LEAN DECISION MAKING: Part 1 – Making the Leap

Lately, I’ve been blogging a lot about the role and responsibilities of the CFO in Lean Companies.

Now it’s time to get down to your single most important responsibility as a CFO in a Lean company  – removing standard costing, and getting rid of all the bad habits that go along with using it.  This will not be easy or quick.   Many factors about your company will determine how much work and time will be required – the level of inventory you have, the size of your company and exactly how your company uses standard costing information to make business decisions.

Your job (as the Lean CFO) is to create the vision,  develop the road map to a standard-cost free company and provide the leadership to make it happen.

When I teach classes about Lean Accounting, I often start by acknowledging the frustrations you probably are feeling by showing this slide you see in my first picture (below.)

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Today, I am about to make the radical case for this: the sooner you decouple standard costing from your decision making processes, the more sustainable your Lean strategy will be.

Lets’ begin by looking at how non-Lean companies typically use standard costing for decision making.  This might be your “Current State.”

 Standard Costing & Decision Making

 Because most manufacturing companies use standard costing systems to value inventory, they believe the standard cost of each product is readily available.  Moreover,  managers in traditional manufacturing companies consider a product cost to be accurate.  The people put a great deal of effort into ensuring this “accuracy.”  They keep run rates up to date, allocate all production costs and continuously monitor actual costs against standard.

 Of course they use their standard costing information to inform their business decisions.  It is still a major source of financial information for understanding the financial impact of business decisions.  Typically there’s a great deal of confidence in using product costs to do financial analysis for business decisions.

 To be perfectly honest, using standard product costs for business decision-making works well in traditional manufacturing companies because that is what standard costing systems were designed for.   But (and this is a big “but) in lean companies continuing to use standard costing for business decision-making won’t work.  It will create conflict and confusion.

 One of two outcomes occurs when Lean companies try to use standard costs in business decision analysis.  Either the wrong decisions get made or traditional manufacturing practices creep back into operations to support the financial analysis, and your Lean strategy gets undermined.

 As the CFO in a Lean company, it’s your responsibility to remove standard costing information from all business decision making.  Your company’s long term lean business strategy depends on it.    You need to do this early in your company’s lean journey and you should begin aligning business decisions around the economics of Lean as soon as possible.

 What Lean tool should you bring to the task?  What will you use when you get to your “Future State?”

 The Value Stream Box Score & Decision Making

 The Box Score – a multi-dimensional view of the value stream’s lean performance measurements, capacity analysis and profitability – is the tool you will use as the basis for all business decision making in your Lean company.  Box scores come in a number of “flavors,”  depending on what they are supposed to do.  Here’s an example of a typical box score that compares some business alternatives.

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Lean companies understand that value streams generate profits, based on the economics of lean – by delivering superior customer value and improving productivity.  Using the Box Score enables a complete analysis of any impacts of a given business decision on lean operating performance,  which in turn will lead to the financial analysis.

Value stream profitability is based on actual revenue and actual costs. The financial analysis of a business decision is based on the change in value stream profitability over a specified time period – say one month. If future state value stream profits are greater than today’s value stream profits, the business decision makes financial sense.

However, financial analysis of value stream profitability must also take into account the impact of the business decision on both operating performance and capacity.  Box Score performance measures and value stream costs have a direct relationship. Improving performance leads to lower costs and vice versa. This is because the only way to improve all lean performance measures simultaneously is through Flow, Pull and Continuous Improvement.

The relationship between capacity and value stream production costs depends on the amount of available value stream capacity and the amount of capacity needed for a business decision to be enacted. This relationship gets to the heart of the economics of lean. If a business decision requires more capacity, and the value stream has that capacity available, there are no additional production costs associated with the business decision.  Value stream production costs change only when the level of resources changes.

In my next few blogs, I’ll be looking at some typical business decisions, and examining how standard costing paradigms compare to using the Lean box score as a method for making sound decisions.