Reduction of non-fuel operating expenses Lower carrying cost related to Capital Expenditure reduction Margin improvements directly attributable to Six Sigma projects “Soft” Savings Difficult to measure or not tied directly to earnings Examples Customer satisfaction Safety or regulatory compliance Cash impact of reduced Capital Expenditure

Savings Definition - Examples Hard Savings Decrease time to post payments received (increase interest income) Decrease Uncollectables (Increase Revenue) Decrease in Office Supply Expense Decrease in Overtime Paid Decrease in Postage Expense Decrease in Travel Expense Decrease in Late Payment Fees Decrease in Rent/Lease Expense Decrease in Utilities Expense Decrease in Repair Costs Soft Savings Capital Expenditure saved net of interest, depreciation, property tax Increase in Customer Service Increase in Customer Satisfaction Increase in customer/employee Safety Aid in Regulatory Compliance Six Sigma changes our approach to work. It focuses on our customer / supplier relationships – internal and external. It’s a different use of metrics.

$1 Million Capital Saved Sample Income Statement Cost Center 12345 ($ Thousands) Revenue $11,000 $11,000 Expenses: O&M $ 6,000 $ 6,000 Depreciation $ 1,000 - $ 50 $ 950 Interest Expense $ 1,000 - $ 70 $ 930 Other Taxes $ 300 - $ 45 $ 255 Other Expenses $ 500 $ 500 Pretax Income $ 2,200 $165 $ 2,365 Result: $165 Thousand Hard Savings $835 Thousand Soft Savings $1 Million Capital Saved SAVINGS * Assumes 20 year depreciation, 7% interest rate, 4.45% Property Tax rate.

$1 Million O&M Reductions Sample Income Statement Cost Center 12345 ($ Thousands) Revenue $11,000 $11,000 Expenses: O&M $ 6,000 - $1,000 $ 5,000 Depreciation $ 1,000 $ 1,000 Interest Expense $ 1,000 $ 1,000 Other Taxes $ 300 $ 300 Other Expenses $ 500 $ 500 Pretax Income $ 2,200 $1,000 $ 3,200 Result: $1 Million Hard Savings $0 Soft Savings $1 Million O&M Reductions SAVINGS Assumes 40 year depreciation, 8% interest, and .5% tax rate

Tracking Savings Savings implemented during current fiscal year Elements tracked by project: Hard Savings - Cost Center & Expense Account Soft Savings - by category Six Sigma changes our approach to work. It focuses on our customer / supplier relationships – internal and external. It’s a different use of metrics.

Validation/Audit of Savings Focus of validation will be on hard savings and capital saved. Preference is for ATOI versus cash. The 2001-2005 Budget/Plan is the baseline against which quantifiable savings will be measured. After project is completed, validated and approved, annual operating budget will be adjusted accordingly. Six Sigma changes our approach to work. It focuses on our customer / supplier relationships – internal and external. It’s a different use of metrics.

1. The purpose of involving Finance in the up-front process is to ensure that the financial targets set for the initiative are supported by the project selection process. This is when initial financial targets for each project are established - both cost and revenue. 2. If the project includes a Lean component, the financial benefits should be validated after the Completion of the lean event. 3. At the completion of the Measure Phase, the BB, Champion and finance representative can validate the financial impact and determine if the project should continue. 4. Upon completion of the Improve Phase, the full scope of the cost savings and revenue generation is determined. Many clients will “book savings” at this point. 5. The final audit of a successful project is at the completion + 3 month point. This is validation that the project met the goals of the project and the revenue/cost were sustainable.

Sample List of Deliverables

Financial Integration Sample Internal Communication Document With Six Sigma Sample Internal Communication Document

Project Savings/Review Package Purpose of Project Savings Project Selection Process Financial Impact Benefit Categories Financial Integration Detailed Worksheets Six Sigma savings worksheet

Purpose of Six Sigma Financial Integration Purpose: Present a method of measuring and integrating process improvement benefits with the financial statements. Problem: Business units continue to have difficulty integrating the expected cost savings from improvement projects, Six Sigma or non-Six Sigma, with the financial statements. Challenge: Develop a way of measuring improvement projects costs and benefits (and the timing of these) which will better allow managers to: (1) more clearly define the expected benefits; and (2) understand the impact of those expected benefits on the business units financial statements. Result: Development of a brief methodology and a measurement system which can be used to plan expectations and measure results by: (1) more clearly defining expected benefits in dollar amounts and timing; (2) indicating the expected impact on the business units financial statements by month; and (3) allowing feedback by comparing results to expectations at (a) the project step level (actionable items) (b) by project (net sustainable results) (c) for the entire pool of projects monthly.

Project Selection Process Company Financial Commitment Goal Deployment Aligned with Org. Goals? Is there financial benefit? Projects Chartered yes Calculate Savings yes no no Write up Charter Customer Sat benefit? Why work the project? yes no Signoff of savings worksheet & charter by mgr & six sigma champion Employee Sat benefit? yes Find project aligned with site goals no Regulatory issue? yes no Why work the project? See your mgr & 6 sigma champion. HS&E benefit? no yes

Six Sigma Project Expectations Require Financial Translation Does the Six Sigma Project directly result in a change in the following: Revenue? revenue equals unit volume of output multiplied by actual unit prices obtained from customers the cost of resources (material, labor, etc.) input to obtain an established quantity of good output is there a one time, non operating expense impact, such as a decrease in inventory levels, which frees up cash and, if so, what is the timing? in which of the next calendar months do each of the impacts occur? Cost? Cash Flow? Timing? Training, worksheets and integration with financial commitments will facilitate “Financial Translation”

Six Sigma Financial Benefit Categories Operating Income OI / Cost Takeout Elimination or reduction of a cost currently incurred in the process Taking a current action to eliminate/reduce a cost which will otherwise be incurred in the future Two subcategories: - In the Annual Operating Plan (AOP) - Not in the AOP Elimination or reduction of a non value added process activity which currently incurs cost Questions to consider: 1. Is this actually a cost takeout (then see above)? 2. Is the “saved resource” re-invested in value added activities? 3. Is the “saved resource” converted to other NVA activities? Reduction in “base line” level of an asset or increase in a liability (example: a one time permanent significant decrease in inventory frees up the cash previously invested in this amount of inventory) In a market with backlog demand, removal of a constraint to growth can increase revenue Cost Avoidance Reduction of NVA (Non-Value Added) One Time Cash Flow Impact Operating Income (OI) / Volume

Financial Benefit Categories

Financial Benefit Categories

Financial Benefit Categories

Six Sigma Scorecard