by Brian H. Maskell, President, BMA Inc. and Bruce Baggaley, Senior Partner
Lean Management Accounting brings together accounting, control, and performance measurement methods that support the introduction of lean manufacturing and sustain a lean enterprise approach over the long term. Lean management accounting must not only actively support lean manufacturing, it must itself employ lean methods.
Lean Management Accounting is one of a number of elements making up a lean accounting approach within a manufacturing company. Other elements include lean financial accounting, target costing, and lean budgeting. In this article we will describe a management accounting approach that supports lean manufacturing, and specifically we will focus on information needed to support lean cellular manufacturing.
Thinking about lean approaches developed in recent years from the work of James Womack and his colleagues. In the book Lean Thinking(1) Womack sets out the concepts of lean manufacturing and lean enterprise. While Womack’s book does not present anything very new for those of us who have been working in advanced manufacturing methods for some years, it does present the ideas of world class manufacturing in a simple, practical, and accessible light.
What is Lean Thinking?
Lean Management Accounting is driven by the principles of lean thinking, as set forth by Womack. The five principles of lean thinking presented by Womack are:
- Value stream
These are the touchstone mantras of lean manufacturing adherents.
VALUE deals with the value we provide to our customers. Value is the complete package of products and services we use to serve our customers and penetrate the market from the point of view of the customer. In line with a target costing approach, this value translates into the price the customer is willing to pay and, in turn, to the product and service costs we must achieve in order to satisfy the customer and the company’s stakeholders.
VALUE STREAM recognizes that the company’s processes create excellence and customer-driven performance. Traditional departmental control structures run counter to lean thinking. We must understand, control, and manage our business through the processes, or value streams, of the organization. This includes three top-level value streams in manufacturing companies; the "make product" value stream, the "design and problem solve" value stream, and the value stream that includes the company’s transactions and controls. These value streams often extend outside of the company itself into the suppliers, the customers, and partner organizations.
The ideas of FLOW embraced by "leaners" have their roots in the Toyota Production System. Anything that interrupts the flow of products and services through the value stream and out to the customer is designated muda – or waste. We must study the value streams and achieve uninterrupted flow from raw material to delivered products and services. We savagely eliminate waste from these processes.
PULL is an important mechanism to enable flow of the products and services. Nothing should be "pushed" through production or service processes. Everything is "pulled" based upon the customer’s real demand and requirement. Again this is based upon the Toyota Production Systems that puts great emphasis on "pull"` and the use of kanban (or other visual methods) to facilitate a pull approach. If this approach is employed throughout an organization there will be very little inventory because the organization will make only what the customer is immediately "pulling" in terms of demand upon the production plant.
PERFECTION within lean thinking has two elements. The first is the classic TQM understanding of quality improvement. Lean manufacturers use both continuous improvement (kaizen) and breakthrough improvement to make on-going and substantial change in their operations. This is how lean organizations pursue excellence in both the short term and the long term.
In addition to classic improvement efforts, lean thinking also regards benchmarking and other "best practice" assessments with a jaundiced eye. The company must, through process analysis and lean accounting, identify the waste within the company’s value streams and savagely eliminate this waste through the introduction of flow and pull methods. True "leaners" reject benchmarking because they say the company’s goals and objectives are to eliminate all waste. The company does not compare itself to other companies. The challenge is internal – "How much waste can we eliminate this month?"
What is Lean Management Accounting?
Lean Management Accounting is a series of methods designed to support lean thinking. Lean management accounting methods must themselves be lean and not introduce additional waste. In particular, all transactions are regarded as waste because they do not add value to the product or services. Lean management accounting seeks to eliminate transactions while maintaining control of the operation, recognizing that control of a value stream (or process) does not always require keeping detailed transaction information. Many times simplified systems are better controlled procedurally through visual approaches and empowerment of the people.
An example of eliminating transactions is the backflushing of materials and costs in a production process. Under a lean approach, instead of reporting the movement of raw material and of labor hours against a production job as it is made, all these transactions can be created when the product is completed on the shop floor.
