Category: Lean Accounting Learning

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.

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.

–Suppliers

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.

–Employees

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.

This is an excerpt from Ed Grinde’s new book Leveraging Lean with Lean Quoting, now available on amazon.com.

This is the third and final article on developing a new lean quoting process.  In the first two articles I discussed (1) the need for a lean quoting process and (2) the part of the process that moves most quotes quickly through to completion.  This last article talks about what happens to the few that fail a filter and must go to the daily opportunity review process.  Those are the orange boxes below.

As shown in the flow chart above, any quote that fails a filter due to capability, capacity, material content, or strategic direction will go to the daily opportunity review boards.  This is a meeting at a location set up to have all functions of the value stream come together to discuss these quote opportunities that will drive the sales, and profits, of the value stream to a higher level by using lean accounting to take advantage of the gains you have made with your lean improvements.  

This meeting needs to be a priority for all concerned, and this is not a meeting for just the quote team.  You want to have people representing the plant floor, the quote team, value stream engineering, the value stream leader, accounting, sales representatives, and occasional visits from the general manager, marketing, and continuous improvement.  At this meeting key and/or large quoting opportunities will be discussed as a team and the decisions made will be by the team.  

The purpose for this cross-functional team is 3-fold.  First is that when it comes to these key quotes you want to hear all functions concerns/issues, if any, about the quote.  Next, with all functions regularly attending these meetings you can get most answers right there at the meeting that the quote team would previously have to wait hours if not days/weeks to get an answer. Lastly, this is a great learning opportunity for all attendees.  They will learn more about the overall business and will make better decisions in the future with what they learn at this meeting.  

What this standup meeting setup could look like is shown below.

Note that there are 4 boards.  They are the Current Opportunities, Financial Impact, Key Opportunities Quoted Status, and the Opportunity Gap Board.  Also, of interest is that this should be a stand-up meeting, ADA considerations notwithstanding.  At the start it will be best if the value stream leader runs the meeting, but after everyone is comfortable with the process you should encourage others to take turns running the meeting.  

How the boards work is as follows:

• The Current Opportunities Board will have all quotes that failed a filter and the final disposition has not been made.  There will be key data about the job being quoted, action items assigned with due dates, and any other pertinent comments.  After deciding to quote or not quote, you take the opportunity off the board.
• The Financial Impact Board is where you will review how large opportunities will impact the value stream profits using lean accounting.  It will contain the lean P&L for the value stream in question, other value streams, and the plant P&L.  It will also show non-financial data to consider such as impact to inventory, is there a quality concern, and will it affect your value stream capacity.
• The Key Opportunities Quoted Board will be used to track the jobs you decided to quote and will stay there until the job is won or lost.  Once a job is either won or lost you take it off this board.
• The Opportunity Gap Board is where you will document jobs you passed on because you were lacking either the capability or capacity to do the job.  You will use this board in your annual or semi-annual value stream assessment to see where you can expand your core competencies and what the potential sales level could be.  It also helps marketing see where new opportunities may lie.

The first few meetings will be a bit awkward because most of these participants are not used to be asked their thoughts and opinions on future business opportunities.  But as you continue with these daily meetings, and encourage active participation, they will become more comfortable with the process and start interjecting their thoughts and opinions.  

This is an excerpt from Ed Grinde’s new book Leveraging Lean with Lean Quoting, now available on amazon.com.

In my previous article I said I will discuss a unique quoting process that will allow you to quote faster and free up quoting manpower to spend the appropriate amount of effort on the few key quotes that can drive your profits higher.  This article will highlight that process.  This new process is designed to run through 95+% of all quotes quickly and get back to the customer faster than the competition.  It also frees up the time for your value stream quoting team to spend the appropriate amount of time on the handful of large and/or special quotes that will truly drive the profits of your company.  

The basis of this new process is to develop filters around key criteria that are pass/fail in nature.  Properly developed, 95% or more of your quotes should go quickly through this process and get to the customer in a day’s time.  The quotes that fail any of the filters will go to the daily meeting for these failed quotes.  This daily meeting I call the Opportunity Review meeting.  Here the quote that failed a filter will get the appropriate level of discussion necessary to determine if you will quote the business.  And if you choose not to, how to capture the data for future consideration.  

Figure 1 shows the high level process.

