The CFO should also take the lead in establishing a communications plan for each of the company’s stakeholders. Everyone needs to understand the benefits of the lean transformation, and to appreciate both the immediate and long-term effects on their jobs and their working lives. The audiences and what they need to hear include:
Senior management: Subjects for discussion should include strategy, organization, performance measurement, financial statements, compensation formulas and the short-term negative financial impact caused by reducing inventories, among others. Much of this should be covered in the initial education courses, but continuing communication is vital to a profound shift in culture and business.
Board of Directors: This should include the same subjects covered with senior management. Because a board will not necessarily be available for education courses, however, consider creating and delivering a presentation.
Shareholders: They need to know what the strategy is, its benefits and the negative P&L effect of reducing inventories during the transition. In a privately owned company, communication can generally occur concurrent with the communication to the board of directors. In a publicly owned company, however, it is not practical to deliver this level of information to shareholders. Instead, you will want to concentrate on communication to the financial analysts that follow the company’s stock. In this way, the analysts will be able to understand the company’s operating results in light of the strategy and can discount the negative effects of inventory reductions. The company should also consider having analysts participate in kaizen events in order to learn firsthand the potential benefits of lean.
Employees: These stakeholders need to understand the benefits of lean and learn how they will contribute and profit. (The authors believe that profit sharing is the best way to bring the Productivity = Wealth principal down to the employee level.) Factory employees that have held a single-skilled job (e.g. punch press operator) must be gently and firmly told that in the future, they will be expected to become multi-skilled as manufacturing cells are put into place. Most importantly, everyone must be told —and told again —that no one will lose employment as a result of productivity gains.
Unions: Union management must be brought into the change process early. In addition to explaining the reasons for change, the benefits to the membership should also be explained. In most cases, there will be provisions in the union contract that do not support lean and need to be changed. Begin this dialogue early as well, while emphasizing the potential benefits.
Banks: If the company’s loan agreements contain traditional financial covenants, a dialogue with the bank needs to begin because the company’s balance sheet will begin to change. For example, if there is a covenant for working capital (typically 2:1), this will become an issue as the company dramatically reduces inventory. Short-term earnings penalties, due to inventory reduction, should be brought into the discussion here, as well. Covenants should be renegotiated to focus more on cash flow coverage rather than asset coverage. Be prepared to explain the benefits of change to the business.
Auditors: Audit plans are based on the business processes and controls that a company uses. If those processes normally change very little from year to year, audit plans tend to remain constant. Once a company embarks on a lean transformation, business processes will change rapidly. This will have an impact on audit plans and auditors need to have adequate time to revise those plans to reflect the new environment. Letting them discover the changes when they arrive to begin the audit will cause confusion and stress.
Suppliers: Although the transformation process begins within the company, eventually it will include suppliers. At some point, suppliers will be required to deliver smaller quantities more frequently, and will be expected to do so by becoming lean, not by carrying more inventory. Suppliers will most likely need to learn to work within the kanban replenishment system. Most lean companies also significantly reduce the number of suppliers used as they stop the old play-one-supplier-against-the-other game on pricing. Accordingly, suppliers need to understand the rules for surviving that process of elimination and the criteria upon which they will be judged. Encourage suppliers to participate in shop floor kaizens, especially in areas that use the products they supply, and to send critical personnel —not salespeople —to represent the company on a team.
Customers: Eventually, the benefits of lean need to be translated into benefits for the company’s customers. If benefits are not felt at the customer level, the company has not fully capitalized on the competitive advantage of a lean strategy. At some point in the transformation process, customers need to become educated on the benefits of lean available to them and how they can take advantage.
There is much to do. As we all know by now, it is easy to talk about lean, but far more difficult to achieve real transformation. But doing is the key point. Talking about lean does not create a better-run business with less firefighting. Issuing a new vision statement does not create greater profit, using fewer resources.
In trying to change the company’s culture, employees will respond to what management does more readily than what it says. As someone once said, “The tongues in our shoes speak louder than the tongues in our mouths.” Passively delegating the implementation of lean down the organization will send, quite loudly, the wrong message. Therefore, the most important step is for the CEO and CFO to become active leaders in the lean transformation.
11
The Payoff
A dynamic business environment where profit and personal fulfillment can flourish is everyone’s goal. We have been able to satisfy these goals by creating lean businesses. This is not to say that we have discovered all the answers. But here is what we have found: benefit for all the stakeholders in a business, from customers to employees, business partners and shareholders.