Similarly, instead of using an MRP or other shop-floor planning and scheduling system, replete with production work orders and shop-floor tracking systems to drive and control production, a lean manufacturer uses visual methods like kanbans. Many companies introduce kanban production control but their accounting systems continue to require the tracking of financial information through production work orders and other documents. Lean management accounting eliminates these requirements so that the accounting systems reflect the simplification and waste reduction efforts required in a lean environment.
Any delay, wait time, inspection, correction, auditing, and so forth are regarded as waste(2). Lean management accounting goes to great lengths to expose this waste so it can be eliminated. The reporting of costs within production, design, sales and marketing, or a support process must be such that the waste within the processes is clearly visible to the people responsible for the process. Traditional standard costing systems hide waste. The waste is concealed within overhead allocations, within the standards themselves, and through inadequate reporting.
Traditional costing and budgeting systems do not address value streams; they are organized around departments. Consequently, they are not useful in managing the value creation process.
A lean accounting system for cost and budgeting is focused on value streams, requires very few transactions, is based upon an understanding of the activities required to complete the job (production, marketing, design, service, or support operation), and the costs associated with those activities.
Because the accounting system is focused on the value stream it can also facilitate continuous improvement. Continuous improvement is vital to lean enterprise thinking. Everybody in the company is responsible for the improvement of the value streams for which they are responsible. Lean management accounting must provide the information to support these efforts.
The purposes of Lean Management Accounting can be summarized:
- To provide the value stream leader with performance measurement and cost information that can be effectively used to control and continuously improve the value stream.
- To provide information for performance measurement and cost reporting to senior people within the organization.
- To provide relevant cost information that can be used to post to the general ledger and the P&L report.
The Elements of Lean Management Accounting
We will look briefly at each of the elements of this lean management accounting approach.
Lean Data Collection—Eliminating Operational Transactions
Lean data collection is a simple method of recording the results of the production cell operation. The emphasis is on minimizing transactions, simplifying the required transactions, and providing visual reporting to the cell leader. Data collection will always be output information, not input information. A lean organization does not report input information like materials used, labor hours, job step information, and so forth. The lean organization reports the completion and (if necessary) backflushes(3) to create materials and cost information and transactions. Later the backflushing transactions are eliminated as inventory is reduced and the processes brought under control.
The data collection system posts such information as takt time and hourly production quantities to visual reporting tools like a white board in the cell or an electronic scoreboard. The lean data collection system also allows the cell leader to collect additional information (like machine downtime, quality-related data, and so forth) that may be currently required for improvement studies. Additional information collected in the cell is often linked to reason codes that report why (for example) a machine is down or time has been lost. The data collection system provides vital, real-time information to the cell leader and also provides the information for performance measurement and value stream costing.
So the object of lean data collection is to eliminate operational transactions that are not required in a lean process as visual controls and lean improvement eliminates their usefulness. The overriding principle is that transactions are waste, being a form of inspection used to bring financial control to an out-of control process. The goal is to eliminate transactions altogether in such transaction-heavy processes as:
-Work-in-process tracking and labor reporting
-Material and component procurement
-Inventory control and valuation
-Inventory record accuracy.
Ideally we would eliminate most of the operational transactions in the above processes because they are wasteful in themselves and they cause more waste. But in a traditional manufacturer, these transactions are required to maintain control of the business. So we can only remove the transactions when the reason for their existence has been removed. The critical question then is "What must be in place from a lean perspective to enable removal of the transactions and still retain control of the business?"
To put this in perspective, we have presented two scenarios below, one of a traditional manufacturing process before lean and one after lean.
It is clear that the former business having a production lead time of 6 weeks and requiring frequent expediting requires a system of detailed tracking to know where an order is in the process. In the latter scenario production lead time is 2.5 days and inventory levels are low and consistent. This requires little tracking; the process is under control. In fact the requirement to track production in this scenario will only add waste into the process. The lean company can eliminate most transactions. The question is at what point along the lean transformation can this occur. That is to say, what has to be in place to permit the transactions to be eliminated and still retain control of the business.
