Lean Beans: Jack’s Cost System for the 21 st Century Sue Sondergelt, CMA Lean Accounting Associate...

Lean Beans: Jack’s Cost Lean Beans: Jack’s Cost System for the 21System for the 21stst Century Century

Sue Sondergelt, CMALean Accounting Associate

Lean Advisors, IncLean Advisors, Incwww.leanadvisors.com

Faculty, University of Phoenix Online, MBA Program“Advanced Cost with a Lean Twist”

IMA 87th Annual Conference & Expo

June 17 – 21, 2006

Las Vegas© 2006 Lean Advisors Inc

Success Through KnowledgeTM

http://www.leanadvisors.com/

FERF: A New Paradigm of Change for Accountants

Lean Thinking Prerequisites for Lean Beans

What’s Wrong with Standard Cost?

Conclusion

11

22

33

44 Lean Beans: Re-creating Your Financial System

Agenda

© 2006 Lean Advisors Inc

Getting Past Old Paradigms

“What Business Are You In?”80’s and 90’s Management Techniques:

– JIT, TQM, TPM, Six Sigma – All Inwardly focused on products.

What Business Should You Be In?- creating VALUE for the Customer.- Outwardly focused on the Customer.

Example: Pratt & Whitney – “Power by the Hour”


Getting Past Old ParadigmsIf we look at the history of Management

Accounting, there has not been much “change” or innovation since Henry Ford spoke on Target

Costing back in the 1920’s:

“We have never considered any costs as fixed. Therefore we first reduce the price to a point where we believe more sales will result. Then we go ahead and try to make the price. We do not bother about the costs. The new price

forces the cost down.”

- By Henry Ford, My Life and Work, 1922


Since 1930 there have been no significant changes in the way in which Financial or

Managerial Accountants “think.”

1990’s: Decade of Tech Tools. Command & Control!

Crash & Burn!

Then in came the Financial Executive Research Foundation…

FERF© 2006 Lean Advisors Inc

FERF: Financial Executive Research Foundation

Defined the Traditional Accountant as:

• “Bean Counter”• Messenger of “Doom & Gloom”• Concerned only with Control• Variance Analysis / Paralysis


“Old” Paradigm vs “New” in Accounting

• MBO• What gets done & what

gets measured counts• Vertical organization• Control• Isolated “functions”• Lone Rangers & one

improvement per year

• MBV (VALUE)• “How” we achieve success

is what really counts• Horizontal organization• Empowerment• Integrated Teams• Kaizen Teams & many

improvements, often


FERF says there will be

Implications

• How will the Finance “function” operate in a process or team-oriented organization?

• Is a “functional” approach to organizing Finance still relevant?


FERF“Initiative on Organization and Strategy

in Financial Management”

• Finance should be Commitment to Cultural Change

• Finance plays a major role in this Organizational Change

(an example: Controller at Gorton Fish)


Gorton FishKaizen Team mapped the Value Stream, from the time

material hit the receiving dock to the time the finished product was shipped to the customer.

After mapping the current state, they went to work

eliminating Waste (miles of conveyor belts, waiting time, queue time, mountains of inventory, handling waste, defects.)

Reduced lead time from 114 days to 10 days, taking $3 million to the bottom line with only an $80k investment (that’s an IRR of 3,650%.)

Who led this team? A new age Managerial Accountant!


Making the Numbers Count

Excuse: Must obey GAAP!

Yes! But only in Financial Reporting!

Management Accounting is proactive.

Simplify accounting systems so that they serveProduction, Marketing, and Engineering….

the entire Organization!

“ADDING VALUE…….”


• Junk traditional “absorption” accounting• Declare Standard Cost and Variance Analysis DEAD!• Keep Standard Cost for Families of parts for sole purpose of valuing inventory on the Balance Sheet ONLY• Use cycle time to allocate overhead (not DLH/not MH.)

More emphasis on L/T than S/T, Judge Production Managers on INVENTORY TURNS and Defects, not Operating Income.

‘Lean Beans’ In A Nutshell

Let’s quickly review “lean thinking” before discussing Lean Beans.


Origins of Lean Manufacturing

LEAN is not a buzz word!

Think of LEAN as a new “brand name” to sell an old Concept.

LEANLEAN JITToyotaProduction System

Henry Ford

“Common Sense”

Early 1900’s1950’s1970’s1990’s


Review of Principles of Lean

1. Create Value for Customer (Product Families)

2. Map the Value Stream

3. Flow (machines/desks lined up in the order in which the operations occur)

4. Pull from the Customer

5. Perfect

Before we discuss Lean Beans, we need to understand

the basic principles of Lean Thinking.