In order to get through the “Yes” lane, there are 4 key filters that have to be passed.  

Filter #1 = The first is the capability filter.  This is a detailed listing/matrix that has what you are able to do on the plant floor.  It will be segmented into green (easy things or things that you do well with common material content), yellow (processes and/or material that you don’t do a lot or have some difficulty with), and red (processes/material that you can’t do or don’t work with.)  Below is an example of a capability filter. 

Filter #2 – Capacity.  Can your value stream handle the volume a given quote would bring to the value stream.  If you are working with a lean boxcsore then you can look to the capacity section of the boxscore to see if you have enough capacity to take on the work. Another way to look at the opportunity is the size being quoted.  This can be in either units or dollars.  Units are a better volume determinant for small parts, but for large products it is better to use dollars.  What you would do is create a filter that states if the opportunity you are quoting is over a given number of units or a given $$ size, then it fails the filter and goes to the daily opportunity review meeting.  

Filter #3 – Material content.  This filter is determined by the material cost as a percent of the target price.  (Target price being what the customer is willing to pay for the product.  Remember, the cost to manufacture the product has no bearing on the price the customer is willing to pay.  More on this in my soon to be released book “Leveraging Lean with Lean Quoting”)  In order to have this filter you need to segment your products into distinct grouping by volume, complexity (high/medium/low) and by product class.  Keep all of these criteria as high a level as possible.  Below is an example of a material content filter.  

You get these percentages through analysis of your sales data and see where you are successful.  From there you make the determination as to what level of material content is deemed acceptable for the smaller orders.  A subset of this is how to handle this filter if you have a target price or if you don’t have a target price.  If you have a target price then you just divide the material cost into the target price and if the material content percentage is lower than the above matrix, it passes.  If it is higher than the material content listed it fails and you either no-quote or you quote at a higher price that passes the filter.  If you don’t have a target price, you can simply divide the material cost by the reciprocal of the maximum acceptable material content based on the matrix above (material cost/(1-max matl content %) and that becomes your minimum target price.  You can always submit a higher price, but this is the lowest price.

Filter #4 – Does this job support your strategic direction?  There is no template for this.  To be able to make this decision you need a close working relationship with your marketing team or whatever function drives this direction.  You don’t want to be taking on jobs that don’t support your strategic direction.  You need to understand what your area of strategic attention is, what is being cash-cowed, and what areas are you avoiding.  Depending on which area the opportunity falls in will determine how you proceed with the quote.  

If the quote makes it through all the filters successfully, then the business is quoted, and you go to the next quote.  This part of the process will drive additional sales merely by being able to successfully complete more quotes and those quotes will get back to the customer faster.  How many quotes for new business have you lost because you either couldn’t complete them in time or they were so close to the deadline that the customer had already made up their mind as to who was getting the business.

If the opportunity fails any of the filters, the quote goes to the daily opportunity review meeting.  This is where the real growth will come from.  Because you have saved the quote team so much time from the above listed process, they will have time to participate in this new daily meeting.  And this meeting will focus its attention on the large or strategic opportunities that will drive exceptional growth.  In my next and last article I will discuss this daily meeting.

This is an excerpt from Ed Grinde’s new book Leveraging Lean with Lean Quoting, now available on amazon.com.

Have you implemented lean within the four walls of your facility and you are wondering, “We have made all of these improvements: faster flow, better quality, improved employee engagement, and increased on-time delivery.  Why don’t the results show up on the Profit and Loss statement?”  This is a common question within companies early (and sometimes later) in their lean journey.  

You may have realized some minor cost improvements using attrition to assimilate the excess employees.  But you are not seeing the large-scale profit improvements.  There is a simple reason for that.  A true lean transformation is not a cost cutting exercise, but rather it is a culture change first and foremost.  It is respect for your employees so they are not worried about their jobs disappearing, and they are challenged to be the best they can be.  After that, it is really a growth strategy.  You need to use that freed up capacity to GROW the business systematically and strategically.  The true benefit to the P&L of lean is to allow you to sell more with the same manpower and equipment.  

