Lean Thinking for Lean Accounting

Chapter 2 – Lean Thinking for Accounting

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.

Lean thinking for accounting does not require you to become a lean expert. But it does require you to understand lean from different perspectives, all of which have an impact on both a company and a company’s accounting function. 

There are five perspectives of lean thinking which will impact a company’s accounting function: 

  • Strategy
  • Financial performance
  • Operating practices
  • Management practices
  • Culture

Let’s look at each perspective in detail, and examine their relevance to lean accounting. 

Lean as a Strategy

Lean thinking forms the foundation for a comprehensive business strategy. The overall goal of a lean strategy is to strive to serve customers better. Because a lean strategy is principle-based, it takes a long-term view of the business rather than a short-term view. Lean thinking principles also align the entire organization with the strategy. Because there is one overarching, never-changing goal – serving customers better – each business function learns and understands its role in helping the company to achieve that goal.

A lean strategy focuses on people-centered learning and improvement.  Successful lean transformations focus on employees identifying the right problems, and then solving those problems using the scientific method. Employees are constantly learning through the use of new practices, tools and methods that develop and deepen their skills. The result of this learning is improvement. Learning and improvement take time, which contributes to the long-term view of a lean strategy. 

Financial impact of a lean strategy

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. 

The primary outcome of most continuous improvement efforts is creating time, or as we shall call it in this book, capacity

The economics of lean will impact a company’s income statement and balance sheet. Serving customers better can possibly create a competitive advantage for a company, which will drive sales growth. From a cost perspective, continuous improvement becomes the primary method to manage costs, either by avoiding cost increases or reducing actual costs. On the balance sheet, lean can make a balance sheet stronger by increasing cash, decreasing inventory, and reducing debt. 

Operational impact of a Lean strategy

In Lean accounting, the operational impact of a lean strategy will impact accounting in two ways. First, to achieve sustained improvement in accounting processes, those processes must be managed and measured differently on a daily basis. Second, lean operating practices and measurement in value streams can be used by accounting to gain new insight into the true cause-effect relationships between business operating performance and financial performance. These new insights can be used to leverage sustained financial success. 

Managerial impact of a lean strategy

Lean organizations recognize that customer value is not created vertically, but horizontally through an organization, in value streams. A value stream is simply all of the actions, completed in the proper sequence, at the proper time, necessary to create value for a customer. 

Value streams have a significant impact in lean accounting, from both a financial perspective and an organizational perspective. From a financial perspective, value streams are the profit centers of a lean company – value streams generate revenue. And as profit centers, they also have costs. In lean accounting, value stream teams are accounting’s customers, requiring relevant and reliable information to optimize value stream performance and improvement. 

Accounting will gain new and valuable visibility into the links between overall financial performance and value stream performance by partnering with value stream teams in practicing lean financial management. 

Impact of Lean Strategy on Company Culture

The foundation of a lean culture is respect for people. Respect for people means lean companies “walk the talk”: they proactively create a psychologically safe, but challenging, environment for their employees. 

When modeling respect for people, an organization continually looks at what is getting in the way of employees being successful in their daily processes, and collaborates with them to identify and eliminate those barriers. In this way, an organization ensures the highest and best use of employees’ skills and capabilities in providing products and services to its customers. Respect for people creates empowerment and engagement at all levels of the organization – an “army of problem solvers” working together to deliver customer value.

Respect for people is also about challenging employees to new levels of service. For example, accounting’s traditional focus is on developing the technical skills of the accounting team. In Lean accounting, the goals are to balance the team’s technical expertise with focus on creating ways to better serve accounting’s customers. 

A Lean culture impacts lean accounting in these ways:

  • Learning – accountants are “doers” by nature, focusing on getting their work done. In Lean accounting, time must be set aside for learning both in daily work and periodic improvement activities.
  • Growth – improving technical competence in accounting is the conventional approach to accounting employee growth. In Lean accounting, that is still important, but must be balanced with developing a deeper understanding of the relationships between people, process, and performance in a Lean company.
  • Investment – in Lean accounting, the accounting function is not considered an “island of isolated experts.” Accounting must invest time, to incorporate Lean accounting practices into all aspects of their work.
  • Collaboration – Improving accounting will require collaboration with the cross-functional business processes of which accounting is a part. Lean financial management will require teamwork between accounting and operations. 


The accounting function in any company is much more than doing bookkeeping. Likewise, an accounting team is much more than bean counters. Accounting validates the financial impact of a company’s strategy. Accounting reports and analyzes financial performance at all levels of the company, which has a great deal of influence upon how a company is managed. Accounting influences company culture by serving as a company’s independent, objective, trusted advisors.

For these reasons, lean thinking for accounting requires understanding lean from different perspectives, in order to develop lean accounting practices and transform the accounting function from primarily transaction processing to lean financial leadership. 

Practicing Lean Accounting

Chapter 1 – Practicing Lean Accounting

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.

The way the accounting function works, and the way accountants think, is very transactional. Accounting must process transactions based on specific time-frames: enter invoices daily, pay employees bi-weekly, pay suppliers weekly, close the books each month, send out monthly reports and analyses. These work routines create thinking patterns which focus on getting the work done to meet the deadlines. There is nothing wrong with this thinking, because it creates reliable and respected accounting functions in companies, which is a good thing. 

But to grasp lean accounting, the accounting function must expand its thinking beyond transactions, and into practices. Lean accounting is about continuous improvement, which means that the process of striving to improve never ends. Continuous improvement is not transactional, but must be practiced. The old saying “practice makes perfect” is applicable to lean accounting. The more that these new practices are mastered, the better you get at lean accounting. 

