Removing Standard Costing from Financial Analysis

Using standard product costs in business decision-making works well in traditional manufacturing companies, because standard costing systems were designed for traditional manufacturing. In lean manufacturing companies, continuing to use standard costing for business decision-making will create conflict and confusion throughout the organization. One of two outcomes can occur when standard costs are used in business decision analysis in Lean companies. Either the wrong decision is made, or traditional manufacturing practices creep back into operations to support the financial analysis.

Accounting’s role is quite simple, lead the company through the process of eliminating standard costing in business decision making. The actual task of making this happen can be quite complex & may take some time depending on how ingrained standard costing is in your company’s decision making process and how fast your company can develop lean-focused decision making methodologies.

Fortunately for accounting, it doesn’t have to start from scratch. Standard lean accounting practices present a plan for how to get from where you are to where you need to be. This blog and the next few blogs will explain how to get your lean manufacturing company into “lean decision making.”

Manufacturing companies typically have long-held methods for doing internal financial analysis and making business decisions. If a manufacturing company uses a standard costing system, standard cost information is usually used in understanding the financial impact of business decisions. These decisions are made in all parts of the company: sales, marketing, purchasing, engineering, operations, senior leadership and accounting. And the people who are actually making the decisions are comfortable and confident in the current methods.

Accounting’s challenge is getting acceptance by the people making the decisions that a lean decision making methodology is better for the company. It’s more about winning over hearts & minds rather than simply creating a new methodology.

Accounting’s first step is to develop a lean-based decision making framework not based around standard costing. A lean-based decision making framework should be based on what I like to call the “economics of lean.” The rate of growth of revenue consistently exceeds the rate of growth of costs, which results in increasing profitability.

The overall goal of becoming a lean company is to become more profitable, primarily through improving the delivery of value to your customers, which drives revenue growth. If a lean manufacturing company really does improve flow, reduce inventories and improve on-time delivery, it should realize revenue growth greater than its historical averages.

The other aspect of the economics of lean is cost control. Please note I did not say cost reduction, because lean is not a methodology to dramatically reduce costs (we will get into this more a bit later). Operationally, lean practices improve productivity which means output increases at a greater rate than the resources needed to produce the output. This occurs because eliminating waste increases resource capacity (or creates time) rather than hiring more people or buying more machines.

As a CFO of a manufacturing company in the 1990’s, my company’s lean transformation resulted in the average sales growth rate increasing from 7% to 20% and profits increasing 66%. We didn’t lower prices or change our product mix. We dramatically changed operations by delivering on-time 95%, without finished goods inventory and an average order lead time of 3 days. This is how I learned about the economics of lean.

I’m going to stop writing here because I it’s important to think about the economics of lean and your company before we start moving into the “how to” phase of a lean decision making framework.

  • How well are the economics of lean understood in your company’s accounting function?
  • In other parts of the organization?

Talk these questions over with your colleagues and I would be interested in reading your comments.