Lean Accounting

Accounting in the emerging lean enterprise has two objectives: to develop accounting processes and practices that are lean, and to support lean management in and throughout the enterprise.

The process of applying lean principles, tools and practices to accounting processes is begun by utilizing the lean tools of 3 MUs, 5 Ss, 4 Ms and 5 Ws-1H to remove waste from current processes. The Lean Performance analysis that is utilized in the Lean Performance project methodology begins with these tools and expands the effort to include an SDCA/PDCA tool that further reduces waste while completing process standards for each process. Once the transition to lean processes is accomplished, and lean process standards are in place throughout the enterprise, use of material information flow analysis (MIFA) practices such as process stream mapping can be utilized to link lean improvements across processes that operate in multiple process streams.

While learning how to forecast the financial impact of lean on the financial statements, accounting and financial management must develop a game plan to implement lean accounting overall while rigorously adhere to generally accepted accounting principles, GAAP, and external reporting requirements and regulations, including Sarbanes—Oxley (SOX). Lean accounting practices strengthen internal accounting controls while replacing "control by transactions" with operational controls and visual management reporting. Many transforming enterprises utilize a "transactions matrix" to match transactions currently being performed to the processes that report, consume, or measure these transactions. Knowing which transactions are being eliminated, or can be eliminated, assists the enterprise to get lean while maintaining appropriate financial controls. A benefit to all is that as the enterprise expands into the use of lean processes and practices, the transactional controls imposed in the mass enterprise are removed in sync with the transformation.

A few last notes on transaction controls: don't surprise your auditors with your new lean processes and visual controls and reports. Auditors generally don't like surprises. Be sure to meet the SOX regulations by including SOX requirements in the process workflow standards that are developed in the Lean Performance project. Process workflow standards are accepted tools that can be utilized to highlight SOX risks and the changes that can be implemented through various process improvement activities (kaizen/process stream mapping) to lower risk.

While reducing waste in their own processes, accounting can begin to support lean management throughout the enterprise by learning how to partner with the manufacturing and service processes that actually provide value to the customer. Lean accounting is actively concerned with understanding the value-creating processes and proactively working to enable lean processes in customer relationship management, new product introduction, and the other critical processes in the enterprise. Accounting transforms to a service center in the lean enterprise, not an impediment as formerly viewed by much of the value-creating processes in the mass enterprise.

The great first fact of lean accounting is that inventory has no (or negative) value. A well-run lean flow takes no annual inventory. The WIP is flushed into product as buffers are consumed. Accounting and finance have adjusted the fiscal year to balance to zero at the critical low trough of customer demand. The need for perpetual inventory records is replaced with simple visual controls for what little inventory remains.

Lean accounting utilizes "plain English" to explain and report financial results, including statements and a "one-day close" to flow financial information back to decision makers rapidly. Financial reports are straightforward, not cluttered with abstract formulas and calculations such as "absorption" and "COGS." Financial and performance results are presented visually on whiteboards or by other visual means by reporting process area, work cell, operating entity, or division (or another meaningful structure in the enterprise). Participants from other process areas are now able to provide ideas and solutions rather than sit in formerly boring meetings in baffled silence. There is an emphasis on process performance measurements: process-oriented thinking is now the norm and the process owners and operators are supplying process-based improvements to accounting for assistance in conversion to EBITDA and other "results" measures. "Scorecard" presentations are utilized to recap financial results. Some financial reporting is developed and presented utilizing the "Box Score," a single-sheet summary similar to Scorecard but also containing operational and capacity performance in addition to financial information. The Box Score can also be utilized to provide information for decisions concerning sourcing, make/buy, and quotes.

One lean accounting practice that is actively being applied in lean environments that are process stream—oriented is process stream accounting as a replacement for standard costing. If the process stream organization fits your lean enterprise, process stream income statements are a common lean accounting practice.

Another practice being utilized to support lean costing is process standard cost, a cost method that isolates individual products and their process standards to track actual cost. One fact is clear: a lean enterprise eliminates standard costs (or other full absorption cost methods) for decision making like quoting, pricing, make/buy, capital expenditure, etc. The recognition that product standard cost is insufficient and leads to poor decisions is a profound moment in the transition from mass thinking to lean thinking. Accepting that mass thinking leads the enterprise to turn down profitable work, causes the enterprise to attract unprofitable or less profitable work, and leads the enterprise to outsource parts that can be made profitably by utilizing lean methods in-house is a serious indicator that lean accounting has taken hold.

