Category: Home Page Feed

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.

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:

1. Detecting defects as rapidly as possible
2. Reducing the effect of defects that occur
3. 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.

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.

Waste is any action, activity or process that does not add value in the eyes of the customer. Waste consumes resource time and in the long run increases costs. In lean accounting this means always being on the lookout for waste and incorporating continuous improvement practices into all of accounting’s work to eliminate the waste and serve customers better. 

Being able to identify waste in accounting requires being able to look at any activity, whether it be the process step or tasks within the process step, and identify it as adding value or not adding value. Non-value added activities can be further broken down into two categories – necessary activities and unnecessary (or wasteful) activities. Being able to distinguish between value added and the two categories of non-value added activities is a learning process in lean accounting. It requires objectively studying a process, through the eyes of its customers. 

Accounting Activities: Value Added

Value-added activities for accounting processes are  the required, essential activities to transform information received in accounting to complete financial transactions or provide the quality information to both internal and external users. 

Accounting Activities: Non-value Added but Necessary

Non-value added, but necessary accounting activities don’t create value, but must be performed due to policy, technology or regulatory requirements or current thinking. From an accounting customer’s viewpoint, these activities create no value, thus they are categorized as non-value added but necessary activities in lean accounting.  Because these non-value added but necessary activities cannot be eliminated, the goal in lean accounting is to spend less time on these activities by identifying and eliminating the wasteful tasks and seeking other methods to minimize the amount of time spent on these activities. 

Accounting Activities: Non-value added and Unnecessary

Non-value added and unnecessary activities, can be considered pure waste. It’s pretty easy to remember the 8 types of process waste using the acronym DOWNTIME:

D: Defects

In accounting, defects can be:

• missing or incorrect information which prevents accounting work from being completed. 
• accounting transactions with other parties which are incorrect
• information delivered to internal and external user that is of poor quality (from the user’s viewpoint) or a transaction which is incorrect.

O: Overproduction

Overproduction is producing more, sooner or faster than required by the customer. In the case of overproduction, the customer can be the recipient of the output or process steps within a process. To better understand overproduction, let’s look at an example of recurring reports. 

Tom, a budget analyst in accounting, produces key indicator reports each month for the executive team’s review of current performance. The reports include trended financial and non-financial metrics at the total company, division and department level. For each indicator, there is a tabular and graphical representation, as well as text analysis and commentary. 

After listening to the executive team – customers of the report, Tom was able to reduce the content in the report by 75% which also reduced the time to prepare the report by 30%. The end result was improved customer satisfaction – making it easier for executive team to find the information they wanted and reducing their searching waste (sifting through all the content to find the specific information they were interested in), which we’ll explain more below.

W: Waiting Time

Waiting is any delay or queue in a process which interrupts the flow of the process. Waiting time usually occurs at the hand-off points in a process. Waiting time is really one of those hidden wastes because of the way those who work in a process think.  From an employee’s viewpoint, if they are waiting on something it may not necessarily be considered a problem as they can work on something else. Waiting time tends to become a problem for an employee when a deadline is fast approaching that the employee must meet. Not caring about waiting time is also often a management problem. Since employees can work on something else, management doesn’t consider it a waste of the employees time. 

N: Neglect of talent

This waste is the failure to appropriately utilize the talents and skills of employees. Many things can contribute to the neglect of human talents and skills:

• Traditional management models which reserve problem solving for managers rather than allowing the people who do the work and therefore understand it best, to solve problems.
• Educated, experienced and capable professionals are often relegated to work that doesn’t maximize the use of their skills and doesn’t directly connect their daily work to the success of the organization. 
• Not taking advantage of existing accounting software capabilities and not properly training the accounting team on these capabilities.

T: Transportation

The waste of transportation is defined as unnecessary movement. The key word here is unnecessary. The goal is not to eliminate all forms of movement, but only the unnecessary. 

Transportation waste in accounting can also manifest itself in non-value added but necessary accounting activities like approvals and reviews, which are hand-offs. Multiple approvals or reviews create multiple hand-offs. 

I: Inventory

Inventory waste in accounting is simply information which is sitting idle and not being actively processed. The primary cause of inventory waste is batch processing. Whether it is multiple documents or pieces of information, they accumulate into a “batch” that then are processed as a batch. The challenge in accounting processes is to better understand the causes of all batches and queues and continually reduce batch sizes. 

M: Motion

The waste of motion is the unnecessary movement of employees. Motion can exist in the daily activities of accounting processes. The keystrokes of manually inputting information is motion. Poorly designed software can cause too many clicks to find or process information. Poorly designed workspaces can also cause unnecessary motion. Think about all the files and data stored in shared file locations and data warehouses. It’s more challenging to see this waste but it still impacts accounting in terms of the cost of the storage as well as the way it may complicate searching for the actual information that is needed.  

E: Excess Processing

Excess processing waste is:

• producing something a customer does not want
• process steps or activities that do not add any value to a product or service a customer wants. 

The great part of excess processing waste is that eliminating it is not difficult. Simply stop producing what the customer does not want or stop activity that isn’t adding value. The difficult part is identifying it, especially in accounting because a great deal of what is excess processing is embedded in non-value added but necessary activities and these activities are usually part of accounting’s routines. 

Practicing Identifying Waste

In lean accounting, practicing identifying waste means developing habits to learn how to recognize it, understand its impact and have a constant awareness of its presence, especially in daily work activities. Practicing identifying waste allows employees to distinguish between the activities which add value for the customer, and those that do not. Seeing waste and understanding it’s negative impact also creates the opportunity for improvement, and to connect to proven methods of improvement to reduce waste. How is waste made visible? By using lean measurements.