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Ross Maynard FCMA

The Theory of Constraints,

Throughput Accounting,

and Lean Accounting

Our Agenda

1. What is the Theory of Constraints?

2. The Theory of Constraints and Flow

3. What is Throughput Accounting?

4. The Performance Measures of Throughput Accounting

5. A Throughput Accounting Example

6. What is Lean Accounting?

7. The Seven Aims of Lean Accounting

8. Lean Performance Measures

9. Performance Management and Decision making in Lean Accounting

10. Accounting Transactions in Lean

11. The Voice of the Customer

12. Throughput Accounting, Lean Accounting and the Financial Statements

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The Theory of Constraints

What is the Theory of Constraints?

• ToC is a management philosophy introduced by Eli Goldratt in his1984 business novel “The Goal”

• Mr Goldratt’s ideas were inspired by work published (in German) byWolfgang Mewes in the 1960’s and 1970’s on “bottleneck-focussed strategy”

• Goldratt defines “throughput” as the rate at which a businessprocess generates money through sales

• Throughput drives profitability and, thus, the aim is always toincrease throughput

• However, the throughput of a process is always limited by at leastone constraint

• The Theory of Constraints argues for continuous improvement -always seeking to increase the flow of work through the constraintso that overall throughput be increased and, therefore, profitability

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What Constrains Flow?

• The Theory of Constraints argues that every business process will have atleast one constraint:

• Physical resources/ equipment

• Internal policies and procedures

• People and skills

• The Market

• If we improve the flow at the constraint, we improve the throughput of theentire process

• The aim to maximise the flow through a process brings us to ThroughputAccounting – the management accounting method that supports efforts toimprove flow

The Theory of Constraints is similar to Lean

• The Theory of Constraints focusses on identifying and removingconstraints to the flow of work through a process as this will increasethroughput

• The Lean philosophy also focusses on flow through businessprocesses (Value Streams)

• “All we are doing is looking at the time-line, from the moment thecustomer gives us an order to the point when we collect the cash. Andwe are reducing the time-line by reducing the non-value addingwastes.”

Taiichi Ohno, “The Toyota Production System

• This quote makes it clear that “lean” is all about flow through abusiness process, and removing impediments to that flow (waste)

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The Five Principles of LeanWe see that Goldratt’sterm “throughput” alsoapplies with Lean.

Where throughput is therate at which a businessprocess generatesmoney (value) throughsales

Increase the throughputand you increaseprofitability because youare doing “more” with thesame resources

The Theory of Constraints and Flow

• Both ToC and Lean seek to maximise (and continuously improve) the rateof flow of work through business processes

• The concept of “flow” suggests that a business should be organised byprocess (Value Streams)

• The Value Stream contains the flow of value through the business fromorder generation to delivery

• Value Streams may be structured in a variety of ways according to theneeds of the business – by market; by product/ service; by region etc

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Drum Buffer Rope

• Drum Buffer Rope (DBR) is an element of the Theory of Constraintsconcerned with optimising the throughput of the constraint step in a process

• The Drum is the rate at which the constrained step can work – i.e. itsmaximum throughput. The rest of the process follows the beat of the drum.

• The Buffer protects the Drum. It is a holding point of inventory in front of thedrum to ensure that the Drum never lacks work. There may also be Buffersto protect process steps that feed the Drum

• The Rope is the rate at which work is released into the process. This isrelated to the size of the Buffer needed to protect the Drum. Work shouldnot be released faster than this as it will clog the system without adding anyvalue.

• Some authors argue that other techniques – such as those used in lean –are more effective than DBR at managing and improving the constraint

Throughput Accounting

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The philosophy of Standard Cost Accounting is that profitability is maximisedwhen labour and machine utilisation are maximised

A Brief History of Cost Accounting

Techniques in cost accounting and cost analysis were developed in the UKduring the Industrial Revolution. The firm of Josiah Wedgewood and theCarron Ironworks both used cost accounting methods from the late 1770’s

Some histories suggest that Andrew Carnegie introduced cost accountinginto the US, from Scotland, in the mid 1800’s

Standard Costing came into its own in the US in the 1920’s with the adventof mass production. The Du Pont Powder Company developed absorptioncosting techniques and General Motors introduced them throughout its vastbusiness

“a management accounting system that seeks to maximise the return onbottleneck activities”

What is Throughput Accounting?

