What is Lean Accounting?

What is Lean Accounting?

Lean accounting describes the financial reporting practices used by a company that embraces Lean thinking: focusing on the value delivered to the client and on waste elimination, through better workflow and material management.

Lean accounting means aligning financial management with your company’s Lean strategies. Through that process, it improves not only the accounting affairs but the entire economics of your business.

Why use Lean accounting?

The general purpose of accounting is to gather, analyze, and communicate a company’s performance, position, and cash reserves - all types of information used to make decisions on how to best manage a business.

As a result of traditional manufacturing processes making it challenging to accurately measure costs, in the 1920s, cost accounting focus started to shift from information for planning to information for control. This led to businesses turning to cost allocation, rather than cost tracking, and that slowly became the new norm.

Aside from directly synchronizing accounting with a company’s strategy, Lean accounting also works to reduce any wasteful practices from finance management, to limit those processes to a minimum, and ensure that financial control does not grow to create an organizational and costly overhead of its own.

A similar waste reduction is applied to the Lean understanding of assets. Traditionally, the cost of excess capacity, e.g. more available team members in a service company, extra inventory in manufacturing, was carried over to the customer. Just in Time, one of the pillars of Lean, flipped this on its head, placing focus on producing only what’s needed & when it’s needed, and reducing inventory to almost nothing.

Continuous improvement,
or why you won’t apply Lean accounting in a day?

Taichi Ohno, leader of the Lean approach created at Toyota, realized that the focus of traditional cost accounting was not on creating maximum value to customers, and included several processes that would, in fact, be considered wasteful by customers.

But a solution to this could not have been achieved overnight, and that still stands for companies making this shift today. First, you need to teach the employees to learn where the value in the process is, and how to efficiently deliver it to the customers. They also need to learn to quickly find and remove waste from the process. Only with that, can a company gradually establish Lean accounting, marrying the value stream and its financial aspect.

Given that the transformation of your business strategy, preceding any work on accounting methods, will take time, Lean accounting can be challenging for managers hoping to achieve significant results in a short time. A Lean approach to company accounting is a result of continuous improvement, just like all things Lean.

How does Lean accounting work?

1. Value stream-oriented thinking

Lean focuses on optimizing the activities that are part of the value stream and minimizing those that do not add value - from a customer’s perspective. Hence, in Lean accounting, the costs are transferred from a product to a product line, standing to show how efficient a line is. This makes Lean accounting able to measure how effective the engineering or service process is. Most engineers are only focused on their effectiveness in building a high-value product - and that’s understandable. It’s ill-advised for there to be a war between targeting quality or achieving low costs.

But the question of cost vs quality relation remains, and it is down to company strategy, and engineering practices derived from it, to sufficiently adjust all efforts to both increase value and minimize waste, creating the means from which the accounting team will be able to accurately calculate costs.

2. More transparent, on-demand reporting

Thanks to the direct relationship between costs and the value stream, expenditure reporting can be captured and processed as quickly as possible. Better yet, ongoing cost amounts can be automated and made available on-demand, as opposed to seasonal bulk financial reporting shared with top-level management only.

The engineers too will derive value from these reports, given how the cost of delivering a product is not tied to just the work and material costs known to them.

Furthermore, because of Lean’s flow optimization, costs that were previously seen as supporting or apportioned can become a part of the production flow. It will allow you to directly measure supporting costs and subject them to the same rigor driving the entire production line.

3. Delivering what the customers value

Value, as a subjective concept in a customer’s mind, is not equal to costs.

Example If the cost of producing an item is $100, on top of which the manufacturer includes a profit of $20, then the cost to the customer is $120. But if the value to the customer was exactly $120, then - arguably - they would leave the transaction without any perceived benefit. They’d have simply materialized the value of their cash. Hence, it’s assumed that the value to the customer is higher than $120, paying which lets them feel that they’ve made a good deal.

It’s similar to purchasing luxury products - their value to you is higher than their price alone. Included in the concept of value is the sense of achievement you feel when buying the product, the pride and joy of using it, etc. It’s due to the subjectivity of value, that luxury product consumers are happy to spend more than just the material cost of an item.

Through continuous efforts to learn what your customer values and applying it to the value stream, it’s possible to achieve a process in which this value will be steadily increasing, while waste and cost will be dropping. In doing so, your company should grow, increase its revenue, and reinforce customer loyalty.

Process execution before accounting

Companies looking to implement Lean financial management first need to adopt Lean ways of operating. Standardizing operations, implementing Kaizen, improving workflows, organizing in work cells - all help with the adoption of Lean thinking, and then accounting.

When this is done, knowing the direct cost of delivering a product line is - first of all - possible, and very useful for planning the organization’s development. Lean companies make it their business to know what is the value that customers get out of their products. Then, if their processing costs get too high, they can turn to re-engineer the process, to keep the market satisfied. Happy customers are the goal for any Lean company, standing to prove its current state, as well as being a factor in predicting its future.

The requirements for adopting Lean accounting are:

  • Identified value streams, with directly tied costing
  • Focus on work based on - and adding to - the customer-identified value
  • Access to cost reports for all teams involved in value delivery
  • Openness to continuous improvements in both the process and accounting.

Example Let’s look at a traditional income statement and a Lean financial statement.
Traditional income statement On traditional income statements, like the one above, you’ll often see notes and annexures explaining how costing calculations are apportioned and how the variance is established, which limits the number of people that can understand it. Lean accounting changes this approach, making the report easier to grasp, no matter your role at the company: Lean financial statement

The source of your company’s Lean accounting has to be based on the understanding of your value stream, with knowledge of the production costs. Once you’re well on your Kaizen journey, Lean accounting is likely to become a by-product of your company and operations design.

Key benefits of Lean accounting:

  • Less waste in your financial control practices, also thanks to the removal of cost allocation, and more hands-on knowledge of your business costs
  • Better understanding of how your financial decisions impact the value stream and the client, and vice versa: easier access to business growth opportunities, through the immediate value - finance connection.