Prerequisites for Lean Beans

You should have the first two principles of Lean in place in your organization:

1. Specify VALUE (set up Product Families)

2. Identify the VALUE StreamIf you have these two principles in place,

you will take millions of dollars to the ‘bottom line.’


What do we mean by VALUE?Principle #1

To be successful in Business, we need to look

“Outside-In” and not “Top-Down.”

Deming: “You must not run your Organization as a functional hierarchy.

You must understand it as a “SystemSystem.”

Managers must change the way they “think!” Think SystemsSystems and not functions,Look “outside-in” and understand what matters to the Customer.


Value-Added AnalysisAn Example…

Start at the moment supplier drops off material:

1. Move off truck 30 min2. Wait in Receiving 48 hours3. Compare to PO 60 min4. Wait in Receiving 12 hours

Could the process be changed so that thematerial doesn’t have to wait?? What aboutdelivering material direct to the location inthe plant where it will be used?

WaitTime

WASTE Time!


“Processing Villages” Interrupt Flow.“Departments” Interrupt Flow.

NoProcessing

Villages!

NoMaterial

Handlers!


Prerequisite to Creating Value

Establish PRODUCT FAMILIES

How?

Matrix of your machines, or processes, or steps, and your Products…


Identifying PRODUCT Families

PROCESSES or MACHINES or OPERATIONS or PEOPLE

1 2 3 4 5 6 7 8

P A X X X X X

R B X X X X X X

O C X X X X X X

D D X X X X X

U E X X X X X

C F X X X X X

T G X X X X X

S H X

A Product Family!


StampingProcess

WeldingProcess

AssemblyProcess

PaintingProcess

RM FG to Customer

VALUE STREAM

Value Stream Improvement vs Process (Point) Improvement

Improving the Whole! Working the ‘Big Picture!’

Lean Principle #2:

Mapping the Value Stream

• Product Concept to Launch• Raw Material to Finished Product•Order to Cash

Three Value Streams:



• Identify all of the steps currently required tomove product from material requisition to delivery of Finished Good to Customer.

• Challenge every step: Does it all add Value for the Customer?

• Many steps are only necessary because of the way businesses are organized (departments and functional silos.)



• How orders come in (information mapping)• How material comes in (material mapping)• How product is shipped out to customerCurrent State and Future State Maps for each Product Family_ a VISION!

…then eliminate steps which do NOT create Value for the Customer.

Different from Process Mapping….


The OLD Company….

Sales Eng’ing Operations Quality Finance HR

One functional silo to another“Toll gates”“Hand-offs” & fumbles!


WARNING!!!REQUIRED:

Complete rearrangement of all of your mental,

as well as physical, furniture.

MUST MOVE PAST “MUDA” (Waste) PARADIGMS!


The New LEAN Company...

ProdDev

Prod FamA

Prod FamC

Prod Fam B

Prod FamD

Prod FamE

ContinuousImprovemt

Office

AdminTeam Shipping

Team

SalesTeam

Smallgroup engineers(R&TS)

From Accounting point of view, no more allocations*,90% of charges are Direct within a Family,increased responsibility in every P&L.

*Lean Beans leaps right over the top of ABC Cost!

Kaizen facilitatorsCEO, CFO,Core Finance,Supply Mngmt

In Field


New Management Accountant’s Role:Creating New Paradigms

• Soft Skills as well as Hard skills. You will always need knowledge of GAAP, yes, but you will also need people skills and some psychology to be successful.

• Fewer Controls. You will need to move away from Controls and move toward adding Value and empowering your people. You will need to be a COACH_ not a supervisor.

• More line integrated. You will find yourself reporting to multiple bosses: some in Finance, some in Operations. There may still be a solid line boss, but there will be multiple dotted-line bosses.

• Share information / data. No more data rich and knowledge poor. You will need to bring the data to the users of the information, and help them understand it.

• No more MBO (management by objectives) but rather MBV (management by Values.)• Help to remove barriers within the company, tearing down functional silos, departments,

processing villages, flattening the organization. You will need to build cross-functional teams to solve problems, cross departmental barriers, and communicate your data and knowledge to all types of employees in all sorts of functional areas. Robert Half, in a recent survey entitled “The Next Generation Accountant,” stated that today’s CFO expects non-traditional accounting functions to occupy 37% of a Sr. Accountant’s time five years from now.