Lean accounting, simply defined, is the application of lean thinking to all accounting systems and processes – all of the roles and functions we just mentioned. What is unique about lean accounting, compared to other applications of lean thinking, is how it is applied to the dual roles of accounting. 

The overriding purpose and goal of lean thinking, in any industry, is to serve customers better. In financial accounting processes, what customers want is common knowledge, such as paying invoices on-time or closing the books quickly. In lean financial accounting, it’s about how to deliver these products and services in the least wasteful way possible. Lean accounting is about paying invoices on-time without having to get last minute approvals. Lean accounting is closing the books on-time without working punishing overtime.

Management accounting, on the other hand, is responsible for providing information (products) and consultation (services) to many internal users. The value that internal users receive from management accounting is the “decision-usefulness” of its products and services. Internal users want management accounting to provide clear insight into both financial and operational performance to make decisions that help the company achieve better results. Management accounting deals with the financial management of the entire company. 

Here is a summary of the practices of lean accounting

Foundational practices – These are standard lean practices which must be learned and mastered for any lean transformation.

  • Understanding Value. Accounting needs to think differently about who accounting’s customers are, what their needs are, and how accounting meets those needs.
  • Identifying Waste. Accounting needs to think differently about how it performs its work. What activities are really helping accounting serve its customers? What activities get in the way or slow down serving customer? Accounting may have gotten so used to these activities that they consider them to be “normal”.
  • Lean Measurement. Accounting needs to think differently about how to measure progress and results in a lean company, beyond the monthly financial statements.
  • Using PDCA. Accounting needs to think differently about managing and improving day-to-day work and how to begin eliminating all the activities that don’t serve its customers.

Applied practices. This is how the foundational practices are used to transform an accounting function into a lean accounting function.

  • Improving Accounting. Accounting needs to think differently in order to improve accounting processes. Accounting needs to look at its processes from a lean point of view, using all of the foundational practices, rather than simply from a technical point of view. Accounting will also have to collaborate cross-functionally, to drive long-term sustained improvement. 
  • Lean Financial Management. Accounting needs to think differently about the information and analyses it provides to internal users in a lean company, again using the foundational practices to inform this change in thinking. Accounting needs to lead in terms of aligning information and analytical practices to support a lean strategy. 

Sustaining practices. This is how lean accounting can provide leadership for a company’s lean transformation. 

  • Lean Financial Leadership. Accounting, and companies, both need to think differently about the role that accounting plays in a lean company, with regards to supporting and sustaining improvements, not just in accounting, but across the entire company, to realize the financial benefits from its lean strategy.

Understanding Customer Value: How Accounting Applies this Foundational Lean Concept to its Work

Excerpted and adapted from the upcoming book Practicing Lean Accounting by Nick Katko and Mike De Luca, to be published in early 2021.

Why does Accounting need to understand customer value?

Accounting is a highly specialized, technical function in a business. Becoming proficient in accounting requires education and practice. Accountants focus on being good accounting professionals, running an efficient accounting department, and getting work done in compliance with their company’s accounting policies and reporting requirements.

Sometimes, though, accounting can focus too heavily on compliance reporting, a very narrow definition of customer value and requirements. When that happens, it blinds accounting to what their other customers value. Accounting can be so focused on the monthly reporting cycle, along with the applicable controls and policies, that accounting assumes this information also satisfies what its other customers want. This assumption can lead to accounting appearing to be out of touch, isolated, or difficult to work with and lead to accounting having a poor reputation inside a business.

The nature of accounting’s work and interaction with others tends to create transactional relationships. In lean accounting, the goal is to put the entire customer experience first in thinking, not just the transaction. To better understand customer needs and requirements beyond the transactions, accounting may need to develop better relationships with their various customers.

Understanding customer value will also allow accounting to better determine if the quality of the information or service it provides meets its customers’ needs. This is not to say that accounting does not already have some understanding of this, which it does from a financial reporting viewpoint and typical financial transactions such as paying invoices. Diving deeper into understanding value will prevent accounting from making assumptions about the quality of the information it supplies to its internal customers.

Another important benefit to accounting in understanding customer value occurs when accounting begins to study and improve its processes. The principle of flow and pull means that accounting’s goal, like any other function, is to flow value to customers at their rate of demand. To understand if you are making progress toward achieving a goal, you must measure it. Understanding value will allow accounting to develop the proper performance measurements to know in real time if value is being created and delivered.

Making improvements is not a haphazard, random process. It’s a disciplined, continuous learning activity requiring the ability to distinguish between the process steps that create value and those that do not. When customer value is understood, it becomes possible to differentiate between process steps that create value and those that do not. Focusing more effort on the value-creating activities and eliminating or reducing nonvalue-added activities results in a better customer experience and, ultimately, increased customer satisfaction.

Customer Value for Accounting’s Customers

Accounting has a variety of customers, both internal and external. Rather than address each type of customer specifically, let’s look at the broader categories of customers based on their primary interaction with accounting, what defines quality, and what informs their experience.

