Jamie Flinchbaugh invited me to his People Solve Problems podcast recently. In this podcast we talk about how lean accounting can help people solve problems. I would also like to add that I read his book – People Solve Problems and it had an influence on me in regards to how I explain the link between lean thinking and lean accounting. I highly recommend reading this book. Thanks again Jamie!
Author: nkatko@maskell.com
The Benefits of a Pull System: A Chat with Phil Ledbetter
I sat down with my friend Phil Ledbetter, who worked at the Toyota plant in Kentucky for 16 years and is the author of The Toyota Template, to talk about the benefits of a pull system in manufacturing.
I read his book prior to its publication and it’s a very good summary of how various lean tools and practices, such as kanban and TPM work together to create a pull system that serves customers better, improves productivity and improves financial performance.
If you would like to watch the chat, here is the link:
https://youtu.be/HPf4Z2sa-s0
Lean Accounting Lesson – Lean Cost Management
Want to learn how lean & lean accounting work together to reduce costs over time? Here are five videos, each less than 5 minutes in length, which explain lean cost management.
How lean drives cost reduction over time:
The Real Relationship between Costs & Time
One of the primary weaknesses of a product costing system is the fact that the longer it takes to make a product, the more it appears to cost. This is because the direct labor dollars associated with any product are calculated based on the direct labor rate multiplied by the standard production time. Additionally, overhead is calculated based on the direct labor dollars multiplied by the overhead rate. This appearance of a higher cost can lead to poor decision making regarding pricing, make or buy or product rationalization decisions.
The product cost calculation makes it appear as if direct labor and overhead costs are variable, based on time to produce as the driver. In reality, direct labor is a fixed cost. Your full-time employees are paid the same no matter which products are produced. Likewise, just about all overhead costs are also fixed, meaning they don’t vary directly based on labor time.
In lean accounting, the relationship between costs and time is based on developing an understanding of what is driving time, or capacity. The time of your employees can be spent creating value (value-added capacity) or not creating value (non-value added capacity). The amount of time spent on each is a function of process performance, not people performance. The more non-value added activities there are in a process, the more people you will need.
Here is a simple example. If 50% of a value stream’s time is spent on non-value added activities, and you need to hire one employee, you will have to hire two employees to get the output of one because there is 50% waste in the value stream.
Your labor cost is a function of the amount of capacity you need, which is driven by expected demand and the amount of non-valued added activities in your value streams. Want to do a better job of managing your labor costs? Don’t focus on the direct labor of the products, focus on understanding capacity of the value streams.
If you focus on continuous improvement, you will eliminate waste and create capacity, which you can utilize to create more value (and more sales) or reallocate to not have to add more people (and add cost). That’s the economics of lean in action.
Conversations, not Conclusions
One of the primary differences between traditional management accounting and lean management accounting is lean management accounting focuses on creating conversations, while traditional management accounting focuses on drawing conclusions.
In traditional management accounting, information about past performance flows upward in a company to accounting and executives, who draw conclusions about performance and dictate “changes” that need to be made. It is then up to the managers to implement the changes dictated.
Lean management accounting focuses on creating cross-functional, collaborative conversations about current operating and financial performance and how to improve both over time. These conversations focus on understanding the true cause-effect relationships between lean operating practices and financial performance. Box Scores drive this conversation.
The effectiveness of lean operating practices are measured by the Box Score’s lean performance measurements. Capacity measures how effectively a value stream is “spending its time” on productive, value-added activities or nonproductive, non-value added activities. Capacity also measures how much capacity is created by improvement activities – available capacity. The value stream income statement in a Box Score reports the actual revenue and actual costs of a value stream.
The three components of a Box Score create conversations around questions such as:
- What level of improvement is necessary to actual serve customers better and drive sales growth?
- What is the financial impact of improving quality, delivery and lead times?
- If we want to improve financial performance, what operational changes and improvements are necessary?
- How do lean practices manage costs?
- How can we increase capacity without increasing costs?