• Help with Organizational learning. People throughout the organization need to know the business cold! People can better help move the organization if they understand it. Provide Cost training for Operations people_ “YOUR BUSINESS 101” for new hires.

• Do bottom line results count more than how we achieved those results? Did the Financial Accountant play games with the Balance Sheet, or did you, the Management Accountant, create Value for the business?


Trends in New Management Lean Bean Accounting

• Emphasis on eliminating Waste rather than just reducing costs. We will be looking at processes and the entire Value Stream rather than just the “point improvements” we got with Reengineering, JIT, Six Sigma, etc. in the 1990’s.

• Emphasis on cost reduction at the new product development stage. Design to Cost and Target Costing are emerging as standard practices in the new organization.

• Utilization of VE (Value Engineering) Teams to:– Create Estimated Cost Accounting Systems. We don’t need to calculate the actual cost

of each individual product separately for internal use, nor do we need to put a cost on every little nut and bolt in our Inventory. At Pratt & Whitney, we did not need to cost every single engine serial number, but rather we cost families of engines based on pounds of thrust.

– Knock down your organization’s exterior walls, and send VE Teams to work at reducing costs at your Suppliers. We are not going to cut the Supplier’s profit margin, but rather help him eliminate waste and improve processes. After all, your Supplier is an extension of your Value Stream.

• Implementation of a Product Cost Management System, to handle cost reduction and cost control, and standardize how we do this across the entire organization. Once we have calculated “estimated costs” for different product families, then we can apply cost reduction ideas across the family of parts.

• Effectiveness on your part will be more important and more valuable than efficiency. People need to be empowered to make changes. Cross-functional teams are getting things done more effectively than Lone Rangers stacked in layers of hierarchy.


Effectiveness vs Efficiency

• What is and what could be

• Outside-in view from customer perspective

• Identifies the expectation gaps between current activities and optimal performance

• Doing the right thing!

• Keep people busy doing anything, just to cover overhead

• Inside-out view• Identifies how much work

I did with the resources I had

• Having good people do the wrong things well


Cost Accounting = transactions= bean counting= Standards= Command & Control!

Cost Management = Target costing= QFD= Cost Planning=

Empowerment/Psychology

COSTS JUST DON’T HAPPEN!!

OLD vs NEW Paradigm

‘OLD!”

‘NEW!’

We should PLAN our costs!© 2006 Lean Advisors Inc

So What’s Wrong withStandard Cost?

How does Standard Cost fit into Cost Management? IT DOESN’T!

When Standard Cost was established, cost was 30% material, 60% labor,So allocating overhead based on labor was legitimate.But today cost is at least 60% material and 10% labor!

If we use traditional accounting to report performance, we are distorting product Costs!

Bottom Line: Standard Cost as we know it (since 1930) just doesn’t “cut it!”

WE NEED SOMETHING DIFFERENT!


Lean Business Structure Demands We Recreate the Financial System

What Variable Cost Management System will cause Product Managers to do the right thing?

• Standard Cost & Absorption Accounting are not it!-- Does not “pull” from the Customer-- Allows “game-playing”-- Measures Inventory and “batches”-- Measures “efficiency”


Standard Cost Measures “Efficiency”

• Efficient use of machines and people creates “volume” variances.

• But in Lean we want to reduce volumes, and make only what the Customer orders.

• In Standard Cost these lower Lean volumes create negative variances and lower profits as these variances hit expense.


Bottom Line Improvements

Three Reasons why we see NO Bottom Line improvements from Lean in the first year:

1. You are still using Standard Cost with Volume Variances creating problems!!

2. Any month you do substantial Inventory reduction, you show your manufacturing expenses increasing.

3. In Lean you have eliminated Waste but not, in the short-term, costs. The Waste you removed has been converted into available capacity, and you will need to DO something with that extra capacity and floor space to “create wealth.”


Robert Kaplan, “Relevance Lost”

“Corporate Management Accounting systems are inadequate for today’s environment.”

Too complex!

• Evolution of Lean is toward simplicity & speed! ABC Costing has only added complexity and cost to the accounting system.

• In any company involved in Lean, Standard Cost becomes a barrier to change!


A New Focus on the Business…..The Value Stream Map!

Without a Vision, the Result will be NO savings reaching the bottom line, because the Value Flow

comes to a halt in a swamp of Inventory and detours up & down, and through Departments.

