Business Automation and Software Blog

The Value of Moving From Cost to Lean Accounting (part 1)

Posted by Robert Baran on Wed, Aug 07, 2019 @ 11:00 AM

As most good business leaders know, practicing lean involves maximizing value while minimizing waste, essentially creating more value using fewer resources. Lean made its first big impact in business with Henry Ford in 1913, before being improved on by a team at Toyota in the 1930s.

Lean is clearly applicable when it comes to manufacturing, but what about accounting?

To take a small step back, what’s interesting about lean manufacturing is that it can create an interesting irony in the financial metrics: When a company implements lean, the financial metrics can actually look worse in the short term, even if the company is in better financial shape than ever.

This is because the traditional methods of cost accounting create multiple ways to make the numbers look good, despite the actual financial health of the business. Lean accounting, on the other hand, focuses on cash flow, anchoring financial metrics to value streams. Small businesses naturally tend toward lean accounting, because they are already trying to keep things simple and focus on the cash flow. But larger businesses may want to consider moving to lean accounting.

Concerned about moving to lean accounting? You’re not alone. Let’s take a look at some of the perceived roadblocks of moving to lean accounting.

Roadblock 1: Believing GAAP Requires Cost Accounting

If you’re stuck in cost accounting because you believe that the Generally Accepted Accounting Principles (GAAP) require cost accounting, it’s time to make some changes. Three of GAAP’s four basic tenets are no problem with lean accounting. The first is materiality, or, what makes accounting information worth including. If leaving the information out changes a judgment or decision, it’s material. Which translates into leaving out the insignificant stuff. Which is, fun fact, what lean is all about.

Next is conservativism, or reporting information in a way that minimizes cumulative income. Lean is also conservative. The third tenet is consistency, or, treating transactions the same way for consecutive periods. Lean follows standard work principles, and thus, consistency.

The fourth tenet, matching, sometimes presents trouble for hardcore cost accounting teams. Matching means that accounting must match costs with revenue. This could slow down accounting if the date of the cost is weeks or months before the customer pays for the work. However, lean manufacturing can create faster inventory turns, reducing that issue. And even if that doesn’t solve the problem, lean accounting teams can instead take a new approach to some timing.

Roadblock 2: Time to Close

Many companies rely on month-end close results in order to make decisions about where the company is going next. The faster they can close the books, the sooner they have information to make decisions and move forward. Still, even if month-end close only takes 2 weeks to complete, information is already more than 2 weeks old by the time decision makers are using it.

Lean accounting allows companies to be nimbler by adding a soft close process to every day, creating a quick view of both profit and loss and cash flow. Soft close information also puts the most recent numbers in front of teams every single day, which means the results they see at a designated hard close (be that month- or period-end) are less surprising. Companies don’t fail because revenue is not precisely matched to expenses in every financial report. They go under because teams are moving forward without current financial data, and may not learn about financial issues until it’s too late to turn the ship.

Roadblock 3: Categorizing Inventory as an Asset

In lean approaches to anything, less is always more. This includes inventory. While cost accounting categorizes inventory as an asset, doing so can be surprisingly problematic. Material costs consume cash, and while it is well recognized that manufacturing needs inventory in order to function and be ultimately profitable, too much can eat into cash stores. This is especially evident when practicing lean accounting, which as stated above, focuses on cash flow.

Inventory is not a bad thing, but it does need to be controlled. Less is more. Too much inventory can end up a liability, and while cost accounting might show more inventory as profits on paper, a company can’t actually pay its bills (or its payroll!) with inventory. If inventory is no longer counted as an asset and instead more accurately listed as an expense in lean accounting, you’ll have a clearer picture of your actual cash flow, which will provide a more accurate profit.

Roadblock 4: Making (or Buying) More to Save More

It might seem logical that making more products or buying more inventory will result in savings down the line. Making more products reduces the cost of creating each one, allowing for larger profit, right? And buying supplies in bulk reduces materials spend, and creates a larger profit, right?

Not necessarily so.

Smaller businesses that produce on an as-needed basis have the right idea: Running smaller batches and producing only what is needed means a company doesn’t have to spend cash on as much material. It reduces the need to hire more employees or pay overtime, and it reduces storage costs from excess inventory. Similarly with material, even though a significant discount on a bulk of material may seem like a good idea initially, if the cost to store and manage the material is more than the savings in purchasing it all at once, is you company’s cash flow actually as positively impacted as you believed?

With lean accounting focusing on cash flow, your company gets a clearer picture of the true costs of every expenditure, empowering smarter decision making, and ultimately improving profits.

Remove Lean Accounting Roadblocks With PositiveVision

How many of these roadblocks do you see in your current accounting processes? If these are already impacting your company’s path to profits, it could be time to reevaluate your approach to accounting. Whether you choose to go lean in your accounting or not, effective manufacturing accounting is made more possible by having the right manufacturing software solutions in place. You can read Part 2 and see more potential roadblocks here.

Are you comparing manufacturing software solutions? Download our whitepaper, “How to Choose a Manufacturing System.” 

Not sure where to start? PositiveVision has your back. A top consultant for small and mid-sized manufacturing and distribution companies, PositiveVision is committed to helping its customers find the best software solutions for accurate accounting and profit growth. See how PositiveVision can benefit your accounting journey by contacting us today.



Topics: manufacturing software solutions, lean accounting