Customer categoryQualityExperience
Users of external reporting information (senior leaders, shareholders, investors, boards, etc.)Compliant with reporting requirementsRational explanations to make informed decisions, evaluations, and assessments
Recipients of financial transactions (company customers, suppliers, employees)Right the first timeTimeliness; ease of interacting with accounting to understand the process and get support as needed
Users of internal reporting information (all levels of management)Relevant and reliable informationA clear understanding of performance to make better-informed decisions and take appropriate action

Users of external reporting information

This group of accounting’s customers includes internal customers, such as senior leaders or owners; stakeholders, such as investors, shareholders, and banks; governing bodies, such as boards and trustees, government, or other regulatory agencies. These users value information that meets reporting compliance requirements and allows them to make informed decisions about a company and evaluate its performance.

As most accountants know, meeting compliance reporting requirements is one of the essential responsibilities for an accounting function. It is the fiduciary responsibility of the accounting function to a business. Accounting professionals are trained in compliance. Because compliance is so important, accounting processes, controls, and procedures are put in place to ensure compliance is achieved before the information is distributed to these customers. Unreliability – or the perception of unreliability in accuracy or timeliness – in externally reported financial information can have grave consequences for a company.

Because accounting understands value to these customers quite well, there is an opportunity  to develop a better understanding of the processes that create this value. Improving these processes through the elimination of waste will create more capacity (time), allow the work to flow faster and error-free, and possibly relieve overburdening of the employees who perform these activities.

Recipients of financial transactions

Accounting processes financial transactions between a company and other parties related to cash receipts and disbursements. The recipients of these transactions are another group of accounting’s customers and include a company’s customers, suppliers, and employees. What these customers value from accounting are  financial transactions completed “right the first time,” in a timely fashion, and for accounting to be easy to work with.

Company’s Customers

Accounting’s primary interaction with a company’s customers is through the invoicing or billing process. A company’s customers expect all the information on the invoices they receive from accounting to be accurate. Inaccuracies become especially annoying to customers if they sent the company a purchase order specifying all terms and conditions but received an inaccurate invoice.

Although accounting doesn’t provide the product or service that the customer is purchasing, it can shape the customer’s experience and impact customer loyalty through how easy and seamless billings and payments are.

Another thing to consider when determining value is to evaluate how easy it is for a company’s customers to interact with accounts receivable. Are invoices easy to understand? Are payment methods straightforward? If a customer has a question about an invoice, does accounting have a quick response time to an inquiry, and is the resolution process simple, friendly, and customer-focused? It’s situations like this, when the quality of an invoice is in question, that understanding customer value, in the eyes of the customer, is most important. Although accounting doesn’t provide the product or service that the customer is purchasing, it can shape the customer’s experience and impact customer loyalty through how easy and seamless billings and payments are.


The mirror image of a company’s relationship with its customers is its relationships with its suppliers. Many companies do everything possible to please their customers but treat their suppliers poorly. For example, under the guise of “cash management,” a company may set payment terms to suppliers beyond the standard 30 days and require their suppliers to accept these terms or not do business with the company.

Suppliers are an essential part of a company’s supply chain. A well-functioning supply chain in a lean organization is necessary to support the value streams which produce the company’s goods and services that drive revenue generation. From the suppliers’ point of view, the overall experience between suppliers and accounting must create value. Yes, suppliers must perform, and those performance criteria must be clearly spelled out. The same is true for accounting.


The value to employees of accurate, timely paychecks and other reimbursements is well understood by accounting. Like customers and suppliers, it’s the overall experience employees have with accounting that matters. The process steps employees may have to perform to be paid or resolve a discrepancy can be cumbersome to an employee and contain unnecessary activities. These activities take up employees’ time, so developing minimal-waste lean processes for employees to record time or expenses creates value in the eyes of employees.

Users of internal reporting

One of accounting’s largest and most customer groups is the business managers (including senior leaders and owners). These managers get a combination of financial and operating information from a company’s management accounting system (of which accounting is the steward) and direct analytical support from accounting to measure performance, perform analysis and make decisions.

Management accounting is the link between a company’s strategy and its operating practices and ensures alignment between the two. Management accounting information and analytical practices also support the customer-facing value streams in a company that produces the goods and services that drive revenue growth.

The value to users of internal reporting information is that it helps them make good business decisions. For any decision-maker, information must be both relevant and reliable. Relevant information improves decision-makers’ capabilities to predict future outcomes or provide more accurate feedback on performance. For information to be relevant, it also needs to be delivered in a timely fashion. Reliable information represents reality at the time an analysis is performed, and that the quality (accuracy) and lack of bias in the analysis can be counted on.

Lean transformation changes what managers value

In any company embarking on a lean transformation, in any industry, the definition of relevant and reliable information will change in some form or fashion. A lean transformation also has an impact on the types and frequencies of analytical practices and accompanying decisions. Another way to say this is that a lean transformation changes what accounting’s internal customers value from accounting. It is very important for accounting to recognize this and be proactive about developing their lean accounting vision.

A helpful context for understanding and prioritizing what information is valuable to accounting’s internal customers is to compare value from the perspective of the company’s customers to what accounting understands to be the relevant and reliable information to its internal customers. It’s important to keep these two perspectives of value aligned so that the work accounting does to improve value to its internal customers will ultimately improve the company’s delivery of value to its customers, the ultimate purchasers of the company’s products or services.

Lean Accounting in a Publicly Traded Company

This lean accounting case study is about a multi-plant, multi-national publicly traded company in the packaging industry that began their lean accounting transformation in 2019. Periodically we are going to check in on their progress in order illustrate how lean accounting can be rolled-out in a larger, more complex organization.

We are presenting this case study in the form of an interview between Nick Katko of BMA and the company’s lean accounting transformation leader. 

Nick: What initially sparked your personal interest in lean accounting?