- What is the operational and financial impact of a business decision we have to make?
The relationships between lean operating performance and financial performance are dynamic, not static. Understanding these dynamic relationships requires using PDCA to understand the root causes, and PDCA requires the right people to have a conversation and draw the right conclusions about root causes.
Want to ensure the success of a lean management accounting transformation? Don’t think of a Box Score as a method of reporting, think of it as a conversation piece to be discussed.
Podcasts – Practicing Lean Accounting
Here is a list of podcast links where we discuss our new book Practicing Lean Accounting:
Podcast Links – Practicing Lean Accounting
Mark Graban
Stephen Dowling
Mark DeJong
Katie Anderson
Gemba Academy
How Lean Thinking Improves Financial Results While Avoiding Traditional Cost Cutting
This blog is an article Mike De Luca wrote for the LEI Lean Accounting Newsletter.
In July, Nick Katko and I presented a webinar for LEI called “How to Use Lean Accounting to Help Design Profitable Value Streams.” As part of reviewing the core concepts of lean accounting, we said that lean is not a cost-cutting method. After the webinar, we received a very thoughtful question from an attendee about what might seem to be a contradiction. The attendee asked how to reconcile our comment that lean is not a cost-cutting method with our discussion on how to improve value-stream operating profit by understanding the lean accounting thinking behind cost drivers. I always appreciate questions like this since they help me clarify my thinking and improve how I communicate it to make it clearer to the audience. I responded directly to the attendee, but this point comes up so often that I wanted to share some thoughts about it and invite a constructive discussion.
“Long-term financial improvement is an outcome of a lean strategy. Lean is not a short-term cost-cutting methodology.”
— from the book Practicing Lean Accounting by Mike De Luca and Nick Katko
In our recently published book Practicing Lean Accounting, Nick and I discuss cost improvement in the chapter on lean thinking for accounting: “Long-term financial improvement is an outcome of a lean strategy. Lean is not a short-term cost-cutting methodology. Although some companies have better financial results as an early by-product of their lean strategy, there is usually a lag between operational improvement and sustained financial improvement. This lag occurs because learning and improvement take time.”
Distinguishing Between Cost-Cutting and Cost-Improvement
First, I’d like to distinguish between my use of the terms “cost-cutting” and “cost-improvement.” I use the phrase “cost-cutting” to refer to what, in my experience, are periodic (often during the annual budget process) reductions to the cost structure that may not be strategic or sustainable long-term. Instead, such cuts are made to balance a budget or meet a short-term organizational cost-reduction imperative. Cost-cutting in isolation, even using lean approaches (and I would say that this is a misuse of lean thinking), may not be aligned with the organization’s strategic priorities. Misalignment occurs when short-term cost-cutting distracts leaders from focusing on – or undermines their ability to invest in – continuously improving customer value. In particular, cost-cutting will not align with lean principles if used as a method to make reductions in force. How can we engage everyone in the organization in driving out waste from their work – and creating capacity that can be redeployed strategically – if they risk losing their jobs in the process?
On the other hand, I use the term “cost-improvement” to refer to the methodical approach of identifying value-added and nonvalue-added activities and applying lean thinking to eliminate the waste and improve the quality, delivery, and cost of those activities. To support this work, lean accounting professionals must help the organization understand both the lean perspective on how costs behave as well as how best to measure the financial impact of our improvement efforts.
This explanation may seem like unnecessary or esoteric mincing of words. However, the point is to understand and be clear on both the intent of and approach to the work of cost management. For example, is the intention to align with the lean strategy, and is the approach to engage the people who do the work in identifying and eliminating the waste without concern for their job security?
Gaining a Clearer View of Cost-Improvement
Next, I’d like to address the statement that better financial results can be an early by-product of a lean strategy. Again, the key point here is about the company’s intent in adopting lean thinking. There are likely companies where a strategic imperative to cut costs prompted their adoption of lean management. Still, I would argue that if they’re faithful to lean principles, they improve their cost structure with a focus on – and certainly not to the detriment of – delivering customer value and modeling respect for the people who do the work.
