What is Lean Accounting?

In the good old days when accountants were in vogue, and IT was in its infancy, the phrase ‘lean ‘accounting probably didn’t exist either as a phrase or a concept. Nowadays, being ‘lean’ and ‘just in time’ is more appropriate for Operations management.

But, if we are talking about ‘lean ‘accounting, what do we mean?

There are a couple of concepts here which at first seem dichotomous, but on closer inspection are very similar.

Firstly Lean Accounting as defined by Operations.

This concept, which has evolved from the Automotive and high volume manufacturing sectors, is relatively straightforward to understand. It means accounting processes designed to report waste and slack in order to give operational personnel the facts to improve their own area of operations into a slicker and faster process.

The Accountant needs to be responsive and identify the relevant controllable costs within the Operational landscape so that service and product delivery is done to maximise return.

The reporting function here is often counter intuitive because what we are talking about is examining the respective operational processes to identify bottle necks, minimise inventory holding costs and have a ‘just in time ‘ mentality. The dichotomy here is that, at every stage of the production process, snags are liable to occur, so the JIT way of working may not work where there are interruptions to the supply chain and, knowing this; managers build in slack to their plans.

JIT aims to meet demand instantaneously with perfect quality and no waste, to an accountant this is music to the bookkeeping ears, however, life (and production processes) is messy.

JIT has a large variety of sub definitions including synchronous flow, continuous flow, stockless production, fast throughput and short cycle time operation.

In more traditional operations management models, excess stocks exist, there will be down time and personnel issues. Operational personnel put buffers in to cope with these, not necessarily telling the Accountant that they exist and using these as permanent backups for when things go wrong.

The larger these buffers, the greater is the degree of insulation between each operational stage and such buffers give the false impression that each stage is operating in an efficient manner.

This is an important point, this insulation effect needs to be identified and accounted for, its most perverse syndrome is the holding of excess stock and so we are accounting for capacity utilisation

When stoppages occur this insulation effect assists in the smoothing of operations. However, we accountants are missing a trick. The whole point of lean operations management is that it is demand led, i.e. you are only producing to order, not producing for stock (which is in itself costly). Unless the output can be sold quickly, there is no point in having surplus stock hanging round.

So lean accounting is all about a) identifying costs of production and eliminating wasteful practices and b) ensuring that costs and costing systems can identify variable and fixed costs which are directly related to the ‘costs to serve’ approach rather than the ‘costs to produce’ After all , if nobody wants to buy the product, what is the point of making it?

The lean philosophy of operational accounting is doing simple things well and efficiently and identifying those areas where buffers can be minimised, efficiencies enhanced and stock holding minimised.

Typical KPIs include working capital ratios and Cash Conversion cycles which attempt to show measures of time expressed in days rather than absolute numbers, so the what is trying to be measured and accounted for here is a process flow of operations rather than absolute returns on investment of profit per out unit.

Where the Accountant struggles in terms of collating data about measuring how ‘lean’ processes are depends on what is precisely being measured. There are Six Sigma metrics, Capacity Utilisation rates, levels of process waste and order fulfilment cysles,

What is important in these sort of metrics is that the measures are consistently obtained over a period of time and rather looking at absolute KPIs they are looked at on a periodic basis for trends .

So, a lot has been written about lean operations management, the accountant can support this initiative by pro actively reporting the key areas of waste, inefficiency and down time, but what of the very accountancy processes themselves, this is the second definition of ‘lean accounting’,

Lean Accounting as defined by Accounting

This is a largely philosophical area in how fundamentally the business views the Accounting Function, and how, more importantly the Accounting Function views its own internal processes in supporting and reporting the operational processes. It is also a function of how the organisation is structured.

The traditional silo approach to organisations has largely been replaced by cross functional design, and lean organisations are now flatter.

KPIs such as time to market, or machine process flow indicate measures of value streams in an organisation and measure flow rather than output, This means that the traditional accouniting functions which are based around post hoc reporting of events ,e.g monthly management accounts, usually produced after the events, don’t sit comfortably in this environment.

