The terms "lean manufacturing" and "lean inventory" refer to an approach to production that eliminates waste and shortens the time between receiving and delivering orders. Lean accounting is geared toward streamlining accounting processes in comparable ways. It also uses accounting to support lean production by gathering useful information about how effectively operations are flowing. Assembling and organizing this information often involves rethinking the assumptions embedded in traditional accounting systems.
Lean accounting is a financial management approach that supports the streamlined processes of lean manufacturing.
Lean accounting is the collection of principles and processes that provide numerical feedback for manufacturers implementing lean manufacturing and lean inventory practices. When you make changes to operations, such as organizing processes in different ways or shifting the ways you use your workers' time, it may be difficult to tell from simply observing workflow how much of a difference these adjustments have made. Production may seem smoother and easier and customers may seem more satisfied, but quantifying these results provides relevant, high-quality information, allowing managers to actually see the consequences of different approaches to workflow and to compare results. The information you receive from lean accounting can provide the basis for making further changes and adjustments, which your lean accounting system can also measure and evaluate.
Lean accounting treats some traditional accounting principles in nontraditional ways because conventional accounting protocols don't fully reflect the value that comes from a lean manufacturing approach. For example, traditional accounting treats inventory as an asset because it quantifies something you own rather than something you owe. Your business might manufacture parts that it later uses in finished products that are sold to customers. If you focus manufacturing resources on producing a large quantity of a particular part, your traditional balance sheet will record the inventory you've produced as an asset which increases your net worth even if it just sits on the shelf of your warehouse for a year. Lean accounting, however, takes into account the fact that unused inventory can actually be detrimental to the well being of your business because it takes up space and requires labor and materials expenditures that you could be using instead to fill a more current order.
The concepts of lean manufacturing revolve around paring down manufacturing and inventory to streamline your operations toward filling current orders with as little turnaround time as possible. This approach redefines efficiency, focusing on throughput (completing and delivering finished products to customers who have placed orders). Traditional accounting instead measures efficiency in terms of how many units your production line completes, regardless of whether customers have placed orders for these units.
A traditional accounting system might show impressive numbers by virtue of the fact that you've leveraged economies of scale and made large quantities of a particular part. These traditional metrics focus on the average amount of time and labor you expend in the process of making each unit without considering the bigger picture. For example, your business will experience a different financial outcome if you deliver parts to an eager customer who will pay for them immediately rather than storing these parts in your warehouse in anticipation of future orders.
Lean manufacturing also emphasizes the principle of short turnaround time. If your business focuses on filling orders as you receive them rather than building up large quantities of particular parts, you'll end up with less waste because the parts you've manufactured in quantity may not be the parts you actually need once the orders start rolling in. Lean accounting quantifies these savings, measuring results in terms of sales relative to inventory and the lead time between a customer placing an order and your company filling and delivering it.
Communication and feedback systems are key in lean manufacturing. The sooner your warehouse and manufacturing teams know what orders have been placed, the sooner they can order the materials they need and set production processes in motion. The lean inventory approach depends on lining up suppliers who can get you what you need as quickly as possible after an order has been placed.
Kaizen is another important lean manufacturing principle based on a Japanese operations philosophy that emphasizes continual improvement. Kaizen can be summarized in five principles that all start with the letter "s".
- Sort: With its strong emphasis on keeping inventory levels to a minimum, lean manufacturing relies on the Kaizen principle of sorting, or identifying items that are no longer useful and getting them out of the way. This practice eliminates clutter and cuts down on the time your team has to spend cataloging and rotating stock that may not even be used. Lean accounting measures the time you save here by evaluating the efficiency of your systems overall once you've gotten unnecessary stock out of the way.
- Set in order: Once you've identified which inventory items you'll keep versus those you'll discard, the Kaizen approach emphasizes creating order among the stock you still have on hand. The process of organizing seems on the surface to interfere with productivity because you're spending time arranging rather than producing. However, lean accounting's observations demonstrate that spending this extra time actually saves time in the long run because you don't spend unnecessary hours looking for what you need in a chaotic warehouse.
- Shine: Like setting items in order, keeping your work space clean makes the most of your resources by allowing your business to operate smoothly and without clutter, unnecessary accidents or equipment malfunctions due to improper care. The net gains from this extra care show up in your lean accounting numbers in the form of increased efficiency and lower repair bills.