Throughput Accounting focuses on economies of flow rather thaneconomies of scale

Standard Costing Accounting seeks the lowest cost per item througheconomies of scale. This concept does not apply in a high variability, multi-product environment

Here profitability is maximised when the rate of flow is maximised

This is the focus of Throughput Accounting, defined by the AccountingDictionary as

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A Definition of Throughput Accounting

"A management accounting method that is based on the belief that, because every system has a constraint which limits global performance, the most

effective way to evaluate the impact that any proposed action will have on the system as a whole is to look at the expected changes in the global measures

of throughput, investment and operating expense.“

Theory of Constraints International Certification Organisation

Throughput Accounting argues that a business process can be managed withthese three measures combined into four KPIs

The Performance Measures of Throughput Accounting

“Throughput Contribution” (T) is defined as Net Sales less Total Variable Cost.Total Variable Cost are the truly variable costs in the process

“Investment” (I) is defined as the money tied up in the process or Value Stream- that is the equipment, inventory, facilities, buildings and other assets andliabilities that form part of the Value Stream (or process).

Note that Throughput Accounting values inventory strictly on totally variablecost only - without labour or overhead.

“Operating Expense” (OE) is the other direct costs associated with the ValueStream or process excluding any allocations or external overheads.

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Throughput Accounting KPIs

“Net Profit” (NP) is Throughput less Operating Expense (T – OE).

“Return on Investment” is Net Profit divided by Investment, expressed as a

percentage. (NP/I). This is a useful measure to compare Value Streams.

We can improve a Value Stream’s return on investment by increasing the revenue of the

Value Stream; by reducing inventory as we improve flow; and by reducing waste

“Productivity” is defined as Throughput Contribution divided by Operating

Expense, expressed as a percentage (T/OE).

This is a reflection of the level of “contribution” in the Value Stream

“Investment Turns” is defined as Throughput Contribution divided by Investment,

expressed as a ratio (T/I)

Any decision that improves this ratio for a Value Stream will improve the profitability of the

Value Stream. Thus “Investment Turns” is a useful way of ranking alternative decisions.

Why use Throughput Accounting?

According to Throughput Accounting, if we improve the flow at the constraint, weimprove the throughput of the entire process

By aligning costs and revenues with the flow through a business process (ValueStream), we can begin to see the performance of the process and its costs arelinked – improve the flow and we also improve the cost

The philosophy of Throughput Accounting is that we increase profitability andreduce cost by increasing the rate of flow through the whole process or ValueStream

It’s all about flow

This Photo by Unknown Author is licensed under Creative Commons 3.0 CC BY

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Business Processes and Flow

Departments can be “optimised” but we need to maximise the flow throughthe whole process to improve profitability

Process Thinking

A business process (Value Stream) runs right from customers through to supplierswithout departmental/ functional barriers or boundaries.

Improving the whole process is the best and most sustainable way of improvingprofitability

The focus is on creating value for the customer

Remove obstacles to flow to increase sales

Processes tell us where customer value is created

We can map process steps to identify value and waste

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Processes and Cost Reduction

Products are not cost-reduced: only processes

There are only three ways of reducing the production cost of a product:

1. Product redesign

2. Improving the production process so it can do more in a given timescale

3. Removing capacity – assets and people – no longer needed

Product costs are reduced by increasing the throughput (flow) of the process in agiven timeframe

We improve the process by taking out waste to increase throughput. Thisincreases the capacity of the process for all the products that flow through theValue Stream

The concept of product cost is irrelevant in cost reduction. What matters is thewhole business process and, in particular, the constrained resources/ activities

A Reminder of the Throughput Accounting Measures and Ratios

“Throughput Contribution” (T) = Net Salesless Total Variable Cost.

“Investment” (I) = money tied up in theequipment, inventory, facilities, buildings andother assets and liabilities that form theprocess

Valued on variable cost only - without labouror overhead.

“Operating Expense” (OE) = other directcosts associated with the process excludingany allocations or external overheads.