Isolated, point improvement victories over waste will fail to improve the whole.

We do not want a bunch of hammers looking for a bunch of nails!(Not bad, but not optimal.)

We need something different…….

A “Systems” approach to Change….a Vision!


Productivity = WealthProductivity = Revenue / #Employees

How are you getting productivity improvements?• Increasing the numerator, or decreasing the

denominator? • Truly increasing revenue, or raising prices?• Truly increasing revenue, or laying off employees?

TOYOTA’s Productivity measure: 400% Improvement over 10 Years!

Focus Needs to be on Productivity, not Cost!


And Focus Needs to be on Our Value Streams!

1. New CM “Reporting” needs to be by Value Stream (VS), and not by Departments.

2. People need to be assigned to a VS3. Few shared-service departments and few monuments

(avoid cost allocations)4. Need Tracking system of “out of control” situations, eg,

scrap and rework.5. Inventory must be relatively low (>25 turns)6. Change the Metrics to motivate7. Get rid of most accounting “controls”, and replace with

“visuals” (Kanbans, Scorecards)8. Validate the financial impact of Lean successes with

“new” Lean P&L’s


Summary of Lean Beans…

1. Replace Standard Cost system with some Variable, Value Stream cost system. (suggest a Target Cost system where one looks at Actuals and trends.)

2. Create “simple Lean Bean” financial statements & P&L’s.

3. Use Target Cost to drive the business from Customer Value, and not from Cost.

4. Use Target Cost for strategic Budgeting.5. Use Cycle Time to allocate overhead.


Lean Accounting is a Philosophyof doing Business

(Not a CD Rom!)

Remember! Goal of Lean Beans is to:

1. Clarify financial statements (simplify!)

2. Give operations folks insight into the business.

3. Keep it simple, and in a language that folks can understand!


Old Paradigm vs New Lean Paradigm

• Standard Cost• Absorption• Variance Analysis

/Paralysis• O/H allocation based

on DLH • Old Cost System =

Standard & Absorption

• Target / Actual Cost• Variable• Variance of Actual to

Target/ Trend Analysis• O/H allocation based on

Cycle Time• New Cost System =

anything that drives the right behavior



• Valuing Inventory• Controlling Transactions• Financial Metrics and

MBO• S/T Goals (Operating

Income)• Make-the-Month• Cost Accounting

• Eliminating Inventory• Controlling Processes• Non-financial Metrics

and MBV• L/T Goals (Inv Turns,

Customer Satisfaction• Cycle time = Takt• Cost Management



• Cut Costs• Saving Cash• ABC Allocation

• Traditional Standard Cost P&L

• Cut Wastes• Create Cash• No Allocations (all

costs are direct)• “Simple Lean Bean”

P&L


WHAT WILL LEAN BEANS DO FOR US?


Mass Production vs Lean Production

Beg Inv 1,450,000DM purch 950,000950,000Dir Labor 900,000Indir Mfg Costs

350,000SubTotal 3,650,000- End Inv 1,450,0001,450,000

Total Costs 2,200,000 Total Revenue 3,000,000 Profit (loss)-pretax 800800,000,000Cash Flow-pretax

800,000800,000

Beg Inv 1,450,000DM purch 500500,000000Dir Labor 900,000Indir Mfg Costs

350,000SubTotal 3,200,000- End Inv 150,000150,000 Total Costs 3,050,000Total Revenue 3,000,000Profit (loss)-pretax (50,000)(50,000)Cash Flow-pretax

1,250,0001,250,000

Adapted from Lean Thinking by Womack

First of all, it will INCREASE CASH!

MASS LEAN

II. INCREASES CAPACITY

• Most companies look for short-term cost reductions as a result of Lean.

• Financial impact of Lean comes from utilizing the increase in available capacity.

• As we gain speed and make more with less, we free up space and capacity. We need to “do something” with that capacity to increase revenue and profits.

We are working smarter and faster, shorter lead times, less waste, serving more Customers.


III. INCREASES SALES

Cash created by reducing Inventory can be used to buy a like business or supplier, and increase sales.

-One company’s strategy:

Use cash from reduced Inventories to buy another similar company/supplier.Used first $11mm in inventory reduction/increased cash flow to buya $25mm supplier with a 10% ROS. In so doing, this company raised its Revenue $25mm and increased operating income by 10%.


