Leaning the bean counters

When electronics contract manufacturer Exception EMS adopted lean manufacturing almost a year ago, there was a nasty sting in the tail. “We hadn’t foreseen it, but there was a negative impact on the bottom line,” says Richard Brighton, managing director of the Calne, Wiltshire-based business. “Our profits took a hit.” It was an outcome that was troubling. For work-in-progress was falling – by as much as £1/4 million in the case of one particular line. And with leaner processes and better efficiencies, capacity had undoubtedly increased: undeniably, reports Brighton, the business could manufacture more boards per week than it had been able to do before going lean. In space terms, too, the manufacturing operation was more compact, with a footprint just two-thirds of what it had formerly been.

What, in short, was going on? Why did a business that was undoubtedly more efficient seem – in accounting terms – to be less so? The answer, says Tom Lawton, head of manufacturing at accountants BDO Stoy Hayward, is one that is depressingly familiar. In accounting terms, any time that a manufacturing business shrinks lead times and work-in-progress, standard costing systems report an underrecovery of the overhead charged to each unit of production that is loaded onto the factory floor. And with its overheads under-recovered, the business consequently sees profits ‘fall’.

Nor, from an accounting perspective, is there any obvious way around this problem, adds Paul Williamson, senior partner and north-eastern head of manufacturing at the Newcastle office of accountants Deloitte. “For external reporting, companies have to use nationally-accepted accounting standards – such as UK GAAP, or IFRS – and they will always regard the under-recovery of overhead that takes place as inventory falls as a drop in profits,” he says. “The good news is that it’s a ‘one off’ reduction in profitability, seen at the start of the implementation.”

Even so, businesses need steely nerves. Many a lean implementation has been cancelled or held back, says Ross Maynard, a senior consultant with specialist consulting firm BMA Europe, because businesses’ cost accounting systems seem to show that labour and overhead costs are rising, not falling, as the switch to lean proceeds. And the contrast with Japan – where lean began – is instructive, observes Dr Matthias Holweg, director of the Centre for Process Excellence and Innovation at Cambridge University’s Judge Business School.

“The western approach is for senior management to use financial accounting to drive the business,” he points out. “From an operational perspective, cutting back on over-production is very sensible – but because inventory is seen as an asset, whether you can sell it or not, this leads to an under-recovery of overhead and a reduction in profit. Japanese companies typically take a much longer-term view, focusing on the intrinsic benefits of the operational improvements themselves, whereas western manufacturers want quick results – and expect to see them reflected in the financial metrics they are accustomed to using.”

What’s more, adds BMA Europe’s Maynard, these traditional accounting-based performance measures, running alongside lean implementations, can actually encourage people to behave in non-lean ways. “Look closely, and you’ll see ‘cherrypicking’ of production jobs in order to maximise earned hours, or batches being combined – at the expense of due-date performance – in order to create apparently more efficient production runs,” he warns. “If you operate in a lean environment, then lean accounting is essential.”

And, like lean itself, lean accounting turns out to be something of an unending journey. Ultimately, accounting standards enshrined in law impose the way in which certain aspects of lean – such as inventory reduction – will be reflected. The trick, it seems, is to develop accounting systems that are in themselves as lean and nonwasteful as possible, and which work in sympathy with lean, rather than actively against it.

For many manufacturers, the starting point is developing accounting systems that ref lect lean manufacturing’s operational realities. At the Reading-headquartered Magal Engineering group of automotive component suppliers, for instance, lean manufacturing is steeped in the culture, explains group IT manager Martin Blackburn. So, at the interface with suppliers, lean is very much the order of the day – with the focus being on ways of working that are lean and efficient, and which don’t encourage anti-lean attitudes to purchase order sizes. Suppliers, notes Blackburn, ship to Magal companies in quantities that make sense to them: operating kanbans over the Atlantic, for instance, is simply unrealistic, he stresses.