I think it’s helpful here, especially in understanding the importance of lean accounting practices, to refer to Taiichi Ohno (industrial engineer, businessman, and father of the Toyota Production System), who is quoted as saying, “Costs do not exist to be calculated. Costs exist to be reduced.”
“Instead of being creative with accounting, Ohno advocated reducing cost by being creative in how we look at our work to find ways to make it easier, better, and faster.”
— Jon Miller
In a 2019 blog, “Not All Costs Exist To Be Reduced,” Jon Miller says, “His [Ohno’s] point was that traditional accounting can fool us into justifying inefficient operations, building up inventory, or acquiring assets because the numbers look good. Instead of being creative with accounting, Ohno advocated reducing cost by being creative in how we look at our work to find ways to make it easier, better, and faster. Today, there are lean accounting methods that allow us to reflect the reality of costs more accurately in a lean operation, where traditional cost accounting does not.” Miller goes on to say that “focusing [solely or primarily] on costs can limit opportunities for value creation.”
For me, then, an organization’s cost-improvement approach must come back to its strategy. What does the company need to accomplish or become capable of in order to grow and thrive in serving its customers? It may be cost improvement, creating capacity, improving quality or delivery, accelerating innovation, or a combination of these. At the same time, I think it’s important to remember the lean tenet of respect for people, that the lean strategy is grounded in people-centered learning and improvement. With clarity around both strategy and intent, organizations can drive meaningful, sustainable, and best-in-class improvements to financial performance.
Improving Accounting: Error Proofing
Chapter 7 – Improving Quality in Accounting: Error Proofing
The Practicing Lean Accounting Blog Series are excerpts from a new book, Practicing Lean Accounting by Nick Katko and Mike De Luca. For updates on publication and purchase, please sign up for the BMA mailing list at www.maskell.com.
Improving quality: error proofing
In lean accounting, the approach to improving quality is called error proofing. Error proofing is a systematic approach to reduce defects over time by:
- Detecting defects as rapidly as possible
- Reducing the effect of defects that occur
- Preventing defects from occurring
DETECTING DEFECTS PROPERLY
In an error proofing system, detecting defects rapidly means creating a systematic response in daily accounting activities after a defect is detected. Defects need to be measured and initial root cause analysis performed on a daily basis.
Daily measurement of the defect rate creates visibility by turning something abstract – a defect in information – into a number everyone can see. It reveals the extent of the problem and also measures the impact of improvements being made. A defect rate measurement can be broad, the total defect rate, or more specific, such as defect rate by type, to achieve greater visibility into the extent of the problem.
REDUCING THE EFFECT OF DEFECTS THAT OCCUR
In lean accounting, a defect in an accounting process is considered an abnormal condition and, as we explained in daily lean management in Chapter 6, standard responses need to be developed to reduce the effect the defect has on the process.
Standard responses are how the process, and the employees working in the process, should react to the defect. Standard responses can contain the following elements:
- A target resolution time
- A specific sequence of activities
- Dedicating a portion of a process team’s daily capacity to defect resolution
- Specific responses based on the source of the defect – inside accounting, inside the company or outside the company
PREVENTING DEFECTS THROUGH PROCESS IMPROVEMENT
The third step in an error proofing system, is to build fail safe mechanisms into processes and activities to:
- Prevent defects from occurring (the ideal solution) or
- Detect defects at the source and prevent defects being passed to subsequent process steps (the next best solution)
In error proofing in lean accounting, go see is the essential method to improving processes to prevent defects because the source of most defects occurs outside the accounting function. Go to the source of the defect and observe the specific activities of the work performed. Identify the root causes of why the defect occurs.
If the source of the defect is outside of accounting, but within the company, it’s best to use a cross-functional team for any improvement activity. If the source of the defect is outside of the company, it may not be possible to do a physical go see, but it is possible to apply PDCA to any defect to determine the root cause. It’s important to note here that there may be limitations to the amount of improvement which can be done with parties outside of a company if this is the source of the defect.