Our quarterly MDA reporting package contained a great deal of plant performance information such as sales, mix, margin and also operating performance using variance analysis. I found the message sent on plant performance very confusing. For example sales for a plant would be very positive but operating performance was negative. In addition our CFO, was not a believer in the variance analysis and he wanted better information to tie the numbers together in a realistic way.

Nick: What were your initial steps to generate interest in lean accounting?

First, I suggested to our CEO and CFO we read Jerry Solomon’s book “Who’s Counting?” After we completed the book,  we decided to explore lean accounting in more detail by getting some training from experienced lean accounting practitioners. In April, 2019 I, along with a small team of plant controllers and financial accounting staff, attended a lean accounting workshop conducted by Jerry Solomon and Nick Katko. Besides learning more about lean accounting, we also learned the importance of conducting a lean accounting pilot to demonstrate lean accounting to our organization.

Nick: In the summer of 2019, I facilitated a lean accounting pilot in one of your divisions. What do you consider the most important aspects of the pilot?

We had some operational managers on the pilot team, including the general manager of the division. The general manager of the division got on board very quickly with lean accounting as we developed the new measurements and a value stream income statement. They integrated this new information into their operational management practices rather rapidly. Within the operational management structure of our business the general manager began using the information to explain operating performance. We engaged in a continuous discussion with key senior leaders so they could better understand lean accounting as it applied to our company and its impact on systems and internal reporting information. 

Nick: What did you do in 2020?

Our goal for 2020 was to do a complete lean accounting transformation for the pilot division so we could identify and resolve all the transformation issues based on a goal of turning off the division’s labor and overhead rates in January, 2021.  We had to work through the impact on our chart of accounts and financial reporting. We addressed all data warehouse issues related to our internal management systems use standard costing. And of course, how to value inventory without labor and overhead rates. We also had to work closely with all the managers that used the current information and involve them in the change management process. 

We decided to work very methodically and bring others into the transformation process rather than simply trying to push change through. I’m happy to say we are converting our pilot division this month. Our plan is to move to the next division during Q1-2021 and continue division-by division. We feel confident the roll-out in other divisions will be faster because we resolved so many issues during the pilot. 

Nick: What advice would you give to any company thinking about lean accounting?

I think there are three keys to success. First, get the key company leaders on board. Our pilot was successful because the support and encouragement of our CEO and CFO. Second, work cross-functionally. We  worked with plant management and FP&A because they are the users of operational information and needed to have a voice in what lean accounting was going to mean for us. We also engaged with IT throughout the pilot because of their knowledge of our data warehouse and reporting systems. We made the decision early on to determine how to “automate” the production and reporting of lean accounting information. Third, work positively inside the company.  It takes people time to understand something new. I can’t tell you how many discussions (formal and informal) I had with fellow senior leaders, plant controllers and plant general managers. 

We will check in on this company later on in 2021.

Value stream management in emergency management


This free article appeared in the Harvard Business Review – Italy as part of a free series of articles published to help companies deal with the consequences of the COVID-19 pandemic.

Companies go bankrupt. This is the naked truth that even Jeff Bezos pointed out stating that every single company is intended to fail sooner or later.  In fact, if we look at the numbers, the average life of Italian companies is just 12 year[GC1] s. The goal of people working in the organizations and of those who manage them is to postpone that moment as much as possible. This can happen if a company is dedicated to continuously improve its processes, defining and deploying efficiently its strategies, focusing on constantly reviewing customers’ needs and designing value streams that can fulfill those needs.

But organizations are social entities that are goal-directed, are designed as deliberately structured and coordinated activity systems, and are linked to their external environment (R. L. Daft 2017). To survive, a company must not only interact with external environment, it also has to manage and organize its internal relations, thus including all the people that cooperate and are connected with external environment. One of the most common ways to manage organization is to create compartments of people that share similar tasks, centralizing decisions and promoting the establishing of hierarchical control. Without a doubt this kind of functional organization has the merit of facilitating vertical coordination and relations between people that works in the same process steps, improving their efficiency.

Evidence is clear that in the last few years markets shows more and more volatility, and customers’ needs are in fast and continuous evolution, but never as drastic as it happened with the actual pandemic, where some companies abruptly had no more market and other, on the contrary, had to face high demand peaks.

In the first quarter 2020 the balance in startup and closed companies is -30.000; to find such a negative trend we need to look at 2013 crisis (Unioncamere Movimprese 17/04/2020). A Cerved Rating Agency study shows that, in case the pandemic would have ended by June 2020, the number of companies with a very low rating (high risk of default) in Italy would have increased of 8 percentage points. If the pandemic would continue till the end of the year, this number could increase to 26 percentage points because of the shocks created on Italian market.[GC2] 

Being able to create compartments in a company in this context could become particularly useful, as it could be necessary to close a portion of the organization due to deep markets changes or because of some infection cases. For a functional organization structure it could be easy to create as well physical compartments as often such organization correspond to a similar structure of offices and space; this could offer the company a chance to close only a portion of the business, maintaining a partial functionality.

Is this organizational model useful to reduce the risks and to face the actual situation? Only partially. In fact, a company that had to face a market fall in a particular product line won’t be able to just “turn off” one of these compartments, as well as it won’t be able to close the purchase office for a reduction in the supply chain workload, or to close the order entry office because there has been an infection case. Doing so would result in the paralysis of the entire organization also affecting the part of the business that is still working. How is it possible to face these extreme events reducing the risk of being wiped out?