The Wiremold Company had about $100 million in revenue and was worth about $30 million at the beginning of its lean journey. About ten years later, in the year 2000, it had $430 million in revenues. During this period, it increased its base business significantly through aggressive new product development and made 21 acquisitions. In the year 2000 it was sold for $770 million. In a decade of tremendous economic growth at the close of the twentieth century, this manufacturer had outperformed the S&P 500 by more than double.
Lantech, as a privately held company that has had no ownership change, does not have confirmable market values to compare for this decade. However, there are some simple indicators of the success derived from lean. From 1990 to 2000, sales increased 80 percent with the same number of employees. As a result, Lantech moved from an unprofitable position to the top third profit category of the market segment, as measured by the Fortune 500.
The minimization of working capital and superior profit has created access to large funds to fuel product expansion. So far, Lantech has acquired companies with complementary products in the U.S. and Holland, enhancing the company’s offerings. During the manufacturing sector recession of 2001, the financial strength accumulated over time allowed Lantech to maintain profitability despite a 20 percent decline in demand, buy the two new companies, and launch a 100 percent surge in new product development efforts. So, by consistently improving the strength of Lantech over 10 years, the company was able not only to avoid the severe impact associated with an economic downturn, but also to capitalize on it.
The question is, with these metrics, why doesn’t everyone go lean? The sad fact is, many companies begin the journey only to be derailed after a few improvements on the front lines. Those companies that stumble and fall do so because they fail to see that lean is a business strategy. When lean is not integrated across the entire company, conflicting business practices will inhibit lean. When accounting is kept in the dark, it will not have the tools to disclose the correct impact of the lean effort.
Lean is not a flavor-of-the-month improvement process for manufacturing or customer service. It is not an inventory management system. Taken holistically, lean is
a business strategy that has colored the way we operate throughout our value chains —from supplier to distributor, from shop floor to executive strategy sessions. To keep lean out of the business office is to deny the company its full potential for success.
Some enlightened banks now look to lean companies as their best investment opportunities —but only when the CFO is completely on board.
“Because [lean companies] don’t carry a heavy inventory and receivables burden, they are focusing on generating maximum cash flow to finance growth, and not to just look to the bank to borrow the most they can. It demonstrates to us that they are focusing on the right things,” says William H. Morgan, Executive Vice President of Fleet Boston Financial.
When the CFO is paying attention to all aspects of the business —growth, margins and asset management —Fleet Boston sees a better customer. But the inverse is also true.
“If the CFO can’t explain the company’s strategy and how it impacts on operations, marketing, etc., then that forces us to bypass him and deal directly with the CEO. Just knowing the numbers isn’t enough,” Mr. Morgan says. In other words, financial executives who ignore lean deny themselves the potential to become true partners.
Yet, there are still accountants out there who seem to believe that “road blocker” is in the job description. Through fear or ignorance, they cling to the idea of the black art of numbers and impenetrable variances —as if their existence depended on the ability to complicate and confuse.
“CFOs must stop protecting their turf and get out of the ‘You can’t do that’ mindset,” cautions Art Byrne, now-retired CEO of The Wiremold Company and one of the earliest adopters of lean in the U.S.
“In many cases, operating people understand the benefits of changing to lean but can’t move forward because of the financial organization and how it establishes performance measurements. But if the CFO has a good business perspective and takes the time to understand the real economic benefits of lean, he can become an advocate of change and adjust the company’s accounting and measurements systems in order to help everyone in the company implement the lean strategy, ” Byrne says.
In talking with CEOs, that idea of the chief financial officer as an advocate for change became a repeating theme. Those CFOs who advocated change, who cleared a path for transformation at the side of the CEO, were the most valued business partners.
“What I look for in a financial executive is a visionary with a controller’s mindset,” says TBM Consulting Group’s CEO Anand Sharma. “Management performance reviews, I often say, is a game of chicken. We have people trying to present only the positive side in their numbers, hoping that nobody asks the tough questions. This leads to some very creative reporting because there are so many ways to dissect the facts. So, from the controller mindset, I expect dependable reliability. I need to know that what is being reported is consistently true; the controller brings realism and sense to the reports.
“Then from the visionary side, I want someone who has business sense, who has good judgment beyond the numbers. He or she should be able to make the numbers more relevant for decision-making, and be able to reveal the impact of decisions on cash flow and intangible improvements. He should be able to look through the clouds and forecast the future —to see the effect of lean in one, two or five years.
