Lean Management has been around for the past 10 to 15 years. While I believe that it can have a positive effect in all companies, I will limit this discussion to manufacturers. In most cases it identifies the primary benefit as reducing costs, maximizing productivity, and satisfying customer requirements. However the greater benefit is Cash Flow improvement. This is also a process that does not occur quickly in a single financial period, but rather is a journey lasting many years, with some significant accounting issues in the early periods. This is another reason why companies need to focus on the long term objective and not instant gratification.
My concern today is: Can Lean Management and Standard Costing Coexist
Most manufacturing companies have been using full absorption standard cost accounting since the beginning if the 20th Century. These systems are designed using a number of accounting routines that attempt to determine the cost of a discreet product. In this process the cost includes: material, direct labor, and overhead. It is also based on the allocation of overhead on the amount of direct labor that is required to produce the product. Commonly known as the overhead or burden rate.
This method of costing was developed in the early days of mass production where it was the norm to have large volumes of a few products, with long life cycles, very few configurations, and customers that were accustomed to having long lead times.
I am sure that most of us can agree that this is not the environment that we find our companies in today. Today we find the opposite. Small lot sizes, short life cycles, a variety of configurations, and lead times as short as 24 hours or less. With these constraints and more companies developing self directed work teams, cellular manufacturing, one piece production, and implementing lean management techniques one can see that the current methods of looking at cost accounting has to change.
Another flaw with this system is that it rewards managers for false efficiency, as these systems create an environment where it is considered good to have all labor and overhead fully absorbed in the cost of the product. This can only be accomplished by producing products. Lots of products up to the capacity of the standard direct labor and plant equipment.
This term “standard” is the amount of direct labor that was determined through a process of time study and actual labor reporting. This combination suggests that the standard labor “approximated the actual cost” of the labor component.
This all seems to work fine as long as we have constant demand for products from our customers.
What happens when that demand changes or even reduces?
Early in my career, I was a user of standard cost accounting. I worked for a manufacturer that used full absorption cost accounting to not only determine the cost of the products and establish selling prices, but also to manage the plant. The system was designed to calculate variances which were deviations from standard for: purchase price, labor efficiency, labor rate, and spending. Management was rewarded on positive variances, and criticized for the negative variances. We also believed that to be a low cost producer we must maximize our efficiency by having all manufacturing resources producing 24/7.
What would result was a very competitively priced product and that may have been true as long as we had customer orders to produce. However when customer demand was reduced, in order to maintain our efficiency we would put “stock” orders into the system. These were based on an expected future order form our customers. If these orders did not materialize we would hold these in inventory. This was considered good management for a number of reasons: maintaining high efficiency, increasing inventory which was good as inventory was an asset and more assets are good.
It didn’t take long for the warehouse to become full and cash to become tight. When this happened we would have the sales department sell the products in inventory at a discount in order to make space available in the warehouse and generate some positive cash flow.
This situation created a fair amount of friction in the company because manufacturing made their numbers and were rewarded, while sales was criticized because they couldn’t forecast their customers purchasing cycles or patterns.
As my career continued, the word “forecast” was used many times. It seemed that the budget cycle needed a sales forecast to determine the financial budget for the company and manufacturing needed a forecast to plan their production using a system known as MRP. This complex system was based on having in addition to an accurate forecast, an accurate Bills of Materials, Routings, labor and material standards.
I believed that it was not only possible, but also necessary to maintain accurate Bills of Material, Routings, and material standards, as well as accurate sales forecasts and labor standards. Accurate forecasts became the larger issue, because like many companies we implemented a complex system of labor reporting and tracking. This enabled us to validate the standard and make adjustments as needed.
But the elusive FORECAST. If the forecast was accurate everything worked fine. If the forecast was inaccurate, we increased inventory, missed customer delivery dates, increased the number of set ups due to machine changeovers, incurred non productive direct labor, and generally (with the exception of building inventory which was an asset and was considered good) became inefficient.
The truth is, all inventory is not equal. Every manufacturer has three types of inventory. Raw Materials, Work In Process, and Finished Goods, and all are valued for financial purposes at cost. When the forecast changed, the inventory that had the greatest impact on it was Work in Process. This is because work stopped and operations were incomplete. In many cases unless they were included in an upcoming forecast, and assuming there was no engineering change, they may never be completed or sold in the future. This resulted in the designation of Obsolete. Raw Material had the next highest impact as unless it could be consumed by another product or included in another forecast, it too would fall into the Obsolete category, unless it could be returned to the supplier for full credit. Finished Goods may have the lowest impact, but only if they can be sold at full price. Otherwise it becomes Obsolete as well.