An organization based on value streams

The best way is to change the organizational model is to switch to a value stream organization. Sometimes big companies adopt a divisional organization, which is similar, because it divides the company by business units, which can make it easier to close or convert those business units that are not profitable anymore or are not useful to satisfy a specific customer’s need. This is something that can be adopted also in smaller environment, creating compartments that don’t put together people that do the same job but, on the contrary, put together all the people that work in the same value stream.

Once you identify your value streams, you can create a team of people that work in different offices or departments, from the order receipt to the production, order fulfillment and shipping. This team won’t report to a functional manager but to a value stream manager, someone who will be accountable for the performance of the entire process. The basic principle is to organize and manage the company as if it were made of many micro-companies, each of them is responsible for everything needed to satisfy a customer. This way the organization is more agile, quicker to react to change because closing or converting a value stream has little impact on the rest of the company. 

To adopt such a model efficiently you need to adopt a different managerial style, where value stream managers have an entrepreneurial role as they are accountable for the profit of the entire value stream. Like entrepreneurs who manage and control a company through a set of KPI and financial reports, a value stream manager is in need of a set of tools that can lead to better decision making to manage and improve the value stream and is also aligned with the strategies defined by the company.

At the same time, these tools are needed to align people that do totally different jobs in the same value stream and that usually, in a traditional organizations, report to different offices or departments. These functional areas have often different KPIs, different objectives and often they are even in contrast among each other. Having a common set of KPI and report is useful to create a common view over the ultimate goals and therefore, using techniques such as lean accounting is mandatory to create these tools.

The relevance of indicators of performance

The first consideration is that the main generators of profit in a company are, as a matter of fact, the value streams. Hence, management accounting and every internal report must be focused on measuring and monitoring such objects.

Defining and implementing a set of operational KPIs is the first step to create alignment among the people working in a specific value stream towards a common objective. These KPIs must measure the relevant performance dimension for a process, that are: velocity, delivery, quality, productivity, flow, and continuous improvement culture. The value stream manager must learn to understand the relationship between the operational measures and the financial performance generated, so that the best possible decisions can be taken to continuously improve the process. 

Management accounting has the important role to build a reporting tool that can show the resources that are used by the process (materials, men, machines, etc.) and the output value generated (product or services delivered to the customer) so that it is possible to link a financial impact with the decision that generated it.

Implementing the value stream management, supporting it with a management accounting system based on lean principles, is a key element to build a lean organization, efficient and responsive to the abrupt market changes we have recently seen that could undermine the company stability and in some cases even endanger its survivability.

Nick Katko , President of BMA, organization worldwide for the lean accounting and author of “The Lean CFO”, (ed. Guerini Next). 

Riccardo Pavanato , CEO auxiell. 

Gianandrea Capo , Value Delivery Manager auxiell.   

 [GC1]Italian data, we should present it as it is or find same information regarding US companies?

 [GC2]Italian data on companies, we should present it as it is or find similar data on US companies?

Myth-Busting: Time Drives Costs

A few years ago I was working with a software company its lean transformation.  During a training session someone made the statement that they must charge higher prices to their new clients for training because their training costs are higher. I opened up a discussion on that statement and the general consensus was “it takes us longer to train our new clients on our software that the competition.”

I raised the point that the software company’s  training costs are fixed – based on the number of trainers they have on staff. I  then facilitated a quick “5-Why” exercise and the primary root cause of why their training takes longer was the complexity of their software.

The thinking inside this software company was the longer it takes to perform the training, the higher the costs for the software company. This is the same thinking that exists in manufacturing – the longer it takes to produce a product, the higher its costs.

The root cause of this thinking is based on traditional cost allocation methods, whether it be allocating training costs to a software implementation project, to a complex tax return in an accounting firm or to a product being manufactured.

Under this thinking, each business would seek to reduce the time it takes to process the products/services to “reduce” costs. Or prices would be adjusted to “cover” the additional costs.

In Lean Accounting, we want to stop allocating costs based on time because it just isn’t really an accurate way to understand costs. In order to make this transition, financial thinking in an organization needs to change.

  1. Processing time creates value: Lean companies recognize that the time to produce a product or service is based on the value-added processing time (e.g. cycle time). Typically, the more value that needs to be created, the more time it will take resources (people and/or machines) to create the product or deliver the service.
  2. Waste adds to costs: any of the 7 wastes of lean adds costs to the business as well as increasing lead times to produce products or services. Some costs may be direct,  such as poor quality in manufacturing increases material costs. Other costs are less direct – a company hires more people than necessary because waste exists in the processes. 
  3. Lean companies also recognize that the cost of the resources, to the business, is typically fixed. This means the business will incur these costs on a regular basis regardless of time spent of individual products or services. Lean companies make cost decisions based on long-term trends rather than which work must get completed today. 

Lean Financial Thinking – Labor Costs

Labor costs are fixed based on how many people are employed. Companies hire more people based on total demand projections. Full-time, hourly employees work a 40-hour week, regardless of demand. Yes, a company may have temporary or part-time workers that they can bring in or send home based on demand, but usually these are not the primary workforce.

Measuring the waste in a process and understanding the capacity of a process is what will control labor costs. Employment of continuous improvement and other lean practices eliminates waste, improves capacity and creates time. This time is then applied to value-added activities, which improves productivity and prevents lean organizations from having to hire additional people.

Lean organizations consider their employees to be their most important asset, which is counter to how employee cost is shown on the financial statements – as an operating expense. The second most important asset of a lean organization is time, which does not appear anywhere on financial statements.

