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To Succeed with Lean Efforts, Manufacturers Must Adopt Lean Accounting Procedures

We all know that "two plus two equals four." But when was the last time you heard someone say, "three plus one equals four" The total is the same – it’s just a different way of adding figures.

The accounting system within most manufacturing companies isn’t much different. Accountants tend to use the same method of adding up the numbers as they have for years. In essence, as long as a system is turning out parts, the people who keep track of income and expenses interpret it as machining efficiency, which is easily quantifiable. Unfortunately, such accounting mentality is only encouraging and rewarding unnecessary overproduction.

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 labor and materials could be traced or easily allocated to individual products that made their way through the plant. In today’s environment, labor is largely fixed and overhead has become a large part of total cost.

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, 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.

"It is very important that people are aware of what standard costing can do to a company trying to implement Lean," agrees Tom Grohne, WMEP manufacturing specialist. "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, Grohne encourages companies to identify and realign their major products into value streams, which will enable a clearer analysis of those specific products’ costs and profits.

"The question I often ask accountants is, ‘What is the goal of your company Is it to increase product profit, or company profit’" he says. "And sometimes I get strange looks. But in many cases, attempts to increase the profit from a specific product is done at the detriment of overall company profit."

For example, Grohne says one of the manufacturers he works with has a product that is very labor intensive, while the remainder of the product offerings are largely machine made and require much less labor. Because the company had a policy of applying burden, based on labor hours, to each product, it appeared that the product that was very labor intensive was very unprofitable and that it should, perhaps, be eliminated.

"I tried to explain how it was unfair that they try to burden the manual product with all the overhead from the manufacturing equipment side of the company," Grohne explains. "When we looked at this product as being unique – having its own value stream – we could more clearly identify and isolate the sales revenue and the direct-variable costs associated with this specific value stream. We are now able to look at the product with fresh eyes. We discovered it was one of the most profitable products the plant produced. And here they were ready to drop it from the line."

Consequently, Grohne suggests identifying the different value streams within a business, and doing 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 product.

"The goal is to make company profit," he says. "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. Acrucial 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 link 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.

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WMEP provides technical expertise and hands-on implementation assistance to small and midsize manufacturing firms on advanced manufacturing technologies and business practices includinglean manufacturing, ISO, value chain management, and strategic repositioning services for manufacturers and manufacturing facilities located in Wisconsin.

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