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Adopting Lean Accounting is Critical to Sustainability

March 24, 2015
Ever since I attended the Lean Accounting Summit last fall, I have been interested in finding out more about the benefits of lean accounting and why so few companies seem to be adopting it.

Ever since I attended the Lean Accounting Summit last fall, I have been interested in finding out more about the benefits of lean accounting and why so few companies seem to be adopting it. Despite attending Operations Roundtable workshops on various aspects of Lean Six Sigma for eight years, I never heard a speaker mention lean accounting. I had no idea how it related to company operations until I took the Lean Six Sigma Yellow Belt course from the Lean Six Sigma Institute last year.

During my course, one local company, Apollo Sprayers, was featured as an example of a company that had adopted lean accounting, and the benefits to the company were impressive. This led me to arrange an interview with Luis Socconini, the founder and director of the Lean Six Sigma Institute, to find more about the benefits of lean accounting. Here are the highlights of the interview:

When and where did you learn about lean accounting?

Socconini: "I learned about the basics of lean accounting when I receive certification in ‘Throughput’ accounting directly from Dr. Eli Goldratt back in 1998, where I found it very interesting to be able to calculate the real cost. ‘Throughput’ calculates the profit/minute, but it doesn't include the quality, only the speed.  

“In 2005, I took certification training in lean accounting at Monterrey Tech in Monterrey, Mexico. Lean accounting is the next step of ‘Throughput’ accounting as it adds conversions costs to the profit/unit calculation. After implementing lean accounting in more than 35 projects, I learned that one of the most important objectives was to know the real cost of every individual product or service."

When did you start to teach and/or utilize lean accounting in working with clients?

Socconini: "I started in 2005 in a large textile company where the high mix and low and high volume was hiding the real cost because they were using standard cost and therefore losing a lot of money in several contracts. We found the root cause of that problem was in the cost system where standard cost was giving a complete different result. I also taught a ‘Theory of Constraints’ class at Monterrey Tech for seven years, which covered the basics of lean accounting. My company now has an agreement with 26 universities to teach this course in Mexico, Bolivia, Colombia, Ecuador, Costa Rica, Peru, and Spain, as well as Southwestern College in Chula Vista."

How has your view of lean accounting changed since you first started using it?

Socconini:"I changed my perception from it being a really complex system, difficult to understand and difficult to explain, to a very simple methodology to make it easy to calculate the real cost every week, every day and even every hour. This makes it possible to make better decisions in real time and enables all the value stream leaders to understand if they are losing or winning."

What does a company need to start measuring to get started on using lean accounting?

Socconini: "First they need to define lean accounting as one of the most important strategies for the business. Second, they need to implement calculating their ‘box score,’ which is a tool to evaluate the financial results every week. Third, by using the box score, they will be able to calculate direct cost of products (normal material) and conversion cost (all the rest of the costs like energy, salaries, utilities, rent, etc (everything but material or direct cost). With the conversion cost by hour, any company from any size or industry will be able to calculate real cost every day regardless of the mix or complexity. Real cost equals conversion cost per unit + material (direct cost)."

What are the benefits of using lean accounting compared to cost accounting?

Socconini: "A company is able to know what is the real cost and with this knowledge, they really know if the company is making money or losing money in real time. They are able to define correct prices for their products or services, decide which products or services are contributing profits and which of them are losers, prepare quotes with realistic information increasing the possibility of making better deals, and be able to define a target cost and compare it constantly with the real cost to drive the most important kaizen events."

A Successful Transformation to Lean Accounting

Socconini was able to provide me with the story of a company that successfully transformed from cost accounting to lean accounting, but was not given permission to reveal the name of the company nor the brand names of the products.

The company is a pharmaceutical company located in Mexico that also produces plastic molded parts used for its products and has 1,495 employees. The company was increasing sales by 20% to 40% each year and the product mix was also increasing. Their inventory was more than 6 months of sales (more than $900 million) and was increasing every year by at least 50%. However, they weren't increasing their profits at the same level that sales were increasing. They frequently didn't have in stock what the customer needed, and their lead-time was three weeks. Their productivity per employee was $1,560.