Lean organizations develop employees’ thinking so on a daily basis they become experts in the difference between value added activities and waste and have the skills to eliminate the waste on a daily basis. This work is done through observation and daily performance measurements. 

Cost allocation systems, which are primarily used by managers, really work in direct conflict with daily improvement activities and measures. It’s important for the financial leadership of every lean organization to eliminate the use of cost allocation methods. 

An Accountant’s Guide to Understanding Lean Accounting

I think one of the difficulties accountants face in understanding Lean Accounting is because we are trained to be “doers” of accounting. Our training & education is about how to perform accounting tasks & functions, from learning the basics of journal entries in Accounting 101 to how to close the month in the company we work at. We want to master how to execute, and the better we are at executing, the better accountants we are.

To understand Lean Accounting, accountants need to adjust their perspective from “doing” to “practicing”. And the first step to begin practicing Lean Accounting is the change the way we think as accountants. 

Lean Accounting is like Lean – it is a journey towards a destination. Our journey is practicing Lean Accounting and the destination is organization improvement. Our journey never ends because the destination is not final. This is the first change in perspective for accountants– changing the way we think about accounting in a Lean organization. It’s not about us (the accounting function) it’s about the organization as a whole and the customers the organization serves. 

The second change in perspective for accountants is the understanding & accepting continuous improvement. All business processes can improve in a Lean organization, including accounting processes. It’s not that the accounting processes are bad, it’s simply that they can get better. It’s important for accountants to change the way we think about the processes we “own.” Accounting is not exempt from improvement.

The final change in perspective for accountants is creating value for your internal customers. Accountants are very good at understanding & delivering value to external customers because the quality of our work is based on GAAP/IFRS, tax laws and other regulations. Internal customers in Lean organizations value specific, relevant, timely, actionable information & data which support Lean practices. Accountants need to listen to what their internal customers value and deliver on that value by making the necessary adjustments to accounting processes to deliver the exact value desired.

“Practice makes perfect” is an old wise saying, and applies to Lean Accounting. The first step to practicing anything new is always mental, whether it be a musical instrument, a sport or a new skill. Once someone opens up their mind, it becomes easier to learn how to do something through regular practicing. If you are new to Lean Accounting, spend time opening up your mind, before diving into the “how to do” of Lean Accounting.

Lean Accounting is applicable to any company, in any industry, that commits to a Lean strategy.

I like to define Lean Accounting this way:

  • Lean Financial Accounting – applying lean practices to accounting processes
  • A Lean Management Accounting System to support any business that is Lean.

I’ve also heard Lean Accounting experts such as Jean Cunningham, Jerry Solomon, Brian Maskell & Orie Fiume explain it this way:  Lean Financial Accounting as “Lean for Accounting” and a Lean Management Accounting System as “Accounting for Lean.” 

It doesn’t really matter exactly what terms or phrases are used, what is important is to understand the distinctions. Let’s look at both in more detail.

Lean Financial Accounting is applying lean practices in all accounting processes to improve productivity, delivery, quality & service. Eliminate waste in accounting processes. A simple example is applying lean practices to eliminate waste in the month-end close process to have a shorter close cycle. 

Any accounting department can begin applying lean practices to its accounting processes, even if your company has not yet committed to beginning its lean journey.

Applying lean practices to accounting processes in no way compromises meeting financial reporting requirements, maintaining compliance with tax laws or other regulations or the internal controls to maintain compliance. In fact, from a lean point of view, maintaining compliance is the quality standard of accounting processes.

Management accounting systems are used by management to control & measure the operations of a business and provide a decision-making framework for all types of business decisions. Management accounting systems are for inside the business and not intended to external stakeholders. What we are really talking about here is financial analysis, operational analysis, measurements & other information required to run the business. Management accounting systems do not have to comply with any external regulations.

When a company commits to a Lean strategy, the fundamentals of how the business operates will change as Lean practices are put in place. How the business is controlled, what needs to be measured and the criteria for business decisions will be different than “before Lean.” Internal financial reports, financial analysis, measurements, data used to control the business and decision-making criteria all must support “Lean Thinking.”

Lean Thinking requires the creation of a Lean Management Accounting System. This is a journey, much like Lean is a journey. Without a Lean Management Accounting System, there is a disconnect between Lean practices and the information management will be receiving to understand how well the Lean business is running. Because Management Accounting Systems are not externally regulated, they can be changed by companies. And changing Management Accounting Systems in no way compromises external financial reporting.

The accounting function must assume leadership in creating a Lean Management Accounting System. It’s vital to every Lean company that this is created, maintained and improved, as it will provide all levels of management the relevant, timely financial and operational information needed to drive a Lean Business Strategy forward to financial success.

Lean Accounting and Inventory Reduction

One of the most critical responsibilities accounting must assume, in a lean manufacturing company using a standard costing system, is to explain the financial impact of reducing inventory.

Most manufacturing companies begin their lean journey with high levels of inventory. Through the deployment of lean practices and methods, inventory will be reduced. One of the most basic lean manufacturing practices is make-to-order. A pull system is designed to pull customer orders through the production process as orders occur. This means products will not be manufactured unless there is an order to ship. No more building inventory without an order.

What happens at the beginning of a lean journey is orders will be filled first from existing finished goods, and finished goods will not be replenished. This will continue until the proper level of WIP & finished goods are achieved for lean operations to maintain flow.

