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In this Oct 2005 issue of On Target :
Lean Accounting Performance Measures
If you’re implementing lean manufacturing, chances are you’ve
already felt the need for Lean Accounting Performance Measures.
You can see the improvements, but they’re not showing up on
the books. So who’s going to support the effort over the long
run if the improvements can’t be put to paper?
It’s a common problem. Lean Manufacturing helps you
identify and reduce waste, giving you extra capacity and freeing
up cash, which is so vital to a small manufacturer. Until you
utilize that extra capacity, machines spend some time idle. You’re
not losing money, having made the right part(s) faster. You’re
actually saving money by not making the wrong products. But from
a traditional accounting standpoint this is “dead time,” and
on paper it can appear that you are losing money.
Traditional accounting is a marker of financial performance.
However, companies also use it to measure overall performance,
not what it was designed to do – especially in today’s
market.
According to lean experts, traditional methods of accounting and
measurement can become a hindrance to any manufacturing business
today, and can be particularly damaging to a company trying to
implement a Lean Program.
The main reason is that businesses still use an accounting
system that was developed and implemented years ago for use in a
competitive environment that does not come close to resembling
manufacturing today.
Back then, the costs of direct labour was 40-50% of a product’s
total cost and materials could be traced or easily allocated to
individual products that made their way through the plant. In
today’s environment, labour is largely fixed ( rarely over
15%.) and overhead has become a large part of total cost because
of more equipment. More expensive equipment.
In effect, traditional accounting systems tend to be hostile
to Lean in that they motivate people to do non-Lean things. As
an example, one of the principles of Lean Enterprise is to
eliminate waste and produce only what the internal and external
customers’ need, when they need it. On occasion that will mean
shutting down a machine or workstation until more of the product
is needed. From a traditional accounting point of view, that is
the worst thing you can do. From a Lean perspective, it’s the
right thing to do.
Rather than focusing on those things that our customers care
about, though, we rely on traditional and complex accounting
measures that are long on variance reports and short on measures
that drive the business. We rely on an accounting system in
which the apparent objective is to keep every person and every
machine busy all the time.
In effect, the full product costing and allocation of
overhead to product costs can lead people to make inappropriate
and sometimes devastating decisions within a company. Instead of
doing a product-cost and product-profit analysis, companies
should identify and realign their major products into value
streams, which will enable a clearer analysis of those specific
products’ costs and profits.
‘What is the goal of your company? Is it to increase
product profit, or company profit?’ In many cases, attempts to
increase the profit from a specific product are done at the
detriment of overall company profit.
Lean manufacturing, in reducing waste, reduces transactions.
That’s a problem because, to measure overall performance,
traditional accounting is based on using transactions to apply
indirect costs. For example, products that are very labour
intensive (compared to product offerings that are largely
machine made and require much less labour) would appear
unprofitable if a company had a policy of applying the overhead
burden based on labour hours, and therefore it would appear that
such products should be eliminated.
Instead, each product should be considered as being unique
– having its own value stream – so that the company could
more clearly identify and isolate the sales revenue and the
direct-variable costs associated with this specific value
stream. Lean Accounting Performance Measures would analyse
results and processes, information that traditional accounting
was never designed to recognize. It’s also exactly the
information you need to improve efficiency and satisfy
customers.
Inventory is another good illustration of the great disparity
between traditional methods and today’s modern manufacturing.
The purchasing people are measured on getting the best price on
raw materials, so they buy in quantity. But a tenet of lean is
acquiring materials only as you need them to produce smaller
runs, only as your customer needs the product. So traditional
methods and lean manufacturing are at odds before the raw
materials even reach the production floor.
Similarly, companies should identify the different value
streams within a business, and do a profit analysis on each
major product family that has independent resources and isolated
costs associated with it, rather than trying to allocate generic
administrative overhead to the products.
"The goal is to make company profit," says ICMA
Education Committee chairman, Professor Janek Ratnatunga.
"You don’t need to waste time and effort on complex cost
allocation routines in an attempt to get down to the minuscule
stock number level. You simply summarize a value stream’s
revenue in, expenses out, and the investment in equipment and
inventory necessary to make the products and make the company
money."
Lean accounting measures focus the company’s efforts on
increasing throughput, decreasing inventories and decreasing
operating costs. A crucial step is selecting measures that are
focused on physical attributes, such as output and cycle time,
as opposed to traditional financial measures.
It is important to constantly identify waste, make everybody
accountable for cost reduction at their own level and links all
reporting to improvement cycles. Accounting control and
measurement systems must themselves be Lean.
You have to realize, though, that powerful forces will be at
work fighting to keep things as they are. Moving away from a ‘keep
everyone busy’ mentality to a ‘focus on the customer’
mentality will be as difficult, if not more so, for the people
in accounting as it is for the workers on the floor.
Concluding Remarks
Traditional accounting is still absolutely necessary for
measuring financial performance. Lean Accounting Performance
Measures are meant to provide additional information. They are
implemented gradually, as lean manufacturing progresses. And
they deliver more accurate, actionable information about overall
performance in today’s lean manufacturing company.
Every person in a company that has undertaken lean
manufacturing initiatives needs to understand Lean Accounting
Performance Measures. Decision makers need to understand what
information Lean Measures give them and how to use it.
Production managers need to know what to measure and report.
Floor personnel need to know what parameters are being used to
measure their performance. And accountants need to know what
information to gather and how to integrate it into their
financial and overall reporting.
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