Net Profit (NP) = T – OE).

Return on Investment = NP/I %

Productivity = T/OE %

Investment Turns = T/I

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Throughput Accounting supports decision making

Current

State

Improvem

ent

Option 1

Improve

ment

Option 2

Sales 1000 1200 1300Material Costs 400 480 520

Throughput 600 720 780Labour 300 250 275

Other Direct Costs 100 100 100Net Profit 200 370 405

Investment 5000 4500 4500

Productivity 150% 206% 208%

Return on Investment 4% 8% 9%Investment Turns 0.12 0.16 0.17

• Throughput Accounting is easyto understand and providesuseful tools for understandingand improving flow in a processor Value Stream.

• Align your cost centres withValue Streams or processes;avoid allocation of corporateoverheads; and you are readyto work out the ratios identifiedto support processimprovement.

A Throughput Accounting Example

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Which is the most profitable product line?

Women’s Shirts Men’s Shirts

Weekly Market Demand 120 units 120 units

Price/ Unit €105 €100

Material Cost/ Unit €45 €50

Cutting time (minutes per shirt)

2 10

Sewing time (minutes per shirt)

15 10

Total Processing time (minutes per shirt)

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You are a shirt manufacturer with a very simple process: cut and sew

Cut Shirt Sew Shirt

Adapted from: “Throughput Accounting”, Thomas Corbett

Focusing on Product Cost does not Maximise Profit

Women’s Shirts Men’s Shirts

Output 120 units 60 units

Revenue € 12,600 6,000

Material Cost € 5,400 3,000

Throughput € 10,200

Operating Expense € 10,500

Net Profit (Loss) € (300)

Cut Shirt Sew Shirt

Available Time: 2400 minutes/ week

Available Time: 2400 minutes/ week

Adapted from: “Throughput Accounting”, Thomas Corbett

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Focus on the constraint

Women’s Shirts Men’s Shirts

Weekly Market Demand 120 units 120 units

Price/ Unit €105 €100

Material Cost/ Unit €45 €50

Throughput per Unit €60 €50

Total Cutting Time to meet demand

240 minutes 1200 minutes

Total Sewing time to meet demand

1800 minutes 1200 minutes

Cut Shirt Sew Shirt

Available Time: 2400 minutes/ week

Available Time: 2400 minutes/ week

Calculate the Throughput per unit of constraint

Women’s Shirts Men’s Shirts

Weekly Market Demand 120 units 120 units

Price/ Unit €105 €100

Material Cost/ Unit €45 €50

Throughput per Unit €60 €50

Sewing time (minutes per shirt)

15 10

Throughput per Minute of constraint resource

€4 €5.00

Cut Shirt Sew Shirt

Available Time: 2400 minutes/ week

Available Time: 2400 minutes/ week

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Maximising Throughput at the constraint maximises profit

Women’s Shirts Men’s Shirts

Output 80 units 120 units

Revenue € 8,400 12,000

Material Cost € 3,600 6,000

Throughput € 10,800

Operating Expense € 10,500

Net Profit (Loss) € 300

Cut Shirt Sew Shirt

2400 minutes/ week 2400 minutes / week

Throughput Accounting: An Investment Decision

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Investment: Focus on the Constraint

Say, we have the opportunity either to invest €10,000 at the Cutting stepto deliver 30% (720 minutes per week) extra capacity; or to invest€100,000 at the Sewing step to deliver 30% (720 minutes per week)extra capacity

A €10,000 investment at the Cutting step might well improve “efficiency”metrics at the process through faster cycle times. However, we alreadyhave plenty of spare capacity at this step and the investment will yield nofinancial benefit

Investment: Focus on the Constraint

At the Sewing step, the 720 minutes per week extra capacity would allowus to completely fulfil market demand for both types of shirt.

An additional 40 Women’s shirts per week could be produced and soldgenerating an additional €2,400 Throughput Contribution per week.