Here is an important point to remember regarding any process improvement for defects that requires cross-functional support. Fixing defects impacts the party where the source of the defect occurs as much as it does accounting. When accounting can take the initiative to work collaboratively to eliminate defects it discovers, it will benefit the other party as much as it does accounting.
ERROR PROOFING WRAP UP
Defects are the bane of accounting’s existence. As such, it is a great place to begin improving accounting because of the immediate impact it can have on process performance and the burden of work on accounting teams. Developing an error proofing system is also a great way to learn and demonstrate PDCA in all accounting processes – payables, receivables, payroll and month-end.
Practicing PDCA in Lean Accounting
Chapter 6 – Practicing PDCA
The Practicing Lean Accounting Blog Series are excerpts from a new book, Practicing Lean Accounting by Nick Katko and Mike De Luca. For updates on publication and purchase, please sign up for the BMA mailing list at www.maskell.com.
PDCA is Plan, Do, Check, Adjust
The easiest and simplest way to describe Plan Do Check Adjust is the application of the scientific method inside businesses. The scientific method is a rational, rigorous methodology to test a hypothesis through systematic observation and measurement. It’s how scientists conduct an experiment and study the results of the experiment to determine if it was successful or not.
For lean organizations, PDCA is both a framework for thinking and the specific steps to solve problems. PDCA can be applied to a single issue, to deal with the natural problems that occur during a work day in any process and to reduce recurring problems through designing and implementing an improved process. Because PDCA is a rational thinking process, it must be learned and practiced regularly, which means not skipping any process steps or abandoning it in favor of top-down management practices when managers see fit.
PDCA for Improvement
In lean accounting, teams learn to apply PDCA to problems and opportunities of various scopes and sizes to drive continuous improvement. The PDCA approach always follows the same thinking, but the amount of effort to complete an improvement activity is directly related to the scope. For small scope improvement activities the PDCA cycle can be quite short and can be part of a regular daily work routine in daily lean management. Larger-scope improvement activities take more time and effort to complete the PDCA cycle and they need to be planned and scheduled.
Scoping and managing continuous improvement is necessary for a few reasons. Employees must dedicate time to improvement, so there needs to be a balance between improvement activities and work responsibilities. Continuous improvement should be considered a team-based learning process (rather than just something that is done alone), so it’s important to create coordinated activities and also share. Some employees may pick up on continuous improvement faster than others and it’s important not to get too far ahead of those who may need more time to learn. Finally, it’s important to strike a balance between smaller scope and larger scope improvement activities.
Based on our experience helping companies improve accounting, we’ve developed a framework to scope improvement activities:
Quick Wins
Quick Win improvements focus on the simple, obvious non-value added and unnecessary activities which can simply be stopped with no negative impact on delivering value. These can, and should, be completed in a short period of time, such as a day, once the team agrees on the change and how to check that it made an improvement.
Daily Improvement
When an improvement idea comes up that is within the accounting team’s control but bigger in scope than a Quick Win, the PDCA cycle typically takes one to two weeks. When the team holds itself to a short improvement cycle, it helps them move more quickly on small, incremental changes that will build on each other rather than trying to “boil the ocean” or get stuck in analysis-paralysis. These daily PDCA improvements can be accomplished in a series of short meetings (30 minutes) which follow the PDCA steps with follow ups in between each one.
Process Improvements
Process improvements are planned in advance with an objective of achieving specific, measurable improvements in process performance. Process improvement events usually focus on:
- Achieving a specific rate of improvement in a performance measure over a specified time frame
- Solving a recurring problem that was not able to be solved in Quick Wins or Daily Improvement activities
- Responding to a significant, sudden disruption in process performance.
Innovative and Transformational Improvements
These improvements focus on radical redesign of a process. In accounting processes, conventional transformational changes typically focus on software-based automation and workflow management. Many of these types of changes are top-down company driven rather than lean focused.