This can occur in stages as the company progresses towards its lean goals. An example of such a progression is shown below for work-in-process tracking and labor reporting.
Lean Performance Measurement
Lean performance measurement is a cornerstone of lean management accounting. The measurement of each value stream is the starting point for control and continuous improvement. The performance measurements must adhere to the principles of lean thinking. It is important that a set of measurements be devised for each value stream that shows how value is created within the value stream and clearly reveals associated waste. It is important that the measurements demonstrate the extent to which the value stream "flows" without interruption, and to what extent "pull" has been introduced throughout the value stream. There must be measures that show "perfection" thinking at work.
Perfection thinking is associated with quality issues – product quality, service quality, process quality, variability, and so forth. But perfection goes further than this because lean thinking is concerned with the application of perfection in every aspect of each value streams. As we discussed earlier, a lean thinking company does not address benchmarking as a method of driving improvement. The goal is perfection and perfection comes from driving out all waste from the value streams.
Cell Performance Measurements
Performance measurement in a lean manufacturing organization starts at the production cells(4). Production cells are the building blocks of lean manufacturing.
A small but focused set of performance measurements is required on each cell. The purpose of the cell measurements is, in lean thinking, to assist the cell personnel to make to takt by alerting them in time to fix problems that would inhibit this goal. So data is collected each hour on actual and takt production rates and explanation of differences between the two. Clear direction is given the cell regarding the conditions under which they are empowered to shut down the cell to fix the problem causing the variation.
Traditional management accounting measurement systems focus on such issues as monthly variance reporting and earned hours, and are used for monitoring and judgment. They do not provide any information to assist with improvement. The lean approach to performance measurement provides a small set of measurements that drive a continuous and sustained war against waste. This can only be achieved if the measurements are helpful tools for improvement and provide useful information. As soon as the measurements are used for assigning blame and punishment the people will begin to "fudge the figures" and the battle is lost.
The collection of the data required for performance measurement must not introduce additional waste.
Value Stream Performance Measurements
In contrast to the cell measures, value stream measures assist the continuous improvement team in achieving the overall objectives of lean. They seek to answer such questions as " Are we meeting our goals for flow, pull and perfection?". Are we improving the overall production of our production process through our lean initiatives?" Consequently such items as lead time, first time through, average cost per unit, sales per employee and on time delivery are measured. Based on these measures the continuous improvement team can isolate the constraints to achieving the goals and focus on right problems to improve lean performance.
But whether it be at the cell or value stream level, a good touchstone for performance measurement is that no data will be gathered that is not already required to control the production process. It is not always possible to adhere to this dictum, but it is an excellent starting point. Most companies collect too much data, have too many transactions, and too many reports. Lean accounting savagely eliminates transactions. There is a subtle issue to be resolved. The question is this: "How much tracking and checking of production is required to have the operation under good control ?" The lean answer is: very little.
A lean manufacturing company is concerned about controlling the value streams through day-to-day visual control and week-by-week continuous improvement. It is not necessary for the information systems and accounting systems to track and check the process. The cells are driven using simple and effective, focused shop-floor measures by cell leaders who are experts in their own value stream. It is not necessary for an accounting system to measure and track these issues(5). The performance measurements must serve the cell and value stream leaders’ needs; not the other way around.
Measuring and Managing the Financial Benefits of Lean
When lean is introduced the executive of the company expect to see tangible financial improvement. Often there is no improvement, and sometimes the opposite occurs. Often it is heard among financial people, "If lean is so great, why can’t we see any financial benefit?"
The reasons why financial benefits can’t be seen even in the face of significant operations improvement is that financial and cost accounting are designed to match the costs with the revenue produced from sales. They take their inputs from the expenses for the period as recorded in the books of the company. There is no provision for showing the financial effects of reduced production lead time, improved quality, on-time delivery and the like. And if the company is writing the same checks for employees, the accounting system assumes that the amounts spent are what it cost to produce the revenue for the period.