The consultants from the Lean Six Sigma Institute included all the accountants in the lean six sigma training and developed a lean accounting workshop to define accounting projects. All company accountants participated in the lean transformation in which the most important changes were:

Lean management tool implementation:

  • Developed strategic plan in one page (Hoshin Kanri) and disseminated the strategies to all employees
  • Developed a new structure based on value streams
  • Changed the plant layout based on value streams
  • Developed a box score and a business model for each of the 11 value streams
  • Developed a talent development system and compensation program

Basic tools implementation:

  • 5S housekeeping in all areas
  • Visual management by using day-by-the-hour boards for every production cell, logistics, shipping and order entry
  • Standardized work: Developed work instructions for critical jobs

Improvement tools:

  • Manufacturing cells and Kanban to reduce delivery time from 3 weeks to 4 days
  • Single minute exchange of die (SMED) to reduce changeover from 6.5 hours to 45 minutes
  • Total productive maintenance to increase availability from 60% to 85%
  • Mistake-proof methodologies to improve quality 

Lean Accounting tools:

  • Implemented lean budget to eliminate the delay on decision-making and track real demand every month
  • Implemented strategy follow-up meetings every month to evaluate progress and return over investment of projects
  • Implemented financial box score to calculate real cost and profit per minute in the most critical products (80-20 rule)
  • Implementation of target cost to guide the teams about continuous improvements by developing kaizen events only when target cost is involved
  • Redesigned the invoices to reduce mistakes in payments from clients and allow suppliers to capture their invoices directly in the company system
  • Reduced cost centers by assigning a cost center account to every value stream. (11 in total)

General results in the first 18 months:

  • Lead-time was reduced from 3 weeks to 5 days.
  • Every value stream had one accountant dedicated to track financial results.
  • Real cost calculations were now possible, and cost per production line or manufacturing cell is calculated at the end of every shift.
  • Inventory was reduced from 6 months to 1.5 months, saving more than $600 million in cash.
  • Reduced employees from more than 1,500 to 999. Only 14 were let go and the rest was attributed to relocation to other plants of the group and stopping hiring (12% turnover).
  • Cost reduction was about 18% on average per item.
  • It was possible to identify which products were really profitable and which were always losing money.
  • Accounts Receivable was reduced from 4.5% of total revenue to only 2.3%.
  • Productivity per employee was increased from $1,560 to more than $2,750 (almost double)

Accountants Key to Lean Changeover

With regard to the future of lean accounting in 5 to 10 years, Socconini believes that only the companies that use lean accounting will be able to understand their critical numbers and therefore will be the companies that can remain in the marketplace. He added that within five years, the top management teams will adopt lean accounting in all accounting processes ─ lean budgets (S&OP) and transform their financial processes of accounts receivable, accounts payable, credit, payroll, financial statements, inventory valuation, etc.

I concluded the interview by asking why he thinks companies are so slow to switch over from traditional cost accounting to lean accounting. He replied, "There are two main reasons: Accountants normally don't participate in the lean training or implementation; they only validate results with traditional calculations. Lean Accounting is not something that is being offered in traditional training in colleges and universities, so accountants don't understand what Lean Six Sigma is as a philosophy and they don't apply Lean Six Sigma principles and tools in their processes."

He added, "Another possible reason is that they think that lean accounting is going to affect the generally accepted accounting practices, but the truth is that the accounting procedures for calculating and paying taxes are not affected at all."

He said, "I am very optimistic that in the near future accountants will be one of the most important professionals to create a real change when they understand and participate in lean transformation as a systematic approach and when they are trained and invited to participate in the company transformation."

I believe that it is critical for accountants to be trained in lean accounting and participate in a company transformation in order for companies to be sustainable in the increasingly competitive global marketplace.

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