- Standardize: Every manufacturing operation has elements in common with other operations and elements that are unique to its specifications and processes. Lean manufacturing identifies and standardizes best practices, drawing on general industry knowledge and also proprietary information developed by your staff. By assembling these insights into operations manuals and training staff effectively, you'll lower labor costs by minimizing mistakes and maximizing efficiency. You'll also increase customer satisfaction through increased consistency. Your lean accounting system will capture these improvements with data that shows strong sales and efficient use of labor hours.
- Sustain: Once you've put the necessary energy and resources into the first four stages of the Kaizen process, you must also develop systems and sensibilities that encourage your staff to sustain and maintain the improvements they've made and even continue improving on them. Lean accounting can track your ability to sustain these efforts by following your progress over time and spotting emerging problems if your systems start to slip.
Although your business may successfully and passionately implement lean manufacturing and lean inventory practices, the success of these practices are not always reflected in traditional accounting reports. The effect of lean inventory on your balance sheet is the most striking example of this discrepancy: Lower inventory levels keep your business running smoothly and profitably, but they show up on a traditional balance sheet as a variable that causes your company to have less value, at least on paper. However, if you're using lean principles successfully, this hit to your balance sheet will be balanced by a corresponding increase in the bottom line of your profit and loss statement, which over time will bounce back to your balance sheet as more cash in the bank.
If you're applying for a loan from a banker who isn't versed in lean principles, you may have to explain these concepts. You can provide notes to accompany your financial statements, or you can provide explanations in person at face-to-face meetings. This background information will help to flesh out your loan application and will provide an opportunity for you to create a well-rounded impression and appeal to the lender's discretion. It is generally a good idea to reach out to lenders and start developing relationships before you get to the point of submitting an application for financing. This relationship-building is especially important if your business works with concepts and approaches such as lean manufacturing, which may be unfamiliar to the lender.
Lean manufacturing and inventory show up on a pro forma cash-flow statement in the form of lower expenses that result in a less-urgent need for outside operating capital, reflecting a lean approach to finance. If you shorten lead times for producing and delivering orders and you keep less inventory on hand, the cash flow needs on your pro forma (and in your actual operations) will sync more closely with incoming cash. Instead of investing in a glut of inventory that requires a large payment up front but brings in revenue over an extended period of time, a lean operation spends money as closely as possible to when it delivers orders and bills customers.
A business using lean manufacturing practices can also develop customized accounting reports that measure its success using lean parameters. For example, you might track the flow of parts and labor over time to glean information about how smoothly and effectively your operations are flowing, or you might compile regular reports that measure inventory turnover, a critical variable in keeping your systems tight and lean.
In addition to tracking the success of lean practices on the manufacturing floor, lean accounting should itself be lean. Its processes should be streamlined and should not require more effort and resources than necessary. To transition to a lean accounting system, it's helpful to use a system that mirrors the five "s" approach of Kaizen. First, sort your accounting operations, evaluating them with an eye toward determining which steps provide the most value relative to the time they take. Discard processes that aren't necessary for legal accounting requirements. Also eliminate steps and reports that don't give quality information about how well your lean systems are working.
After sorting your processes, set them in order by developing a sequence of tasks that makes the most of your accounting time and also yields the best possible information. For example, when evaluating workflow it makes sense to track inventory purchases before recording sales figures because the inventory is necessary to generate the sales rather than vice versa. Next, shine your processes by eliminating unnecessary steps and upgrading your spreadsheets and platforms so they'll provide the best-quality information with the least amount of input and backtracking.
Once your systems have been tightened and cleaned, start standardizing your lean accounting processes by creating written protocols and training personnel to follow these clear procedures accurately and consistently. Create standards and schedules for recording information and relaying it to coworkers who rely on these figures to understand and evaluate their production and purchasing activities.
Finally, sustain your lean accounting practices by following through and doing the scheduled tasks on schedule and making sure your coworkers do the same. Evaluate these processes regularly and update them as often as necessary, especially as systems and circumstances evolve. Keep accounting and production staff informed about changes you've implemented, especially when these changes affect their work and their responsibilities.