IV. Saves Time & Money in Accounting Systems

• Lean Beans eliminates loads of “transactions”• Eliminates army of people on Standard Cost• Work Orders are no longer needed• Many procurement costs go away as we are

using Kanban systems, LTA’s, fewer Suppliers.• As you reduce Inventory, most of the perpetual

inventory system can be eliminated. No more cycle counting!

• “Simple Lean Bean” financial statements are quick and easy to put together!


Traditional P&L This Year

Last Year

• Net Sales• Cost of Sales:• Standard Cost• Purchase Price Variance• Material Usage Variance• Labor Efficiency Variance• Labor Rate Variance• Overhead Volume Variance• Overhead Spending Variance• Overhead Efficiency Variance• Total Cost of Sales• Gross Profit• Gross Profit %

Who in Operations understandsthis accounting jargon?


Example of a “Lean Bean” Financial Statement

• Net Sales• Cost of Sales:• Purchases• Inventory material (incr)/decr• Total Material Costs• Processing Costs:• Factory Wages• Factory Salaries• Factory Benefits• Services & Supplies• Equipment

Depreciation• Scrap• Total Processing Costs• Occupancy Costs:• Building Depreciation• Building Services• Total Occupancy Costs• Total Manufacturing Costs• Inventory – labor/overhead (incr)/decr• Cost of sales• Gross Profit• Gross Profit %

Actual, Last Month Actual, This Month Target

Adapted at The Wiremold Company

LEAN P&L Future Future Target

Current State State Future

P&L for EACH State One Two State

Product Family Jan Feb Mar Dec

Revenue 4 MM 4.5 MM 5 MM 6 MM

Material Costs 1 MM 0.9 MM 0.8 MM 0.7 MM

(purchased & expensed in period)

Conversion Costs 1.5 MM 1.4 MM 1.3 MM 1.0 MM

(DL & Mach, O/H based on C/T)

Profit 1.5 MM 2.2 MM 2.9 MM 4.3 MM

ROS 37.50% 48.88% 58.000% 71.66%

Remember! ALL Costs in a Product Family are Direct Costs!© 2006 Lean Advisors Inc

Lean Beans Scorecard

QCD ScoreboardActual

Current VSMActual

Future VSM1Actual

Future VSM2 Target

for a Product Family 7-11 7-18 7-25 12-31

Sales per Ee $200,000 $200,000 $200,000 $250,000

Productivity (FG/Ee/Day) 20 26 28 50

Inventory Turns 3 3.5 4 20

On-Time delivery 85% 90% 90% 100%

Quality (first pass yield) 60% 70% 75% 100%

Space (in Sq Feet) 1200 1000 900 400

Pn Travel Distance (ft) 100,000 80,000 75,000 500

Available Capacity 2% 10% 12% 10%

Lead Time (in days) 400 400 350 14

Cash $100,000 $150,000 $200,000 $1,000,000

More non-financial than financial measures!

Six Steps to a Healthy, Lean Organization

1. Re-create the Organization (Product Families & Lean Thinking).

2. Re-create the Financial System (No Standard Cost nor Make-the-Month, but rathera Variable, Contribution Margin Cost Management system.)

3. Level Order-taking and Scheduling. (Cycle time = Takt time)

4. Give Customer “What he wants” at the “Price he wants.” (Product Development, QFD & Target Cost.)

5. Recreate Supply Management (Fewer suppliers/Commodity Mngmt.)

6. Growth Strategy (Have one! Will not see ‘bottom line’ results without this.)


Conclusion…

A statement from Art Byrne, CEO of The Wiremold Company,

“If you want to compete with me, and you are doing batch and I am doing Lean,

then over time I am going to kill you. I am going to take your market share.

You just don’t have a chance.”

And your Lean successes will never hit the ‘bottom line’

unless you are using ‘Lean Beans.’


Lean Beans!

Bean Counter No More!

Business Manager!

New-Age Managerial Business Partner!

THANK YOU!

• Established in 1998• Experts in Lean theory & application

(hands-on experience – lived it.)• 100s of implementations across most industries• Advisors/Experts in N.A. (Mexico), divisions in Spain,

India and China• Training and implementation - English, Spanish, French, Cantonese

and Mandarin• Effective training and implementation methods• Various methods of Training / Implementation customized. • a) On-Site b) Webinars c) On-Line

Lean Advisors, Inc. www.leanadvisors.com

© 2006 Lean Advisors Inc Success Through Knowledge

Lean Beans: Jack’s Cost System for the 21 st Century Sue Sondergelt, CMA Lean Accounting Associate...

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