But, as Magal consumes the supplied goods in the form of its own kanban quantities, it notifies the supplier, with the company’s group-wide kanban-aware ERP system SSL WinMan handling the accounting and payment processing – in effect, self-billing. “People often expect us to have more sophisticated systems than we do – but we prefer to keep things brutally simple,” says Blackburn. “If the authority to supply is the kanban, not a purchase order, then the objective is to get away from exchanging paper-based accounting transactions between trading partners,” adds Jonathan Davies, sales director at SSL WinMan – a number of whose manufacturing customers operate in just this way. “You still need an invoice for taxation purposes, but the idea is to file it, not process it.”

Such techniques only go so far, though: inevitably, manufacturers will want to see the impact of lean operational changes in hard pounds and pence. Here, the challenge is trickier. “People think that when you re-layout a line, there will be a big saving,” says Tom Wedgwood, a director of Great Malvern, Worcestershire-based Newton Industrial Consultants. “And if you eliminate a forklift truck driver or two, then yes, you can see the impact of this in the accounts. But other savings achieved through lean are more intangible – and often, you have to dig quite deeply into the accounting systems to see how they handle particular transactions and movements.”

One solution is to do that digging ahead of time – and to get the accountants on your side, and helping with the task. At Telford-based Alcoa Fastening Systems, for example, where lean manufacturing goes back 10 years, the accounting implications of every proposed lean improvement are carefully scrutinised beforehand, explains continuous improvement manager Jonathan Griffiths.

Whether it’s something as simple as reduced forklift truck movements, or a major scrap reduction project, Griffiths’ continuous improvement role calls for him to sit down with finance and jointly ask: How will we measure this? “There’s a targeted financial impact for every targeted lean improvement, and if we fall short of achieving the targeted saving, we have to explain why,” he says. “The accounting function acts as ‘score keeper’, and is charged with making sure that the operational improvements we make actually get through to the bottom line.”

It’s a view shared by Jim Byrne, financial controller at adhesives manufacturer Henkel’s Dublin plant. As another business with a solid lean transformation in place, Henkel’s view is that financial reports should be harnessed and adapted so that they serve both accounting and operational needs, says Byrne. “Look at the factory floor, and you’ll see prominence given to usage KPIs, yield KPIs and scrap KPIs,” he explains. “These are actually how we manage the business – yet they all roll-up into the variance reports that go towards creating the monthly P&L (profit and loss) figure.”

That said, adds Byrne, certain financial measures have either been abandoned or restricted to senior management – a labour productivity measure, for instance, has been transformed instead into a focus on OEE. “We don’t want people making the wrong decisions about scheduling small orders,” he explains. “On a monthly basis, we aim to recover overheads to generate our required profit, but the decisions about product mix and plant scheduling that directly impact this are taken at a senior level – to avoid sending out the wrong signals.”

But is there a way to move to lean accounting without such contortions? “I’ve heard a lot said about lean accounting, but seen far fewer examples of it working properly in practice,” notes Mark Knowlton, Cliftonville, Kent-based partner manager at MAS South East. The news is mixed, but promising. For green shoots are appearing: Judge Business School’s Matthias Holweg, for instance, points to techniques like throughput accounting – around since the 1980s – and activity based costing being adapted for lean environments. In particular, he notes, value stream accounting shows especial promise.

That’s certainly the view of BMA Europe – which, together with its parent organisation BMA Inc, has implemented value stream accountingbased projects at big name manufacturers such as Boeing, Textron, Schlumberger, and Siemens. By eliminating the distortions of standard costing, value stream accounting helps businesses “reach very different decisions about costs, profitability, and spare capacity,” notes BMA’s Maynard. And while accounts drawn up on a value stream basis still need adapting for the purposes of external reporting, it’s ‘adapting’ and not ‘duplicating’, he stresses: “It’s not a question of companies having to have two sets of accounts.”

Yet in the end, lean accounting may be more an attitude of mind than a set of books. “Often, lean is about doing more with what you have, rather than doing the same with fewer resources,” observes BDO Stoy Hayward’s Lawton. “The profit comes from producing more from the same cost base, rather than producing the same from a lower cost base.” That has certainly been the case at Liverpool- based printed circuit board manufacturer Brainboxes, adds managing director Stephen Evans. “Going lean, we’ve doubled the number of boards we can make – using the same core team of employees.”