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When you go lean, remember that the demon waste lurks within your finance and accounting processes

by Brian H. Maskell, President BMA Inc.

Society of Manufacturing Engineers

Lean accounting methods make essential financial information available throughout a company. They allow people in the financial community to contribute to the implementation of lean manufacturing and distribution, instead of remaining on the sidelines, waiting for improvements to show up on the bottom line.

Lean management accounting aims to provide information useful to the people in production plants who are actively implementing and sustaining lean manufacturing. Lean accounting includes the development of local performance measurements to allow cell leaders, value-stream owners, and managers to understand and monitor production processes and their improvements. Performance measurements can provide operational information to senior managers, program managers, and company executives. While the format and style of the reports will differ at each reporting level, their content will come from the same bottom-up data. All current information should be constantly available to people at all levels of the organization when they need to see a report.

Another aspect of lean accounting, value-stream cost management, a simplified form of activity cost analysis, provides cost information in a focused manner. The value stream consists of all tasks required to serve a customer and create value. Most companies have several value streams, each relating to a different family of products and different market channels. Value is created for customers through a series of processes and tasks performed by people from different parts of the company. Lean manufacturing seeks to eliminate the waste associated with the flow of these tasks. Most companies focus initially on the value stream within their own operations; in fact, the value stream extends to the company's suppliers and customers. Traditional companies focus on optimizing departmental effectiveness. Lean companies focus on perfecting the value stream process.

As the value stream becomes lean, costs of activities within it are calculated, using data derived from value-stream mapping and process redesign. This cost information enables companies to evaluate the benefits of lean improvements, and helps them establish priorities for further improvement initiatives.

Cost data also help establish root cause costs, so companies can understand the financial implications of fundamental issues within the value stream. Value-stream cost analysis can also track the success of improvement projects, and monitor cost savings derived from lean changes. In lean accounting, we strive to provide information with a value-stream perspective, to make waste visible at all levels, and to drive the company forward in the pursuit of perfection that is basic to lean thinking.

Performance measurements and cost information are integrated with continuous-improvement processes. Once the initial lean changes have been made, the lean organization initiates continuous improvement, so that everyone within a value stream is responsible for making ongoing improvements in a systematic way. Lean accounting provides not only cost and performance information, but also targets the monitoring methods that enable people in the value stream to remain focused upon improvement.

In lean accounting, the accounting systems must themselves be lean. Transactions are to lean accounting what inventory is to lean manufacturing. All transactions are waste, and should be systematically eliminated. The accounting, control, and measurement systems must not require the reporting of any information not already required by operations personnel for the physical control of processes.

This approach includes a number of techniques. In exception reporting, we assume processes work correctly, and only report when things go wrong. We report the outcomes of processes, rather than incomes. An example of this approach is the backflushing of materials and (sometimes) labor reporting. In backflushing, a computer calculates the quantity of materials, labor, and all other resources needed to manufacture a product. Instead of individually reporting the use of materials, labor hours and other resources, these transactions are computed and posted when the product is completed or shipped.

Production paperwork like work orders gives way to kanban-style pull methods and visual systems. Work-in-progress inventory tracking is eliminated as inventory is reduced and standardized. These and other methods constantly reduce the amount of data gathered to maintain the accounting, control, and performance-measurement systems.

After backflushing becomes widespread in an organization, after wasteful activities like labor reporting are eliminated, and after exception reporting is adopted, the information gathered can be posted directly to the general ledger, thus eliminating more financial transactions.

Many companies make the mistake of introducing lean thinking only to their manufacturing processes. There's usually a great deal of waste and ineffectiveness within a company's finance and accounting processes. They need to be subjected to the same analysis and waste-elimination efforts as processes within the value streams. Lean-thinking principles include understanding customer value, introduction of flow and pull approaches, and the quest for perfection. All can be applied to financial processes.
There are many advantages to making financial processes lean, such as the following:

Enormous waste exists within these support processes, and a company can make substantial savings by eliminating it.
A company moving into lean manufacturing needs to have management information made available in a more timely way. Going lean in the finance and accounting processes eliminates delays and introduces nonstop flow and pull methods, ensuring provision of timely, accurate information.
Eliminating waste from the finance and accounting processes frees people within these areas to work on lean projects. There's an important place for finance and accounting personnel within a company pursuing lean thinking, but in many companies these folks are not included in the lean changes. Often too busy to participate, they also don't have a clear picture of their role. Once they focus on eliminating waste in accounting and finance processes, these people can get involved in solving the company's problems.
For finance and accounting people to become involved in lean improvements, they need to understand lean thinking. The best way for them to acquire this understanding is by requiring them to apply lean thinking in their own processes. Doing so is an excellent training/ learning opportunity.

Target costing is the voice of the customer speaking about financial issues. While deceptively simple, it calls for a profound change in thinking within many companies. Most lean-thinking organizations employ some method of gathering customers' views of their products and services, and use this information when developing new value streams and techniques to serve the customer. Target costing gathers similar information from a financial perspective.

Target costing assumes the price of the products and/or services the company supplies is set by the market. Finance and marketing people work together to understand what a customer will pay for the products and services the company offers, and how that price changes according to different features and characteristics of those products and services. As a result of this study, the company understands the value it provides to the customer--often for the first time--and how the customer perceives that value.