This is pure profit as our Operating Expenses have already beencovered. The investment would pay-back in 42 weeks

Only 600 additional minutes are needed at the Sewing step to meetmarket demand – leaving 120 minutes per week spare capacity. Thisoffers the potential for new product development

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Sources on Throughput Accounting

• “Throughput Accounting”, Thomas Corbett, North RiverPress 1998

• “The Goal: A Process of Ongoing Improvement”, EliyahuM. Goldratt and Jeff Cox, Gower Publishing Ltd; 3rdRevised edition 2004

• Wikipedia articles on the Theory of Constraints andThroughput Accounting

Lean Accounting

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Lean is all about flow through a business process and removing impediments to that flow (waste).

Remember our Definition of Lean?

“All we are doing is looking at the time line, from the moment the customer gives us an order to the point when we collect the cash. And we are reducing the time line by reducing the non-

value adding wastes.”

Taiichi Ohno, Toyota Production

System

The Five Principles of Lean

As with ThroughputAccounting, if weincrease thethroughput, weincreaseprofitabilitybecause we aredoing “more” withthe sameresources

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It’s all about flow

The Philosophy of Lean• Lean is a time-based strategy – focus on flexibility and speed of response to

the customer; and streamline the production/ service delivery process

• Improve the flow and you improve profitability

• Customer value is king: why would you perform any activity that the customeris not willing to pay for ?

• Improvement never stops, the aim is to maximise competitive advantagethrough operational excellence

• The people in the process are the ones best placed to improve it

Like ToC, Lean is all about the flow of work through a business process and removing impediments to that flow (waste).

Profitability is related to the rate of flow

By increasing the capacity of the Value Stream, we increase its

profitability

In a lean environment, cost is related to the rate of flow through the Value Stream

By measuring and managing the flow, we manage the cost

By improving the flow, we reduce cost, and increase capacity

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Lean is a People Process

Improvement is the responsibility of the

team. Managers facilitate the team by

provide support, expertise and training

as necessary

Processes are improved by

people working together using

problem-solving tools

Involving peoplein lean is moreimportant than

lean tools.

Creating a culture of improvement is

about people feeling free to

raise issues and concerns

The people in the process are the best placed to understand its problems and constraints

All of this requires

Trust

Cost accounting in a Lean Environment

• Traditional Standard Costing was developed for mass production.

• The philosophy is that profitability is maximised when labour andmachine utilisation are maximised = variances.

• The focus of Standard costing is on lowest cost per item througheconomies of scale.

• This does not apply in a high variability, multi-productenvironment. Here profitability is maximised when the rate offlow is maximised.

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There is no “Standard” Cost!

In a business process, the cost of the product is related

to flow…

Many factors affect the rate at which work flows through a business process:

• Product mix; scrap and rework; quality issues; downtime etc

This means there can be no one “standard” cost as the cost of the processvaries from minute to minute; from hour to hour; and from day to day

The “Standard Cost” is a highly aggregated average calculated over a longperiod of time but meaningless for performance management in the process

Performance Management in lean means measuring and managing the rate of flow, and continuously improving it

However, there is a process cost

However, if we can stabilise the rate of flow of work through aprocess we stabilise its cost

And if we can improve the rate of flow, we create capacity to do moreprofitable work in a given time period

Thus, measuring and managing the rate of flow of work through abusiness process is the key to improving profitability

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So what is Lean Accounting?

Lean Accounting was developed to provide management accountingsupport that compliments the lean philosophy:

• Focus on customer value

• Measure and manage flow with the aim of improving it

• Support continuous improvement by providing timely accountinginformation that is understandable and useable by improvementteams

• Apply lean principles to accounting procedures

• Support decision making and planning with a lean perspective

Who developed Lean Accounting?

Lean Accounting has its roots in contribution costing and wasdeveloped by accountants working in businesses that implemented thelean philosophy – where “traditional” approaches to costing werehindering improvement

In 2003, “Real Numbers: Management Accounting in a LeanOrganization” was published by Jean Cunningham and Orest J.Fiume, both of whom had worked in lean enterprises

Also in 2003, “Practical Lean Accounting: A Proven System forMeasuring and Managing the Lean Enterprise” was published by BrianMaskell and Bruce Baggaley. It was the first proper textbook on LeanAccounting

The annual Lean Accounting Summit continues to present the latestthinking in Lean Accounting

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How does Lean Accounting differ from Throughput Accounting?