Another prominent lean accounting practice is the use of Target Costing as a concurrent process element of new product introduction. Target Costing is utilized to determine the market possibility of a product being developed. Knowing the MUDA-free process cost of a product enables the analysis of customer and market potential to be conducted with a clear insight into profit potential. Participants in target costing include sales and marketing, product design, operations, inventory and logistics, and other process areas in the process stream in your enterprise.

Sales and Operations Planning (S&OP) is an integral element of Lean Commerce, and accounting has an important part to play. Each month as the S&OP process is completed, sales and marketing provide a product, product family, or process family forecast for the following 12 months. Product engineering projections for new product introductions are combined with current product projections. This projected Customer TAKT (rate of demand) is compared to the forecast provided by operations of their capacity or Operations TAKT (rate of supply). Customer demand is agreed upon, and operations capacity adjustments are planned accordingly. Involvement by top executives as well as process stream or process area management validates enterprise commitment to the enterprise plan. In the near term, immediate adjustments are driven through the follow-on processes of MPS and MRP to adjust buffers and kanbans. The capital budgeting process depends on the S&OP figures for equipment and facilities utilization projections. Resource planning for employment and hiring is conducted from the central plan as well.

Financially, the budgeting process is updated monthly, and the annual budgeting process is eliminated in favor of this "continuously updating" budget.

Among the most critical issues cited by proponents of lean is the need for active management involvement. The Lean Performance methodology presented in this book initiates from management policy deployment. Without this, there is no project and no lean transformation. Implement your new (or old but not working lean) ERP system utilizing another methodology than Lean Performance if management is not able to perform policy deployment. The regular management policy deployment activities are utilized by accounting to drive process improvement to the enterprise.

The most important element of management involvement in the continuing lean transformation and lean enterprise is to be loyal to the people in the enterprise. The Lean Performance cultural principle is "Loyalty to people enables continuous improvement." Be loyal, or be a mass producer. There are two elements of cultural loyalty that can be facilitated by the accounting function in a lean enterprise. Tracking the number and profit impact of each process improvement is the first. Often, process owners and operators express an improvement in terms of a process measurement such as units, feet, or cycles. Accounting can assist in each case by developing a meaningful "translation" from process measurements to financial measurements. The second critical involvement is in the development of profit- or gain-sharing programs. Sharing the gain is the surest way to keep the gains coming.

Lean accounting is concerned with the accurate measurement and reporting of the costs and opportunities evident in a lean transformation. Understanding the changes, risks, and opportunities to the enterprise inherent in those changes is the province of the lean accountant. Measuring operational improvements and their profit impact is an important contribution that can be accomplished in the new lean accounting processes and practices.

A fundamental paradigm shift is necessary for the formerly mass managers to shift from short-term cost prevention to long-term asset utilization and business growth. Key to the analysis of costs and opportunities of lean transformation is the utilization of freed-up capacity. There are process owners and operators who formerly worked in mass processes who are available for more value-creating work. As lean transformation eliminates MUDA, and less of the available capacity of the enterprise is utilized to produce the same or more value-added output, the cost of not acting to proactively leverage these newly available resources to contribute to cash flow and profit is a hidden risk of transformation. As we enjoy better information about the real costs of process and product, in the now lean enterprise we have more capacity, both in facility and people, to put to productive use.

Capital planning in the lean enterprise is not a return on investment analysis, but rather is driven by the 3P process. Considering the available people, capacity, and other enterprise resources, a 3P process develops multiple possible strategies to utilize the resources and grow the profit stream. Perhaps a new flow facility can be designed within the existing walls that allows for a better QCD on a product or products. Strategies can encompass manual, low-tech approaches or fully automated high-tech approaches for new products and services. The accounting function is critical to this activity.

Lean accounting is one of the rapidly solidifying process areas of the lean enterprise. Far from being an impediment to lean transformation, proactive lean thinkers in accounting are becoming a recognized asset to lean transformation and the continuing transformation to the Virtual Lean Enterprise.

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