PDCA for Daily Lean Management
Daily lean management incorporates the four foundational practices (understand value, identify waste, using PDCA and lean measures) into a coordinated set of tools and routines designed for accounting teams to gain experience in these practices in the normal course of their work:
- Tools:
- Visual boards that the team uses to show the most important information about their work.
- Performance measurements that cover how the process is working as well as track improvement in outcomes.
- Routines:
- Daily huddles, stand-up meetings or status checks.
- Team problem-solving meetings.
Daily lean management focuses on planning the work, executing the work, reacting to abnormalities and identifying improvement opportunities for all accounting processes.
Planning the Work
Planning the work is a three step process:
- Understand the demand on the process
- Understand the available capacity of the process
- Prioritize demand against available capacity
Executing the Work
Disruptions are a natural occurrence in any business process, so “executing the work” in daily lean management is not only performing the tasks to meet the daily work plan, it is also establishing real-time “check and adjust” routines to identify abnormalities and having standard responses that minimize the impact on completing a daily work plan. Another way to say this is to developing “routines to handle the non-routine” or “standards to handle the non-standard.”
The Daily Huddle – Plan, Check and Adjust
The final component of daily lean management is the daily team huddle. Daily huddles are short (10-15 minute) “stand-up” meetings around a visual board. Daily huddles are conducted using a standard agenda to answer five basic questions:
- What is the plan for today?
- How did the process perform yesterday?
- What problems and issues did we encounter? (Capture data and analyze themes)
- What were the root causes of the problems and issues?
- How should we address the problems and issues?
PDCA is natural for Accountants
Because PDCA is an analytical, objective and numbers-driven improvement system, it plays right into accountants’ strengths and skills. Accountants spend a great deal of time performing financial analyses and drawing conclusions. PDCA leverages these natural skills, applying them to operational analyses and conclusions. An accountant’s world revolves around numbers. PCDA uses numbers and data focused on operational improvement, which accountants must learn how to use through the use of daily lean management practices, then apply to process improvements.
Using Lean Measures in Lean Accounting
Chapter 5 – Using Lean Measures
The Practicing Lean Accounting Blog Series are excerpts from a new book, Practicing Lean Accounting by Nick Katko and Mike De Luca. For updates on publication and purchase, please sign up for the BMA mailing list at www.maskell.com.
What sets lean performance measurements apart from conventional measurements is they are much more than reporting measures. They are part of a measurement system that is integrated into the daily work of process teams and are actively used to understand value, identify waste and practice PDCA. Let’s look at the four attributes which separate lean performance measurement systems from other types of measurements.
Relevant
Lean performance measurements must be relevant to the strategic objectives of lean – deliver value and eliminate waste. They must also be relevant to any specific process being measured to reveal the actual problems and issues that are preventing value from being delivered. Measuring the following criteria of process performance will ensure that a process team will have the relevant information for understanding operating performance and making improvements:
Delivery (“What by when”)
Customers value the on-time delivery of a product or service. This is a pretty consistent value proposition across all types of customers, companies and also business processes. The key component of measuring on-time delivery is basing it on when the customer wants delivery.
Quality (“Detect quality before delivery”)
In Chapter 3, we explained one aspect of customer value is a certain level of quality specifications which must be achieved by any business process. It’s best to measure defects as frequently as possible; frequent feedback helps to understand the root causes of defects.
Lead Time (“Speed is a competitive weapon”)
Lead time measures the length of time it takes a process to “complete an order.” Lead time is an important measure because it reveals both how the process performs as well as the delays between process steps. Average lead time is measured in the unit of time, (weeks, days or hours), which is most applicable to the process being measured.
Productivity (“Increasing output with same resources”)
Another impact of reducing waste and applying available capacity to value added activities is improving the productivity of any process. Productivity can be defined as increasing the output of a process with the same resources.
