By Tim Heston
About 15 years ago Drew Locher, president of Change Management Associates, helped put on a conference that brought together
accountants, CFOs, and operations personnel,
mainly from large companies. He was one of several consultants who saw early on a conflict between operational changes brought about by lean
manufacturing and company accountants who
questioned the benefits. The annual conference,
which continues to this day, has attracted several
hundred people every year. It covers a concept
called lean accounting.
“We told them, in a very nice way, that everything
they learned in school was wrong.”
Locher said this back in March to attendees of
The FABRICATOR’s Leadership Summit, held in New
Orleans. Unlike the annual lean accounting confer-
ence, this summit, part of the Fabricators & Manu-
facturers Association Annual Meeting, drew CEOs
and top operations personnel from mainly small
and medium-sized custom fabricators. “For most
of you, whatever you’re doing now, don’t stop. You
know it’s all about cash flow.”
Most who attended Locher’s session found that
they practiced at least some elements of lean ac-
counting without even knowing it. As Locher de-
scribed, that’s mainly because “small businesses try
to keep things simple.”
Small businesses may not have formally defined
value streams, and they may not distribute finan-
cial, operational, and capacity information to em-
ployees on a weekly or daily basis (a common lean
accounting practice). But they don’t have bosses
telling them to make the quarterly numbers, nor
do they play games at the end of financial reporting
periods. They also don’t balk at an increased cost
of goods sold (COGS) a;er an inventory reduction.
They sign the paychecks, so they know all too well
that inventory doesn’t make payroll—but the cash
freed from that inventory reduction does.
Locher clarified that it’s not as if financial people
working at large companies don’t value cash. It’s
that they’ve been taught cost accounting, a method
that thrived in the days of the Ford Model T. But in
the world of modern manufacturing, cost accounting can produce some misleading information.
This is where lean accounting can help. Various
books have been written on the subject. Locher recommended Practical Lean Accounting: A Proven System for Measuring and Managing the Lean Enterprise,
by Brian Maskell, Bruce Baggaley, and Larry Grasso.
The method essentially fixes a big irony of lean
manufacturing: When a company implements lean,
the financial metrics in the short term can look
worse, even if the company, flush with cash, is in
better financial shape than ever.
Using various tools (standard work, 5S, and
the rest), lean manufacturing aims to shorten the
order-to-ship cycle by concentrating on flow velocity and, ultimately, allowing a manufacturer to
increase capacity and potential revenue with the
same or fewer resources, including less inventory.
Even without increased sales, the cash flow benefits can be profound.
While traditional cost accounting doesn’t ignore
cash, it does present all sorts of ways for people
to make the numbers look good, even when their
employer is starved for cash and on the brink of
Lean accounting, which focuses on cash flow,
uses statements that resemble one’s personal finances—that is, how much cash is coming in and
going out, and when—and anchors financial metrics to value streams. It then boils it all down to
what’s known as a box score. This shows financial
metrics like revenue, material costs, fixed and variable costs; operational metrics like raw-stock-to-dock days and on-time delivery; and basic capacity
information (how much is used and available). This
is distributed weekly (or even more frequently) so
that everybody can know about the problems soon
a;er they happen and not weeks or months later,
when it’s too late to fix them.
As they do with lean manufacturing, company
leaders o;en don’t see lean accounting as necessary, applicable, or even possible in their organizations. During his presentation at the summit in New
Orleans, Locher grouped these perceptions into
nine myths people have about accounting in general—myths that, if believed, can make problems
worse, not better.
Myth No. 1:
GAAP Requires Cost Accounting
Many in accounting departments, particularly at
large companies, believe that they can’t move away
from cost accounting because, as Locher put it, “the
Generally Accepted Accounting Principles won’t let
us change. That’s not true at all.”
The GAAP has four basic tenets, three of which
present no problem for lean accounting and lean
manufacturing. First is materiality. Accounting in-
formation is considered material when its omission
would alter a person’s judgment and decision-mak-
ing. “Lean is all about materiality,” Locher said. “We
don’t care about the insignificant stu;.”
The second tenet is conservativism. Accounting
information should be reported in a way that tends
to minimize cumulative income—that is, conserva-
tively. “Lean folks are pretty conservative,” Locher
said. “We’re aligned with that.”
The third tenet is consistency. Transactions are to
be treated in the same way for consecutive periods.
“Lean people have no problem with that,” he said.
“We’re the ‘standard work’ people, a;er all.”
The fourth tenet is matching. That is, accounting
must match costs with revenue, and here is where
challenges arise, especially in companies with low
inventory turns. This requirement is a driving force
behind allocation accounting, which can slow the ac-
counting process to a crawl, especially if the date of
costs (expenses for material and labor) occurs weeks
or months before the customer pays for the work.
But as Locher explained, as inventory turns increase, the time between “money out” (expenses
for material and labor) and “money in” (revenue)
decreases, so matching becomes less of an issue.
Even with quick inventory turns and short raw-stock-to-the-shipping-dock cycles, matching still
can be a problem, particularly if a fabricator deals
with slow-paying customers. Lean accounting departments can overcome this issue by taking a new
approach as to when financial tasks need to happen. This relates directly to myth No. 2.
Myth No. 2:
We Can’t Close the Books Until ….
“Many organizations take weeks to close the books,
to find out how they’re doing,” Locher said. “But if
you’re depending on this information to make decisions, you need to close the books as quickly as possible. Without timely financial information, a company will forever look in the rearview mirror and see
where it has been, not where it is going. The older
the information, the less relevant it is. Some companies I work with do a so; close every day.”
If it’s not about cash, it doesn’t matter