Manufacturers & Distributors ARTICLE - When implementing lean manufacturing principles, don’t overlook accounting

Target Audience: Manufacturing and Distributing Companies, M&D Industry Employees, Manufacturing Distributors

If you’re using lean manufacturing principles to streamline your company’s operations, have you looked at how your accounting system is faring as a result? As lean manufacturing approaches prosper, financial experts are realizing that standard cost accounting doesn’t work in a lean environment.

When you begin looking to eliminate waste in manufacturing processes, you also need to target waste in your finance and accounting processes. To be effective, lean thinking must be applied companywide.

Measure for measure, lean wins

Traditional accounting marks financial performance, but it isn’t a good measure for overall performance. It doesn’t, for example, reflect improvements in lead times, scrap rates, on-time deliveries and other indications that waste is being eliminated and efficiency is being improved in your plant.

In addition, as you go lean — using existing inventory and streamlining processes — cost accounting typically will show a temporary drop in net income. Deferred labor and overhead become expenses on the income statement rather than assets on the balance sheet. Even though these drops typically are brief, they can be unsettling to key stakeholders who can’t see the concurrent overall improvements — and ultimate cost savings — in a traditional accounting format.

So at first you may want to supplement traditional accounting procedures with lean financial statements that reflect operational advances as they occur. Parallel lean and traditional statements that illustrate results both ways can ease acceptance of lean accounting procedures, as well as help familiarize everyone with how they are developed and presented.

Lean accounting not only provides a more accurate record of your company’s performance, but also:

• Helps ensure that you have the timely, accurate information you need to run the company, and
• Eliminates waste and cuts costs in your finance and accounting departments.

Getting lean is just as challenging for bookkeepers and accountants as it is for factory personnel. For example, lean manufacturing means that you count, control and measure differently. Thus, what you count, control and measure must be treated differently in your financial statements as well.

One touted approach is to organize costs by value stream rather than by department. A product’s value stream includes everything from design and engineering to customer service and payment collection — in short, it represents every expense you put into making the product valuable to your customers.

Lean accounting allocates the costs associated with all activities to product families, divvying up the expenses according to how much each family uses each activity. To get individual product costs, distinct product features and specifications are factored into family costs and adjusted accordingly.

Obviously, running a business involves expenses that can’t reasonably be assigned to any product or value stream. The goal of lean accounting is to arrive at an accurate but relative measure of costs, rather than the traditional effort to allocate every expense to a precise, unchanging cost center.

Pinpoint target costing

In a lean accounting environment, target-costing practices can be used to price products from the market’s point of view. Finance and marketing personnel collaborate to understand what customers will pay for a product and how the acceptable price changes with additional or fewer features.

Armed with that understanding, they can translate customer-derived prices into target prices and then break target costs into appropriate categories and assign the expenses accordingly. Although the approach isn’t difficult, it marks a radical departure from tradition, and your finance and accounting team may require some time to adjust and to accept it.

But even the best target costing procedures can’t fully establish the ultimate product costs that are the basis for sales and negotiations with customers. Why? Because customers may value time to market or a particular physical attribute enough to pay more for it.

By using lean accounting principles that assign costs and set prices according to the value customers place on products, however, you can make adjustments to your manufacturing processes that will help align product costs and features more closely with customer expectations.

The bigger picture shows success

Most financial experts agree that standard accounting procedures can’t accurately indicate all the improvements that a move to lean manufacturing brings about. They also recognize that changing to lean accounting is unlikely to be quick — or even all that easy. Just as a move to lean manufacturing is a gradual, ongoing process, lean accounting must be implemented shrewdly and carefully.

Inventory can be a key factor

One area subject to significant scrutiny in both lean manufacturing and lean accounting is inventory. Using standard accounting, inventory is treated as an asset that is matched to revenue when it’s sold. Such systems may track inventory well, but they often don’t do as good a job of tracking the cost of holding it.

Space, warehouse personnel, insurance, utilities and other expenses associated with maintaining inventory may be assigned to overhead accounts in traditional financial statements — accounts in which the true cost of carrying inventory is lost. Lean accounting reflects the cost of inventory, and its true value. Of course, lean manufacturing principles dictate that inventory be substantially reduced, but lean accounting offers an accurate financial picture of what remains.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

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