Cost (“Costs do not exist to be calculated. Costs exist to be reduced.” Taiichi Ohno)
Accounting and accountants spend a great deal of time calculating and analyzing costs. What is important for accounting to understand is that many of the conventional methods of cost analysis it uses may not work well in lean organizations as performance measurements of cost.
Lean thinking decreases costs over time in two ways:
- Improvement activities can generate actual cost savings that can be specifically identified during an improvement activity, such as a reducing overtime or scrapped/wasted supplies. These actual cost savings will be realized in the short-term on an income statement.
- Improvement activities can possibly prevent future cost increases. As we have previously explained (and will be repeated many more times in this book!), improvement activities create capacity in a process. Applying this available capacity to value added activities improves productivity and has the financial impact of avoiding future cost increases, such as hiring more employees, to meet increased demand on a process. There is no short-term realized cost savings but the growth rate of costs in the long-term will be reduced.
Safety
The typical lean measurement of safety is Incidents per Employee. Conventional thinking on measuring safety is that it’s primarily in manufacturing or healthcare. Safety in service businesses is also quite important. Conditions like repetitive motion injuries (e.g. carpal tunnel syndrome) and eye strain from computer use can impact employees in service businesses. Also the idea of psychological safety which has to do with respect for people!
Morale: Respect for People
Lean performance measurements for morale focus on getting real-time feedback and measuring what contributes to desired outcomes. This can be done through simple and frequent staff input. Teams can check morale during their daily huddle for feedback about how well the team feels set up for success that day (good/neutral/bad) and track trends over time. Or the team will be asked if they went home yesterday evening feeling good about their day or not.
Process Team Ownership
Process teams “own” their lean performance measurements. Process teams often calculate their own performance measurements, rather than having them calculated elsewhere in the organization. Calculating measures drives a better understanding of their purpose and creates ownership. The purpose of teams defining and calculating their own measures is for the team to understand and use them to identify improvement opportunities.
Process teams self-monitor and self-report their performance measurements through the use of visual performance boards. Process teams are also responsible for using their lean performance measurements in performing PDCA to determine and address the causes of both positive and negative performance factors.
Measure Frequently
Typically lean performance measurements are a combination of daily, weekly and monthly measures each used for a specific purpose, as we will now explain.
Daily Measures for Process Control
Daily measures are best for process control and detecting abnormalities in process performance, and they align with daily lean management practices. Daily measures answer questions such as:
- How did the process perform today relative to requirements, targets or expectations?
- What problems & issues were identified?
- What is being done to address these issues?
Weekly Measures for Improvement
Weekly measures focus on measuring process improvement over time (such as lead time and productivity), rather than daily process control. The purpose of weekly measures is to determine the specific, recurring wasteful activities which are impeding the delivery of value, then conduct process improvement activities.
Monthly Measures for the Lean Strategy
Monthly measures focus on measuring lean thinking from a strategic viewpoint. Lean organizations develop specific initiatives as part of their strategy deployment process. Monthly measures answer the question: Are the initiatives successful? Monthly measures allow company leadership to gauge whether adjustments need to be made to any initiatives. Like improvement measures, targets are usually set for strategic measures. These targets are usually annual targets.
Create Visibility into Problems
Improvement can only occur if process problems are revealed, become visible and the extent of problems can be quantified. This is one characteristic by which lean performance measurements differ from conventional measurements, which focus more on reporting. Successful lean transformations focus on employees identifying the right problems and solving those problems using PDCA. Lean cultures embrace understanding process problems and openly discuss problems with no fear of personal blame on anyone.
Lean Measurement Wrap Up: Measures that Matter
In the 21st century most companies rely on information technology systems to “run the business” and these systems create the capability to measure almost anything. In lean accounting, it’s important to measure what matters:
- Serving customers better
- Learning and improvement
- Problems and issues
The seven categories of lean performance measurements create objective visibility and insight into process performance, and they create the opportunity to use the measures, in conjunction with PDCA, to drive improvement throughout a company. Let’s now move onto Chapter 6 – Using PDCA.