“The CFO should be a visionary partner of the CEO. His job is not to create the transformation; it is to clear the way for the CEO and to keep the wolves off his back.
“In a large company, he should be selling lean to the board through his understanding of the numbers and the business impact in the future. In a small company, he will also be the controller so he will have to be reliable, solid as a rock and consistent. He or she must be able to provide an interpretation of the long-term implications of lean when reporting to management. Those are the best CFOs to have —those who can explain the short-term realities and long-term implications.”
There is certainly a great need for financial leaders who can partner with CEOs and provide the kind of support required in tomorrow’s quickening business environment. Where will these leaders come from, and who will train them?
At this writing, a great shortage exists in the accounting field. The number of accounting degrees awarded in 1998-1999 was 20 percent lower than in 1995-1996. In the second half of the 1990s, enrollment in accounting programs dropped by 22 percent. One of the reasons most often given for that stiff drop-off in accounting enrollments is the fact that accounting education has simply not kept pace with changes in business practices.
So now accounting firms fight over qualified candidates or look to other countries to import those interested in a career in finance. Why are there so few people entering this field?
One reason for the low turnout might be the generally accepted perception of accountants as hapless bean counters. There are no TV shows featuring accountants in a positive light and we didn’t make the cover of Time magazine until 2002, when some financial executives were shown in handcuffs. We are not suggesting that we need to be elevated to rock star status, but we know that we must capture the imaginations of young people in order to keep fresh ideas circulating.
To do this, universities must adapt the curriculums to be more dynamic and encompass a larger idea of the accountant as business partner. We want lean to be a topic of study, not only in the Operation Management courses, but also in Human Resources, Strategic Planning and Accounting. This will seed the newly graduating student with ideas that will make her more valuable to a business from day one.
But the schools can only go so far. It is up to us, the current leaders, to create environments open to change and new ideas, to make our work attractive to the best and brightest of the upcoming generation.
Recently, a young woman was talking with Jean about what she might study in college. This young woman seemed to have many of the characteristics required for success in accounting. Of course, Jean encouraged her, but in the back of her mind she worried that this young woman might go through all of that hard work and land in a company that was not dynamic, not open and fun —not lean. Sure, there are financial executives vital to their companies’ successes, who encourage fresh ideas and practices and remain flexible. But the perception of accounting as boring drudgery exists because, far too often, it is true.
From the chapters of this book, you may have gotten the impression that creating an accounting transformation is difficult, time-consuming work. It is. It will require all of your skills as a professional and a human being —including intelligence, creativity, compassion and vision —to do it well. It is not a journey with a destination, but a way of life.
A commercial banker who was once presented with a company’s new lean approach responded with, “That sounds great. So when do you think you will be finished?” The answer, of course, is you will never be finished. Lean is a strategy, a discipline that permeates and changes the culture, the people, of a business.
This is not the end of the story. We fervently hope this book inspires others to try new techniques, to push the borders further, to go into unexplored areas of the business and become personally involved in kaizen or continuous improvement events. Shake up the financial statement.
Rediscover your relevance.
Lean Accounting Concepts
& Principles
1) Accuracy is more valuable than precision.
Accuracy and precision are often the same. An invoice of $200 is both accurate and precise. But when they are not the same, it will take more time and cost to be precise than to be accurate. Quick test: if a value were 10% higher, would you make a different decision? This test will help you decide how much precision is needed to be accurate.
2) Do not confuse a fixed cost for a variable cost.
Different decisions require different data. A variable cost is one that will change in correlation with volume. If you do not sell a widget, you will not need the material to produce the widget. That is a variable cost. If you d
o not sell a widget, you will still need to keep the lights on in the engineering department. That is a fixed cost. Look at the change in cash to help differentiate fixed from variable.
3) Eliminate absorption accounting for manufacturing transactions.
While labor and overhead manufacturing cost is required to be capitalized for unsold inventory by Generally Accepted Accounting Principles (GAAP), it is not required to absorb for every inventory transaction. It can be analytically created for all inventory by a product line or grouping. So, stop making hundreds of piece-part transactions. If you have stable WIP, or the lead time of the product is shorter than the fiscal period, transactional absorption adds no improved understanding of operational performance.
4) The next cost is more important than the last cost. Or, mind the whiplash.
Real Numbers Page 14