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Insight: Benefits of Lean In the Accounting Department

Lean practices are rapidly becoming a survival requirement for automotive suppliers who want to maintain decent margins.

Lean practices are rapidly becoming a survival requirement for automotive suppliers who want to maintain decent margins. Unfortunately, the vast majority of lean practices are implemented in manufacturing processes only. Some limited attention has started to be paid to the elimination of waste in the areas of engineering and pre-production launch. However, one of the biggest opportunities for productivity improvement is found in the finance and accounting functions. Yet they are still largely mired in practices that were specifically developed to support mass production manufacturing.

IRN, Inc. and Ernst & Young, LLP (http://www.ey.com/global/content.nsf/US/Home) have been collaborating on a study of how manufacturing companies, especially automotive suppliers, are restructuring their financial and accounting systems to become enablers of, rather than barriers to, world-class manufacturing performance. Traditional accounting and financial control systems (including budgeting, inventory valuation, overhead allocations, cost accounting, and financial reporting) have emerged as significant barriers to deep implementation of lean practices. Since these systems were developed to support traditional batch manufacturing, this should not be a surprise. However, because of their close ties to financial compliance and corporate decision-making, they have proved particularly difficult to change. While some of the opportunities for improvement in these systems are efficiency-oriented (elimination of many wasteful trans-actions), the major advantages are strategic—especially from more accurate understanding of costs to make decisions about pricing and product mix.

Most of the financial accounting and control systems used in manufacturing companies were designed for a very different kind of operating environment, one characterized by:

Large volumes of inventory. It was not untypical for companies to haveinventory turns of 5 or fewer per year, with inventory tying up financial assets equal to 30-40% of annual sales. In this situation, elaborate systems must be in place to accurately track and value inventory.

High direct labor content. Direct labor often accounted for 60% or more of a product's cost. Extensive systems needed to be developed to track labor costs as they occurred; allocate them to specific products; and compare them to standards.

Long, standardized runs. Schedules were characterized by high-volume runs of the same products with few changeovers and long lead times.

Large volumes of direct suppliers. Large numbers of suppliers would deliver direct to the factory in large batches (several weeks of inventory at a time). Suppliers would frequently change based on price differences. Complex control systems were needed to track supplier purchase orders and deliveries, and match them with invoices for accounts payable.

Manufacturing Has Changed; Finance Hasn't
The lean revolution has radically changed manufacturing practices. Inventory levels in a lean organization are measured in terms of hours, not weeks or months. Labor content is frequently less than 10% of product costs due to high levels of outsourcing and automation. Production schedules are characterized by short runs and frequent product changeovers. Production is organized around individual cells or value streams, not batch-oriented processes. And lean supply chain management has led to a small number of strategic suppliers who are managed through long-term contracts. These suppliers often manage inventory of their products in the customer's facility, delivering multiple times daily.

Unfortunately, while the manufacturing systems in many companies have been transformed, the finance and accounting systems developed to support mass production manufacturing have remained unchanged in most companies, even those with a deep lean orientation. Overhead is still allocated based on direct labor (often requiring overhead rates of 600% or more because direct labor is so low); standard costing systems are still used to establish prices; complex systems are still used to value inventory; and financial accounting is still used to measure and monitor operations.

Operational & Strategic Opportunities
The opportunities available to companies who are willing to focus their lean thinking on their finance and accounting functions are both operational and strategic in nature:

Reduction of wasteful transactions. Operational improvements can be made in lean companies that eliminate many wasteful transactions, including three-way matching; labor tracking; work orders; variance reporting; vendor invoices and purchasing orders; and cycle counting. A major part of this simplification process involves the shift to a much simpler inventory valuation system. The need to value inventory is a driver of many wasteful accounting and finance activities. Advanced lean companies have radically reduced levels of inventory, and high levels of visual control on the shop floor, allowing them to value inventory through a simple end of month visual count. Inventory levels in many such companies are so low that they are no longer "material" from a GAAP point of view.

Improved knowledge of real costs. A major advantage of implementing lean finance practices is a deeply improved knowledge of real costs by value stream. Lean companies are organized around value streams. Value stream costing allows the development of costing systems based on the value stream, not individual products. Detailed value stream maps allow you to know the exact costs of a particular value stream, as well as opportunities for "Kaizen Costing" or the reduction of costs during production. As many costs as possible are "internalized" in the value stream and made direct, not indirect. Cell-based balanced scorecard systems, as well as regular value-stream mapping updates, allow you to have immediate knowledge of changes in production rates and other variables that are inputs to the pricing and quoting process.

True knowledge of real-time costs (what some companies call "natural costing") creates strategic advantages in knowing how to price products (or when to accept/decline customer-mandated price changes); knowing when to make vs. buy components; making choices about product mix; and deciding what work to quote.

Of particular importance to automotive suppliers is being able to accurately understand and manage product development and launch costs. As program launches increase, and suppliers take on more engineering design responsibility, the importance of these costs to overall profitability increases dramatically. Traditional finance and accounting systems are not well designed to track and manage these costs. 

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