What are your biggest expenses?  Usually it is materials, depreciation, labor and fringe benefits, utilities, and supplies.  The only real variable costs are material content and a few supplies.  Your depreciation does not change just because you have improved flow time by 75%.  You might see a reduction in overtime each month from efficiency gains; otherwise, your labor will only change if you reduce the employees you redeploy due to productivity gain.  But doing that will stifle your lean deployment.  If there is attrition, you can avoid hiring by utilizing the redeployed employees.  But again, these are not huge savings.  Most of your utility expense is for either heating or cooling the facility.   Therefore, the only utility savings comes from running equipment less which is minimal from a financial impact. 

Also, your lean activities pull capitalized labor and overhead from the balance sheet to the income statement as your customers realize that you are delivering product faster.  While this is good, they will realize that they do not have to order so far in advance nor keep as much inventory on hand.  You may see a short-term sales drop because your customers will start depleting their excess inventories without reordering because they know you can deliver faster.  

In Exhibit 1-A you can see the impact to the value stream income statement.  This explains why top management might not be able to understand all the excitement on the floor about the improvements from all the lean efforts.  

If this were all you had to look at, you would not want to go any further with lean.  Sales have stayed the same.  Your profits actually decreased in dollars and as a % of sales.  Even if you removed the impact of pulling into the quarter the capitalized labor and overhead from prior quarters that were sitting in your inventory, Exhibit 1-B shows that the impact is minimally favorable.  Here you see that we only added $65,250, or 0.4%, to the bottom line for all our effort.  

Let’s look at the income statement where instead of reducing the labor to sell the same amount of product, we use the freed-up capacity to strategically sell more product.  That impact is shown in Exhibit 1-C.

This is the real power of lean as a strategy!  We improved our profit margin by 1.6% points and $729,600.  In our analysis you will note that we acknowledged we could selectively and strategically go after business in a more aggressive fashion.  A slightly lower selling price will create a higher material content percentage (35% to 45%).  Because we utilized our excess manpower capacity to sell more with the same number of employees, we were able to make a significant improvement in our profits. Using lean as a growth strategy, using your freed-up capacity, is the most effective way to take advantage of your lean improvements. 

Thus far, the discussion has been around the strategic issues as they relate to the Profit and Loss statement.  Another area in which lean impacts the financial statements is on the balance sheet and the statements of cash flow.  For the balance sheet you will see a lowering of all three components of inventory – raw material (RM), work-in-process (WIP) and finished goods (FG).  You will see a decrease in FGs because you will need less in stock since you can replenish your FG inventory much faster.  You will also see a lowering of WIP inventory because your product is moving through the plant much faster and not sitting nearly as long.  This is partly because it is flowing faster but also because you should have instituted Standard WIP (SWIP) which controls the amount of inventory allowed on the floor between successive operations.  Finally, you will need less raw material in stock because you can schedule the receipt of the raw material in smaller quantities and more frequently due to the speed of product flow.

Because you will have less money invested in your inventory, the line of credit you utilize to manage your business will require less money, thereby reducing your interest expense.  Finally, you will have an improved cash flow as you sell more product and tie up less money in inventory.  This outcome is critical to a growth strategy since now you have more cash available for capital expenditures, if needed, or for other investment opportunities.  

Even with all these balance sheet and cash flow benefits that are important, we find that too many managers/general managers/presidents fixate on the impact to the income statement.  As noted earlier, until you properly utilize your excess capacity to build and sell more product, the benefit to the income statement is minimal at best.  So why are customers not flocking to you with new business?  You are delivering faster and with better quality.  They get their product on time and can reduce their in-house inventory.  You would think that you would be flooded with new opportunities and you would win many more quotes.  

So far, your lean activities have attacked the plant floor but not the quoting process.  How do you change the whole quoting process to be nimbler, thereby allowing the company to process and win more quotes at the margins desired?  You simply cannot continue to use standard cost thinking, silo activities, and linear processes to accomplish the growth that lean promises.  Just like leaning out the factory floor, you must lean out your quoting processes to utilize the capacity gains your other lean efforts have garnered.  In a subsequent article I will discuss a unique quoting process that will allow you to quote faster and free up quoting manpower to spend the appropriate amount of effort on the few key quotes that can drive your profits higher.

NICK KATKO, RICCARDO PAVANATO, GIANANDREA CAPO

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?

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. 

Here is a 35 minute interview I did for the Kaplan’s Financial Management Network, which answers the basic questions about Lean Accounting:

https://players.brightcove.net/2974989255001/rJ3YfAK4e_default/index.html?videoId=5851931685001

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.