A simple algorithm translates product prices into target product costs. If the company requires a gross profit of, for example, 35%, then the target product price will be set at 65% of the customer-derived price. This target cost is then broken down into the various elements of the product and services, with target costs assigned to major parts of the product and major service activities.

In a truly lean manufacturing operation, data gathered on the floor must be available to persons throughout the organization, to management and to accounting. (Photo by Du Pont)

In addition to target costs, one or two other prime parameters may determine a customer's understanding of value, such as time-to-market or delivery lead-time, or a physical attribute of the product. This handful of cost and customer issues is then used throughout the entire business to bring product costs and features into line with the customer's needs. Because the end cost of a product is largely established by the product's design, and the manufacturing engineering associated with that design, this process often leads to a fundamental redesign of the products

To determine product costs, and therefore to negotiate prices with their customers, many companies rely upon information developed by their cost accounting systems. As lean accounting is introduced, much of this traditional information is eliminated. In addition, companies going lean usually recognize the inadequacy of traditional cost accounting methods when it comes to providing valid cost information for specific product families and individual products.

Lean accounting uses the same value-stream cost-management information to determine product costs that was used to understand the value stream and its support processes. This information comes from the activities and activity costs associated with the value stream and support processes. These activities and their related costs are assigned to product families according to how much use each family makes of the activities.

Value-stream cost management data provide excellent product family costs. The cost of an individual product and related services will vary according to the features and characteristics of the product. Individual products can be costed by adjusting product family costs by factors associated with the features and characteristics of the product.

Such features and characteristics can be the same as those identified as customer issues via the target-costing process. Features and characteristics can be assigned according to the production and distribution processes within the value stream. A product requiring closer tolerances, for example, may attract additional costs in the production process. These same features and characteristics can help determine the cost of new products during the design process. The same information can be used to determine the profitability not only of product families, but also of specific customers or distribution channels.

Understanding statistical variability in processes is a key aspect of lean thinking. Introduced to manufacturing processes through the use of SPC, DOE, and FMEA, these same methods can be used in other business processes. All processes, including financial processes, are subject to variability, and all processes can be improved by studying and eliminating process variability.

A traditional company uses detailed and wasteful budgeting methods to control financial risk. Lean companies use the practical control and improvement of value streams and support processes to control financial risk. A traditional company uses detailed budgeting and financial tracking to control every department. Lean companies understand where the elements of risk are and focus their control efforts upon those issues.

Often a controller will find lean accounting methods disturbing because he/she is afraid that the company will lose financial control of the business. This reasonable concern often translates into conflict and animosity between finance and operations personnel. This situation must be avoided as the company pursues lean thinking and perfection. Control of financial risk comes from analyzing value streams and processes, determining where high-risk activities are located, and addressing these issues in detail. Focusing on these high-risk activities provides control and measurement mechanisms, and also allows managers to work with value-stream owners to eliminate process variability.

Underlying lean accounting is the role of the organization's finance and accounting people. There's an important role for finance and accounting personnel in a lean enterprise. They will spend a great deal of time working with people in operational areas to help them improve processes and reduce cost, and will spend much less time on traditional transaction processing and report generation.

Change of this sort frightens some finance and accounting people because it represents a dramatically different approach within the company and, to some extent, demands a very different way of thinking about financial data. Some people will accept these changes immediately; others will resist to the last ditch. Most people need a considerable amount of training and a gradual changeover to their new roles, as the company transforms lean thinking from a theory to everyday reality throughout the workplace.

 

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Traditional
 
Intermediate
 
Becoming Lean
 
Budgeting
 
Performance Measurement
We have extensive and detailed budgeting for every department and cost center, and for every cost account and subaccount. We have a formal budget development approach, and every department manager develops budgets that are submitted to senior management for approval. Budget versus actual reports are printed monthly and reviewed in budget meetings
 
The company's primary performance measurement is done by the accounting department. We make extensive use of variance analysis, financial ratios, and other financially based measures. We are very concerned about productivity, and use measures like direct labor productivity and equipment utilization. Our primary performance measures are available monthly as part of the month-end reports, and many other reports are used for reporting local performance.
We have simplified our budgeting process by establishing budgets at value-stream level. Our budgets are by value stream and in summary form. This reduces the number of cost centers and accounts. Control of value streams is achieved by continuous improvement processes, and our finance people actively work with continuous improvement teams.
 
We have a single, balanced performance measurement system using both financial and non-financial measurements. We have eliminated most of our traditional reports. The new measures are derived from our company strategies, and focus on value streams. Most are available in real time and can be pulled from the data warehouse or intranet. All performance measurements have valid targets for teams to work towards, and are simple, direct, and easy to use.
We only create high-level budgets for planning purposes. The company is controlled primarily through nonfinancial measures and the continuous improvement process within the value-stream organization. We use the monthly sales and operations planning process to update plans and monitor progress.
 
We have added a lot of statistical analysis to the performance measurements, and the measurements are used by finance people and other specialists to understand risk and capability within the value stream and processes. We use methods like DOE to determine risk elements and focus on high-risk areas for business control and improvement. All targets for the performance measurement system are driven by customer-focused target costs and performance objectives. We use the measurement systems to highlight root causes and drivers of waste.


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