What is needed is an analytical tool that shows the effects of lean upon the resources used. For although the effects can not be seen in the aggregate, lean improvements cause a decided change in how the resources are used—shifting from non productive uses such as change over, rework, making excess to making them available for increasing the business or for elimination. From the point of view the value stream manager and senior manager, two questions are thus important at the time lean is being planned. The first is "How much capacity will be made available from the lean initiative?" and the second is "How can that capacity be used to grow the business and improve profitability?"
The method used to answer these questions is an extension of the process used to design the value stream. Value stream design most commonly done at the beginning of the lean process using a technique called value stream mapping. Value stream maps depict the "current state" pre lean and the planned "future state," charting the flow of the manufacturing process before and after lean. In order to understand how capacity is used, we must understand the activities taking place within the value stream and the employee and machine time consumed performing them. Information about activities is derived from the information about each manufacturing process that is included on "data boxes" on the value stream maps. Using the data-box information, the uses of resource capacity can be derived--whether used productively, non-productively, or available to be redeployed—and compared before and after planned lean improvements. The resulting comparison thus shows the effects of lean on the way resources are used and provide the basis for planning the best ways to use the capacity freed up.
While non-financial performance measurements can provide excellent motivation towards lean goals, we need a clear understanding of cost if we care to achieve customer-focused price targets through continuous improvement. Tracking the actual costs of a value stream leads to alignment of cost reporting and lean goals.
Yet the use of standard costing by lean manufacturers inevitably leads to difficulties in sustaining enthusiasm and support for lean. Some of the problems ouR clients experience as they become more mature in their lean implementation are as follows:
- Distortions of profitability due to inappropriate overhead allocation methods
- Motivation of non-lean behavior such as large batches, over-production and make-for-inventory approaches to absorbing capacity freed up by lean
- Requirement for significant and wasteful detailed reporting of so-called "actual" information about labor hours, material usage and job steps processed
- Considers labor a variable cost when for practical purposes it is largely fixed.
So the question that lean companies must face is what purpose their standard costing systems serve and the conditions under which they could be done away with and replaced by a method that is simpler and consistent with the goals of lean. The method we recommend to our clients is what we call value stream direct costing, in which all costs incurred by the value stream are charged into a cost pool for that value stream. The product cost is then the average cost of items manufactured by the value stream during the period. A depiction of the cost pool is presented below:
In practice the method has a great deal of similarity to process costing used by pipelines and other process industries. The justification for taking this approach is that as companies reduce lead times to a matter of days, practically eliminate inventories, they begin to have more of the characteristics of a process manufacturer that a producer of discrete products—that is the products flow through a process that is relatively fixed and homogeneous for all products.
The direct costing method has distinct advantages:
- Simple and easy to use
- Useful for measuring the performance of the value stream "Average Cost per Unit")
- Eliminates the need for transaction and overhead allocation.
But the ability to use it is predicated upon a company’s hitting certain milestones in its lean maturity path—namely, short lead times, low and stable inventory levels, and most of the resources required to run the value stream organizationally within the value stream. As a company moves closer to operating as a lean enterprise the manufacturing processes cease operate like a traditional job-shop or batch production. The focus on production flow through the value stream means that the operation begins to look more like process manufacturing. The management accounting needs to reflect this. Value stream costing has similar attributes to the process costing that has been used by process manufacturing organizations for decades.
A concern often expressed when we talk about value stream direct costing is that not all the products made by the value stream are the same—some are more difficult to make than others, so much so that a simple average would seriously distort their costs. In such cases we advise clients to supplement the average costs with a technique known as "Features and Characteristics Costing" In this approach the features and characteristics of a product that cause it to be more difficult to manufacture are identified and the average cost factored to take account of the relative additional effort.