Consequently full absorption costing and MRP have a significant effect on the amount of inventory that a company carries and the longer it is held, the greater financial risk.
How does Lean Management change this?
The simple answer is by eliminating waste. Lean Management focuses on what is important. In most companies the answer is: To satisfy my customers needs at the least cost.
This means that a company will transition away from building products to a forecast, and build only to customer demand. In order to do this a company must consider the following:
• Have complete Buy In and 125% support from the CEO and all of senior management.
• Identify an internal champion or hire a consultant to form teams, provide training and direction, and be responsible for the successful transformation. Remember this is a continuing process that will become the culture of the company.
• Provide support and training for all company employees.
• Implement aNo Lay Off policy as the result of process improvements realized from Lean.
o Employees need to believe in and trust the process.
• Expect Lead Time reduction
o Reduce the amount of time it takes from the receipt of a customer order to delivery to the customer.
o Look for ways to reduce set up from hours to minutes.
o Consider one piece production and produce only the quantity required by the customer.
• Eliminate Waste (non value added activities)
o Quality Control
o Labor Reporting
o Overhead Allocations
o Develop process diagrams and work to eliminate or rethink steps in the process.
o Eliminate meaningless reports and develop new relevant reports that are useful to the reader.
• Supply Chain buy in
o Suppliers need to understand that the will be producing to actual demand, so initially orders may be smaller and deliveries more frequent.
• On time delivery
All of these activities will have a dramatic effect on the company, and it all sounds like it relates to manufacturing and operations, but there are also many issues that Accounting needs to deal with and prepare for.
Monday, February 8, 2010
Lean Management and Standard Costing
Seven Tips for Selling your Business
A seminar that I attended recently indicated that according to a Price Waterhouse study done in 2000, the number 1 reason the sale of a private business fails is the LACK OF PLANNING by the seller. Another study found that only 28% of private business owners have done any exit planning.
If you're a typical small business owner, you spend more of your time working on today's issues than tomorrow's potential. That may keep the doors open for now, but what about when you're ready to retire, or no longer have the will or energy to run your business?
As mid to large businesses grow, owners typically realize they'll need to find a way out, but most small business owners do not have an exit strategy. Rather than simply selling inventory and closing the doors, the suggestion is that small business owners can increase their wealth by capitalizing on the goodwill or customer base they've built up.
When you are planning to sell your home, you want to make it look as attractive as possible to the buyer, you make an investment in repairs and improvements. Here are some basic business practices that many entrepreneurs overlook, but can help keep the company buffed up and ready for the marketplace.
Key Business Practices:
1. Write down the business processes You can't sell a business that is in your head. So, you need to write it down. Entrepreneurs don't typically like dealing with details and the fine points, but you must document how everything works in your organization. For example, spell out the roles of management and employees, not titles, but their actual responsibilities. Or describe a typical customer visit. Franchise companies list these types of details; a small business owner can use the same tactics to show the value of their company to a potential buyer.
2. Set financial goals You cannot sell a business that is not making money. And, how do you know if you're growing if you don't know where you started and where you're going? Once you've set some target goals,measure them on a regular basis. Look at the internal processes of your business and make sure they are still working for your customers and your company alike. You may be pleasing customers, but are you making money? Know what your return on investment is, so you can explain it to those interested in buying your company.
3. Have a marketing budget and plan Many small business owners don't allocate money for marketing. A marketing plan, with a corresponding budget, is key to attracting and keeping customers. One rule of thumb is to spend the equivalent of one staff salary on your marketing and advertising. Think of it as your "silent" employee working 24/7. Market awareness of your brand and demonstrated customer loyalty can dramatically increase the value to potential purchasers. Marketing is the last thing you cut even if times are bad.
4. Keep track of customer information Often, the most valuable aspect of a business to a potential buyer is your customer list, especially if your potential buyer is a competitor. Keeping track of customer contact information including name, address, phone number and email (along with permission to contact them electronically) is a must. Being able to deliver customer profiles and buying habits to a new owner demonstrates how well your business is run and makes your customer list invaluable. If business owners don't have customer data, they'll be in trouble.