The design of a lean pull system does have levels of WIP and/or finished goods built into it as a buffer against the variability of demand and differences in production cycle times. When designing a pull system, lean practitioners can usually figure out exactly what quantity of raw material, WIP & finished goods is necessary. Inventory quantities will continually decline until the desired level is reached.

In financial accounting this means the overhead capitalized into inventory through production of product will be consistently less than the overhead portion of cost of goods sold. In standard costing terminology, overhead absorption will be consistently “under absorbed” as inventory is reduced.

As a result, profitability will be lower than in periods of overabsorption. And people who don’t understand this will think “lean is not working.”

Accounting can take a leadership role in this issue by modeling the financial impact of inventory reduction.

Implementation of lean practices to create a pull system is very methodical and disciplined, so inventory reduction will not happen suddenly. Early in the Lean journey, accounting needs to develop a relationship with the lean practitioners to understand the plans to reduce inventory.

Discussing days of inventory (or inventory turns) is the common language between lean operations and accounting. Inventory days is one of the basic lean performance measures used to understand how well lean is working. Accounting can use projected days of inventory as a basis to model the financial impact of inventory reduction.

  • Expected overall rate of improvement in days of inventory (or inventory turns)
  • Breaking down this overall rate by raw materials, finished goods and work-in-process
  • Target rates of days of inventory/inventory turns

Armed with these numbers, it is not difficult to develop simple monthly/annual financial forecasts to model  the financial impact. Accounting’s leadership role is to use these projections to explain to all levels of management what is going to happen financially as lean practices reduce inventory levels.

Accounting’s message to the company must be: Lean is working!

Lean Accounting: Aligning Financial Management Practices

Lean companies organize their entire operations around value streams. The simplest definition of a value stream is all of the necessary process steps from receipt of a customer order to delivery of the order. Value streams cut across the traditional department structure. The goal of a lean business is to flow orders through their value streams as fast as possible, with the highest quality.

Most financial accounting systems are based on a traditional department structure. Accounting uses their financial accounting systems as a source of all internal financial analysis, such as departmental expense reports & profitability analysis. Accounting also uses their financial accounting systems to maintain compliance with external reporting.

For internal financial analysis, a lean organization needs to transition away from departmental-based analysis to value stream-based analysis.  This is necessary to create alignment between internal financial statements, financial management practices and value streams, which are the primary unit of organization and management in a Lean organization.

Value streams are the profit centers of a lean business. This means all internal financial information should be focused on the profit centers of the lean business. All direct value stream expenses should be assigned to value streams, and all relevant expense analyses should be at the value stream level. Analyze expenses and profitability at the value stream level. Think of expenses as the “cost of resources” and learn how value stream performance can be improved to manage these costs by using lean performance measures to link operational performance to financial performance.

Here are 3 general guidelines lean organizations  should follow for creating an effective financial management practices around a lean strategy.

The financial impact of any decision is based on the impact on total value stream profitability. Value streams are the profit centers of a lean enterprise and all financial analysis should be performed at this level.The dynamic cause and effect relationships between value stream operating performance, capacity and profitability are real and can be modeled financially.

Stop using cost allocations! Most cost allocations have a level of subjectivity in them, such as product costs in manufacturing companies. Other cost allocations are an attempt to make a fixed cost variable by linking it to units or services produced. Using rates in financial analysis is dangerous because they can make it look like costs are decreasing, when in reality they are not changing. It is critical to eliminate cost allocations and understand the relationships between operating performance, capacity and costs using problem-solving practices. This is done by creating an environment in which true root cause analysis can be conducted on cost behavior and operational solutions can be put in place to achieve the desired cost behavior.

Here is an example in manufacturing – direct labor costs. Standard costing systems assigns direct labor based on a direct labor rate & volume produced. If a manufacturing business was considering eliminating a product or product line, the financial analysis would show a “direct labor savings”, because direct labor is assumed to be variable. The reality in most companies is your full-time employees come to work every day and get paid a full day’s pay whether they produce 100 products per day or 500 products per day. Actual labor would decrease only if fewer employees were employed.

Lean Accounting Thinking is to begin to understand how costs change in a lean manufacturing company, without using cost allocations. If cost allocations are commonly used in a company’s in financial analysis, it’s time to begin migrating away from them by introducing the value stream income statement.

The lean idea that eliminating waste creates time – the time spent on waste is now available to create value (often described as “creating capacity”). Lean accounting incorporates this into financial management practices: the creation of time has no financial impact, but how the business uses that time does. A lean business can use this newly-created capacity to sell more products or services, and the financial impact will be increasing revenue without corresponding increases in costs.

Lean Material Cost Management

In lean accounting, a value stream income statement needs to show actual material cost, this and is typically defined as actual material purchased. Actual material purchased is used to align material cost to lean operating practices, so lean performance measurements can be used to do root cause analysis.

There are three operational stages for material after it enters a value stream:

  1. Sold – material can be processed through the value stream and sold
  2. Scrapped – material is defective and scrapped during operations
  3. Stored – material can be stored as inventory, and subsequently either sold or scrapped

At the beginning of the lean journey, material in most value streams will likely be in all 3 stages. Then as quality & flow improves, the quantity of material scrapped & stored will reduce. Eventually if a company can reach 30 days of inventory, actual material cost will be what is purchased & sold within period.

As lean manufacturing operations improves quality, value stream material cost will decrease because less material is being consumed. Using a standard lean performance measure such as first time through or scrap rate, it’s not difficult to calculate the financial impact of better quality.

