In this blog, I’d like to explain 3 general guidelines accounting should follow for creating an effective lean decision framework for your lean manufacturing company.
#1- Financial Impact on Value Stream Profitability
The general rule for lean decision making is to understand the financial impact of any decision is based on the impact on total value stream profitability. Hence, the necessity for value stream income statements in a lean manufacturing company. This is a departure for most accounting professionals in manufacturing, as many financial analyses get broken down by specific product, product family, business unit, etc.
The change in actual value stream profitability will accurately reflect the economics of lean, as described in an early blog. Another advantage of using actual value stream profitability is that the profitability impact will be realized because the analysis is based on actual revenue and actual costs.
#2 – Stop using Cost Allocations
Most cost allocations have a level of subjectivity in them (such as all rates in a standard costing system). And many cost allocations are an attempt to make a fix cost variable by linking it to units produced. Using rates in financial analysis is dangerous because they can make it appear that costs are decreasing, when in reality actual costs are not changing.
Here is an example in manufacturing – direct labor costs. Standard costing systems assigns direct labor based on a direct labor rate & volume produced. If a manufacturing business was considering eliminating a product or product line, the financial analysis would show a “direct labor savings”, because direct labor is assumed to be variable.
The reality in most companies is your full-time employees come to work every day and get paid a full day’s pay whether they produce 100 products per day or 500 products per day. If a company were to eliminate a product, these employees would still be full-time employees, which the actual labor cost for the company does not change. Actual labor would decrease only if fewer employees were employed.
Accounting’s responsibility is to begin to understand how costs change in a lean manufacturing company, without using cost allocations. If cost allocations are commonly used in your company in financial analysis, it’s time to begin migrating away from them by introducing the value stream income statement.
#3 – Lean Improvements create Capacity
This is a fact of Lean: eliminating waste creates time – the time spent on waste is now available to spend on creating value. This is also described as creating capacity.
This fact of lean must be incorporated into your lean decision framework. The creation of time has no financial impact, but how the business uses that time does have a financial impact. The majority of the time, a lean manufacturing company will use this newly created capacity to build & ship more products, and the financial impact will be increasing revenue.
In your lean decision making framework, it’s essential to be able to incorporate the amount of time being created so accounting can properly project revenue that can be realized.
In the next blog, we will begin to look at lean cost analysis in more detail.