• In short, not a huge amount

• Throughput Accounting focuses on finding and removing the constraint (bottleneck)and then moving onto the next constraint

• Lean Accounting takes a more holistic view and considers the flow of work throughthe whole process (Value Stream)

• Throughput Accounting uses only the three performance measures and the fourratios derived from them

• Lean Accounting has a broader palate of measures and KPIs (but rather ignores theconcept of “Throughput”)

• Lean Accounting provides more of a structure for performance measurement andimprovement

• Lean Accounting emphasises the role of the people in the process as agents ofchange

Lean Accounting has Seven Aims

Focus on improving flow and profitability by

eliminating constraints

Highlight the impact of process improvement –eliminate waste, improve capacity, improve flow

Create strategic growth by planning by Value Stream with the focus on improvement

Deploy performance measures that motivate

improvementSupport relevant, & timely decision making

Eliminate unnecessary accounting

transactions

Drive the growth of the business by increasing

customer value

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Books on Lean Accounting

Practical Lean Accounting, Brian H. Maskell and Bruce Baggaley. 2003, 2012

The Lean CFO, Nick Katko, 2013

Accounting for the Lean Enterprise, Gloria McVay et al, 2013

Who's Counting? A Lean Accounting Business Novel, Jerrold M. Solomon, 2003.

Real Numbers: Management Accounting in a Lean Organization, Jean E. Cunningham and Orest Fiume, 2003.

Lean Accounting 1: Performance Measures that motivate Improvement

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Principles for Lean Performance Measures

We want our performance measures to support the lean philosophy andto show how effectively it is being applied:

• Customer value

• Flow

• Continuous improvement

• Involve and empower employees

• Provide strong operational control

• Simple to collect, analyse and understand

• Connected to strategic goals

The focus of Lean Performance Measures is different

• Concerned with understanding the reasons behind performance

• Responsibility lies within the process

• Reveals problems, so that they can be resolved and kept from recurring

• Frequent feedback drives problem solving, and learning

• Focus on learning and development to improve the process

• Results oriented

• Top-down control; authority oriented

• Assumes the past is a guide to the future

• Focus on control of resources, people and results

• More emphasis on meeting targets than improving the process

Lean UseTraditional Use

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Environmental and Community measures

The three levels of Performance Measurement

• The KPI’s of the organisation: senior managers monitor the achievement of strategic goals and initiate strategy changes

• Typically reported monthly

Strategic Measures

• The deliverables from the process which should directly connect with strategic KPI's. They guide improvement activity

• Typically reported weekly

Process Output Measures

• Monitor how a process is running in real time. Tracked by the people that work in the process, corrective action is applied as soon as problems arise

• Typically captured, reported and actioned throughout the working day

In-Process Measures

What makes a good lean measure?

• Clearly defined

• Easy to collect

• Needs little manipulation or analysis

• Timely

• Reliable

• Linked directly to activity

• Avoids creating a perverse incentive

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Lean Performance Measures in summary

Process Stability

Flow

Customer Value

Quality

Delivery

Safety/ environment

Improvement activity

Process Stability

Lean Performance Measures have two key aims:

1. To monitor the stability of the process

2. To support process improvement

When we stabilise a process we stabilise its operating cost

When we improve the flow, we reduce cost, and create capacity to do more profitable work with the resources available

We monitor process stability by plotting performance data as a time series

On Time Delivery

70.00%

75.00%

80.00%

85.00%

90.00%

95.00%

100.00%

25 26 27 28 29 30 31 32 33 34 35

Week Number

% o

n T

ime D

eliv

ery

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How do we create Lean Performance Measures?

The Performance Measurement Linkage chartCRITICAL SUCCESS

FACTORS

PROCESS OUTPUT

MEASURES

IN-PROCESS

MEASURES

STRATEGIC

MEASURES

PROCESS CRITICAL

SUCCESS FACTORS

WORKFLOW

GOALS

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The Performance Measurement Linkage Chart in action

This picture shows a linkage chart developed during an actual workshop. Sticky notes are used to make repositioning and changing chart components flexible and easy.

