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What can traditional accounting learn from lean manufacturing?

A company's health ultimately depends on its departments working together toward common goals. Here's information to help operations and finance do just that.

This is what the leaders in a company's manufacturing organization wish their CFO and finance department understood: Traditional accounting does not tell the whole story.

We -- operations and finance -- are all in this together, all working toward the same goals including customer service, cost reduction and effective use of resources. But some traditional accounting measures do not properly recognize the improvements and benefits that operations strives for in the plant. And sometimes, the pursuit of a particular financial objective can unintentionally cause difficulties and higher costs in other areas.

One likely outcome of a focus on traditional accounting metrics is a singular focus on inventory reduction. Yet this can lead to customer service problems and increased costs in other areas of operations. Inventory is necessary. A blanket reduction usually leads to shortages causing backorders and lost business along with expensive expediting, premium freight, overtime, additional setups and other costs that can easily exceed the inventory reduction savings.

Inventory can often be reduced intelligently and avoid these additional costs, but such reductions only can be achieved with careful planning and a modest investment of time and effort that can be difficult to accommodate in a busy, lean operation. The manufacturing side of the organization asks that the CFO and the finance team be patient and support the manufacturing organization's investment in process improvement. And by the way, a reduction in inventory reduces the assets on the balance sheet, and that can cause problems including non-compliance with lender covenants.

Traditional efficiency and utilization measures can also be problematic financial measurements that can cause conflict between operations and accounting. One of the prime tenets of lean manufacturing is to avoid overproduction -- in other words, to avoid making more of any part or product than is needed. Overproduction increases inventory that must be stored, handled and managed. Furthermore, any extra parts or products may become damaged or obsolete. These are all considered waste, and eliminating waste is the singular focus of lean manufacturing.

The pursuit of high efficiency and high utilization can encourage overproduction. Production schedulers and managers are encouraged to increase lot sizes to increase efficiency and lower unit cost. When the production schedule does not completely consume available capacity in a work center, the pursuit of high utilization encourages managers to pull in future work to keep the resource busy -- another form of wasteful overproduction. Some of the most effective and lowest cost production facilities in the world have low or modest efficiency or utilization by traditional measures.

Be sure to discuss any notable changes in cost-of-goods, inventory or other operationally driven financial measures with the responsible operational managers to identify the reasons these measurements changed. The changes may point to issues that need to be resolved and operations will thank you for helping them detect emerging problems. But the changes may also be a reflection of operational improvements that are misrepresented in traditional accounting and financial measurements.

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This was last published in September 2016

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