5. Keep employees in the loop Your staff represents your company to customers and buyers alike. Make sure they know your goals. Communicate with your employees and ask for ideas. They can help you dress the business up for sale. If you've decided to sell because the business is in trouble, let them know. It is unlikely to be a surprise and few things demoralize a staff more than having to rely on water cooler rumors. Try to avoid staff salary cuts if possible. Your people are the face of your business and a salary cut may backfire. Try looking at your business processes and finding ways to save money instead.
6. Look at your company with the eyes of the buyer Ask yourself what information you and your professional advisors would require if you were purchasing the business, and then develop a plan to provide that information. These may include such items as:
Historical Financial Statements and Tax Returns
Ownership Structure
Key Management Bios (Who will be key to the future success)
Where's the niche? (What is special about this company)
Litigation and other disputes
Other risk factors
7. Get professional advice Identify the areas of your operation that need improvement and look for specialized help to simplify your processes. Make sure to test them before the potential buyer does. There are consulting professionals on a part-time basis who have knowledge implementing transition strategies for businesses and can help you, for a reasonable fee.
So, don't ignore one of the most vital elements of your business plan, the exit strategy. With careful planning and monitoring from day one, your last days of business can bring rich rewards.
If you're a typical small business owner, you spend more of your time working on today's issues than tomorrow's potential. That may keep the doors open for now, but what about when you're ready to retire, or no longer have the will or energy to run your business?
As mid to large businesses grow, owners typically realize they'll need to find a way out, but most small business owners do not have an exit strategy. Rather than simply selling inventory and closing the doors, the suggestion is that small business owners can increase their wealth by capitalizing on the goodwill or customer base they've built up.
When you are planning to sell your home, you want to make it look as attractive as possible to the buyer, you make an investment in repairs and improvements. Here are some basic business practices that many entrepreneurs overlook, but can help keep the company buffed up and ready for the marketplace.
Key Business Practices:
1. Write down the business processes You can't sell a business that is in your head. So, you need to write it down. Entrepreneurs don't typically like dealing with details and the fine points, but you must document how everything works in your organization. For example, spell out the roles of management and employees, not titles, but their actual responsibilities. Or describe a typical customer visit. Franchise companies list these types of details; a small business owner can use the same tactics to show the value of their company to a potential buyer.
2. Set financial goals You cannot sell a business that is not making money. And, how do you know if you're growing if you don't know where you started and where you're going? Once you've set some target goals,measure them on a regular basis. Look at the internal processes of your business and make sure they are still working for your customers and your company alike. You may be pleasing customers, but are you making money? Know what your return on investment is, so you can explain it to those interested in buying your company.
3. Have a marketing budget and plan Many small business owners don't allocate money for marketing. A marketing plan, with a corresponding budget, is key to attracting and keeping customers. One rule of thumb is to spend the equivalent of one staff salary on your marketing and advertising. Think of it as your "silent" employee working 24/7. Market awareness of your brand and demonstrated customer loyalty can dramatically increase the value to potential purchasers. Marketing is the last thing you cut even if times are bad.
4. Keep track of customer information Often, the most valuable aspect of a business to a potential buyer is your customer list, especially if your potential buyer is a competitor. Keeping track of customer contact information including name, address, phone number and email (along with permission to contact them electronically) is a must. Being able to deliver customer profiles and buying habits to a new owner demonstrates how well your business is run and makes your customer list invaluable. If business owners don't have customer data, they'll be in trouble.
5. Keep employees in the loop Your staff represents your company to customers and buyers alike. Make sure they know your goals. Communicate with your employees and ask for ideas. They can help you dress the business up for sale. If you've decided to sell because the business is in trouble, let them know. It is unlikely to be a surprise and few things demoralize a staff more than having to rely on water cooler rumors. Try to avoid staff salary cuts if possible. Your people are the face of your business and a salary cut may backfire. Try looking at your business processes and finding ways to save money instead.
6. Look at your company with the eyes of the buyer Ask yourself what information you and your professional advisors would require if you were purchasing the business, and then develop a plan to provide that information. These may include such items as:
Historical Financial Statements and Tax Returns
Ownership Structure
Key Management Bios (Who will be key to the future success)
Where's the niche? (What is special about this company)
Litigation and other disputes
Other risk factors
7. Get professional advice Identify the areas of your operation that need improvement and look for specialized help to simplify your processes. Make sure to test them before the potential buyer does. There are consulting professionals on a part-time basis who have knowledge implementing transition strategies for businesses and can help you, for a reasonable fee.
So, don't ignore one of the most vital elements of your business plan, the exit strategy. With careful planning and monitoring from day one, your last days of business can bring rich rewards.
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