As lean manufacturing operations improves flow, it will also lead less material being consumed. Using a standard lean performance measure such as inventory days or inventory turns, the financial impact of inventory reduction can be calculated. This is very important to show on a value stream income statement, because the external financial statements will not show this as reducing inventory only has a balance sheet impact – improving cash.

One financial analysis accounting needs to move away from in a lean manufacturing company is simply analyzing material price. Don’t get me wrong – the logic of lowering material prices does have a positive impact of profits. But in lean manufacturing operations, material price is balanced with supplier quality, delivery & lead time.

The price of anything is a reflection of value. Lean manufacturing operations values short lead times, high quality and on time delivery from its suppliers because this type of supplier performance will increase flow, and thus increase revenue. Suppliers that provides the best overall performance with lowest price usually become preferred suppliers.

The danger of focusing financial analysis simply on lowering material prices is the only short-term solution is large volume purchases from suppliers that offer volume price discounts. But this is “anti-lean” because it increases inventory.

Lean Production Cost Management

The purpose of a value stream income statement is to analyze current value stream costs compared to current value stream performance measures to determine root cause analysis of current costs.

Actual production costs for any value stream include the labor costs for people that work in the value stream, costs to own, lease, operate and maintain machines in the value stream, a portion of the facility/factory costs and any other production cost that can be directly attributed to the operation of a value stream.

It’s important for the entire lean organization to learn & understand the relationships between value stream performance measures and actual production costs on a value stream income statement. Understanding the root causes of value stream performance measurements reveals direct insights into the current state of production costs and also what improvements can be made operationally to reduce and/or better control production costs. Let’s look at some examples.

The cost of labor & machines in any value stream can be explained by understanding value stream productivity. A typical lean productivity measure is output divided by the number resources to produce the output. The numerator “output” is usually related to revenue. The denominator “resources”  is usually based on number of people or actual hours worked by people or machines.

The primary root cause of low productivity is that the resources are spending too much time on wasteful activities, rather than the activities that generate revenue. Eliminating the waste frees up capacity, increasing revenue without a corresponding increase in costs.

On a typical value stream income statement, actual material, labor and machine costs will account for the overwhelming majority of value stream costs, possibly up to 80% of total costs. Concentrating all efforts understand the root causes of these 3 costs using lean performance measures will create very strong cost management practices.

Financial Impact of Continuous Improvement

A lean business strategy is a business growth strategy. How this strategy works can be best summarized as follows: lean practices, tools and methods are adapted to create a culture of continuous improvement, which reduces and eliminates wasteful activities, creating available capacity. Lean companies use this available capacity to create value for their customers, which increases sales without increasing the costs related to capacity, such as labor cost.

Calculating the financial impact of continuous improvement aligns the lean strategy and lean operating practices directly with the actual impact on profitability. The financial analysis is very dynamic in the fact that value stream operating performance, capacity and profitability must be analyzed simultaneously for every improvement event. Following is the standard work for performance such a financial analysis

The first step is to understand the specific operational impact of a lean improvement, which usually results in the creation of capacity (or time). There may be some direct cost savings, such as decrease in scrap or overtime, but the primary impact of most improvement events is the creation of capacity. The resulting financial analysis is based on determining how to use available capacity to grow revenue and/or making other decisions about the available capacity.

Revenue growth opportunities should be looked at in the classic marketing approach:
• Can we sell more existing products to existing customers?
• Can we develop new customers for our existing products?
• Can we develop new products for existing customers?
• Can we develop new products for new customers?

Here are some issues to consider when a company is reviewing options of revenue generation:
• What impact will lead time reduction have on your competitive position in existing markets?
• How can you position yourself against your competitors if you lead times are less that theirs?
• If lean principles are applied to the product development process, what impact will this have on generating revenue from new products?
• How much available capacity will be required in generating this revenue?

Based on the different scenarios of using the available capacity to increase revenue, a future state value stream income statement can be created to show the actual impact on value stream profitability based on each scenario.

After taking into account all sales opportunities, he next step is looking at capacity. In the area of capacity management, the focus should be reallocating available capacity created through improvement efforts.

Reallocating capacity:

  • Cross train employees to create a more flexible workforce. A cross training program should be part of continuous improvement and progress measured by performance measurements
  • Assign available employees to continuous improvement activities when productive activities are not available. A formal company-wide continuous improvement program should be created that identifies employees with available capacity and matches them to continuous improvement activities.
  • Bring outsourced activities in-house. All outsourced production activities should be analyzed to determine if the company possesses the resources to perform these activities in-house. If the resources exist, bringing outsourced activities in house will reduce costs

The financial impact of reallocating capacity between value streams is to shift expenses between value streams. Transferring capacity to another value stream creates available capacity in that value stream, and sales scenarios must be modeled again.

Wrap Up

When a company commits to a lean strategy, the fundamentals of how the business operates will change as lean practices are put in place. How the business is controlled, what needs to be measured and the relevant information for business decisions will be different than “before lean.” Internal financial reports, financial analysis, measurements, data used to control the business and decision-making criteria all must support “Lean Thinking.”

Lean thinking requires the creation of a lean management accounting system. This is a journey, much like lean is a journey. Without a lean management accounting system, there is a no alignment between lean practices and the information company management will be receiving to understand how well the lean business is performing. Because management accounting systems are not externally regulated, they can be changed by companies. And changing management accounting systems in no way compromises external financial reporting.

The accounting function must assume leadership in creating a lean management accounting system. It’s vital to every lean company that this is created, maintained and improved, as it will provide all levels of management the relevant, timely financial and operational information needed to drive a lean business strategy forward to financial success.