There will still be a need for Financial reporting and ,management accounts still have their uses, but the ‘Lean accounting system’ simply has to be as close to real time as possible.

Process flow reporting needs to be available instantaneously so any downtimes or blockages can be immediately identified and available to all those involved in the operations from senior management to machine operatives. There may be some visual indicators in this process such as flashing lights when a machine is inoperative, but the accountant can help identify more subtle changes in the process flow, for example, tracking the number of deliveries that have been made on time and in full.

However, I started this section with the notion that and Accountant has to be involved in drawing up the numbers or time related criteria. This is not necessarily the case in larger organisations where measures of down time or numbers of stock outs can easily be recorded by production personnel. This accords with the more modern day theory of Accounting in an organisation that says a lot of routine number crunching, or in this case, value measurement can be done by IT or indeed ‘non accountants’. Recording data is not the sole domain of the Accounts department, so the role of the Accountant in the ‘Lean Accounting’ landscape needs to be scrutinised.

Again, individual measures of waste, throughput or downtime are operational matters, where an Accountant can add value is through reconciling The financial implications of these key metrics into some form of meaningful statement.

Re drawing the management data would lead to a better understanding of the impact of being lean. It is the old questions of what do we want this information for and what are we going to do with it when we get it? An Accountant will come into his own by designing user friendly formats, with an agreed frequency and an appropriate communication device. Let’s not wait for the month end, but highlight when things are going wrong immediately so corrective action can be taken, if non standard information is required, be lean and agile enough to provide it asap.

Lean Accounting and the Accounting process

The advent of ERP systems has provided a seamless data flow from Operations to Balance sheet. The Accounting function itself has had to change as more requests for ‘real time’ information is being made as a result of organisational ‘leanness’ In these austere times CEOs really do want to know the instantaneous results of their actions .

Also the way the metrics are assembled and the assumptions behind them need to be made transparent. Lean Accounts functions and processes need to be designed so that they are simple to understand and the end user understands the processes by which the metrics are complied. Date sensitive information such as Stock days needs to be examined carefully if the warehouse personnel are putting in inaccurate stock levels and wrong dates. ERP systems work well because they are in real time, if ‘time’ gets distorted because of input errors or lack of understanding, process flow control and accounting falls down. Lean accounting can’t work without organisation wide standardisation of input. Accurate Source material is vital to correct reporting, so accounting departments may actually cease to exist, the Accountant of the future may well be surrounded largely by operational personnel who are inputting key data, but not necessarily recognising they are doing accountancy related tasks.

Conclusion

The challenge for the Accounting functions is to meet the demand for more qualitative information on a timely basis and manage the accuracy of remote personnel. Harnessing technology and streamlining processes is not the sole domain of Operations management, the same principles apply to the Accounting processes and being lean also means being agile.

At the smaller end of the organisational spectrum, Accounts personnel will have to get used to doing more with less as ‘lean Accounting’ in itself will mean an end to the splendid isolation of the accounts function , and getting more involved in operational matters is crucial.

“What is Lean Accounting?” is anoft-asked question. Everybodyworking seriously to implement lean thinking in their company eventually bumps up against their accounting systems. It soon becomes clear that traditional accounting systems are actively anti-lean:

• They are large, complex, wasteful processes requiring huge amounts of non-value work.

• They provide measurements and reportslike labor efficiency and overhead absorption that motivate large batch production and high inventory levels.

• They have no good way to identify the financial impact of the lean improvements taking place throughout the company. On the contrary, the financial reports will often show that bad things are happening when very good lean change is being made.

• Very few people in the company understand the reports that emanate from the accounting systems, and yet they are used to make important and farreachingdecisions.

• They use standard product costs which are misleading when making decisions related to quoting, profitability, sourcing,make/buy, product rationalization, and so forth. Almost all companies imple-menting lean accounting are making poor decisions: turning down highlyprofitable work, out-sourcingproducts orcomponents that should be made in house, manufacturing overseas products that can be competitively manufactured here at home, etc.

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