The exhibit below depicts the process we recommend for calculating and using the features and characteristics method:
The features and characteristics approach enables product costs to be calculated using a few simple pieces of information about an item; and this information can be quickly and easily updated as the value stream process changes. Additionally, new products can be easily costed because the same features and characteristics can be assigned to new (or proposed) products.
An additional value of the features and characteristics approach is that it supports the top-down target costing philosophy that is essential for a company espousing the lean approach to customer value. Features and characteristics provide the direct link from a top-down target cost to the day-to-day activities on the shop floor.
Target Costing – Top Down and Bottom Up
The final element of lean management accounting is target costing and budgeting. There are two kinds of target costs; top-down and bottom-up. The top-down target costs are derived from an understanding of the value the customers recognize from the products and services the company provides. This value is then simply translated into the product cost required to meet the customers’ expectations and the needs of the company’s stakeholders. From this top-level target, individual target costs are established for the various features and characteristics of the company’s products and services. This breakdown then drives the cost reduction efforts of the business.
Bottom-up target costing complements the top-down needs by identifying, through the improvement cycle, how appropriate amounts of waste can be eliminated from the value streams throughout the organization. By carefully identifying the waste within a value stream and the root causes of that waste, the value stream owners can confidently commit to the achievement of certain cost savings.
Bottom-up target costs are set as a routine part of the continuous improvement cycle. Just as all the performance measurements used for a cell (or other) value stream will have carefully evaluated targets, so the product or service costs will also have targets. These targets must be specific values and be linked to a specific attainment date, and are derived from two sources. One source is the improvement team recognizing the cost savings that will result from their current improvement efforts. The other source is from senior management creating cost reduction policies in line with the customer-driven requirements of top-down target costing. A cell’s improvement team will use both these methods to create an impetus for change and improvement.
Many companies attempt cost reduction programs by an edict from the top. The order is made to cut costs by 25%. But traditional companies have no consistent and effective mechanism for understanding and removing cost. Lean management accounting provides a clear understanding of where the costs derive and also what must be done to achieve the cost reduction. This provides senior managers with the information required to make intelligent and radical cost reduction without the classic, ignorant "slash and burn" of the re-engineering and down-sizing days of the early 1990’s.
Lean cannot be sustained long-term without changing the traditional measurement and management accounting processes. This paper has presented the basic elements of an approach that supports the goals of lean manufacturing and that provides information to maximize the financial benefits from lean. By implementing the methods in conjunction with a well designed lean manufacturing initiative, managements can be assured that lean will become more than an initiative but a way of managing the enterprise for growth and profitability.
1. Lean Thinking by James P Womack and Daniel T Jones, Simon and Schuster, New York, New York, 1996
2. Many people refer to Shingo’s Seven Wastes: waste of processing, waste of waiting, waste from defects, waste of motion, waste from inventories, waste from over-production, and waste of transportation. (see Non-Stock Production by Shigeo Shingo, Productivity Press, Cambridge, MA 1988)
3. Backflushing is a technique widely used by lean or world class manufacturing companies to eliminate transactions. When a production completion is reported the information system records the completion by an inventory transaction and related financial transaction. The system then goes on to record the raw material and component transaction corresponding to the completed job. This is achieved by reading the bill of materials for the item manufactured. The labor hours, machine hours, and other direct costs are posted through reading the production routings and standards associated with the manufacture of the items. Backflushing in lean accounting often also posts the activity costs associated with the production.
4. In this discussion we will refer to production cells as the building blocks of a lean operation. The same is true of engineering teams, design groups, sales teams, customer support teams. The lean approach is not restricted to manufacturing. Proponents of lean thinking of use the term lean enterprise to show they are referring to the entire organization and not just manufacturing.
5. You don’t need a weatherman to know which way the wind blows. (Bob Dylan, Subterranean Homesick Blues, 1965)
6. Feature Costing: Beyond ABC by James Brimson, Journal of Cost Management, Jan/Feb 1998 Volume 12 Number 1