A starter set of Lean Performance Measures

Strategic Measures

• Sales growth

• Profit/ Contribution growth

• Gearing/ Acid-Test

• Market Share/ growth

• New product development/ launch

• Customer satisfaction

• Customer growth

• People development/ skills/ safety

• Environmental/ social responsibility

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Process Output Measures

• End-to-End Flow Time (Lead Time)

• Quality – right first time etc

• Scrap and Rework

• On-time Shipment/ delivery

• Number of Active Customers

• Number of customers spending

over £X in Y months

• Improvement activity

• The main reasons for complaints/ returns

• Customer Support Performance

• Customer satisfaction

• Employee Turnover

• Skills matrix performance

• Safety/ environmental

• Contribution Margin

A starter set of Lean Performance Measures

The Throughput Accounting KPIs are also Process Output Measures

“Net Profit” (NP) is Throughput less Operating Expense (T – OE).

“Return on Investment” is Net Profit divided by Investment, expressed as a

percentage. (NP/I). This is a useful measure to compare Value Streams.

“Productivity” is defined as Throughput Contribution divided by Operating

Expense, expressed as a percentage (T/OE).

“Investment Turns” is defined as Throughput Contribution divided by Investment,

expressed as a ratio (T/I)

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Value Stream Continuous Improvement Board

Value Stream Continuous Improvement Board

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In-Process Measures

• Day-by-the-Hour Production (adherence to schedule)

• Work in Progress vs Standard Work in Progress

• Quality: Scrap and Rework

• Operational Equipment Effectiveness

• Preventative Maintenance (adherence to plan)

• Skills matrix performance

• Safety

A starter set of Lean Performance Measures

In-Process Measurement Board

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Why so few “cost” measures?

• Financial measures are lagging indicators, showing the outcome of theorganisation’s processes after the event, but they do not show us where theproblems in the process are, or why they occur

• Operational measures are directly linked to performance and are easier tointerpret. Financial measures require a “conversion factor” which obscures theresults

• The measures we use should be balanced to give a broad picture, andoperational measures are key to driving improvement

"Costs are not

causes, they come from

causes",

Cost is the outcome of the process.

It does not tell us where, how, or why problems arise

W Edwards Deming

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Measuring and Managing Performance 1

• The focus of performance measurement and management in LeanAccounting is improvement (not judgement)

• At the Process level performance measures are reported weekly

• The purpose is to guide and support the process manager and his/herteam with continuous improvement.

• The tools of weekly performance management are:

Performance measurement boards

Timely root-cause analysis

A Process Improvement Team

The weekly process (Value Stream) Box Score

Measuring and Managing Performance 2

• At the In-Process level performance measures are reported daily – oftenevery 2 to 4 hours

• Managers and supervisors/ team leaders support the process team toidentify and resolve issues

• The tools of daily in-process performance management are:

In-Process measurement boards

Timely root-cause analysis

Time for improvement activity

• “Significant” problems are escalated to the Process Improvement Team

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The focus of Lean Performance Measures

The data provided by the lean performance measures give the

Voice of the Process

The requirements set by the customer are the

Voice of the Customer

Where the Voice of the Process does not meet the Voice of the

Customer then we must make improvements

The Key to Performance Improvement

Managers and their teamsupporting employeeroot-cause analysis and problem solving.

The focus must be on the enhancing customer value:

Making what the customers want, on-time and in perfect quality.

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Intermission:Test your Knowledge Part 1

Question 1: How does the Theory of Constraints define “throughput”?

a) The speed at which work moves through the constraint in a process

b) The rate at which constraints are removed from the process

c) The rate at which a business process generates money through sales

d) The rate at which the business attracts new customers

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Question 2: In the Theory of Constraints how do we improve profitability?

c) Implement Drum-Buffer-Rope

b) Conduct kaizen events

a) Increase throughput

d) Increase flush-through

Question 3: The Theory of Constraints and Lean share a common focus. What is it?

c) Reducing corporate overheads

b) Eliminating checks and inspections

d) Improving the flow of work through a business process

a) Simplifying variance analysis

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Question 4: How does Throughput Accounting define “Throughput”?

c) Process contribution less corporate overheads and expenses

d) Sales value of the goods or services produced less their material cost

b) Net sales less total variable cost

a) Net sales less the cost of bought-in goods and services

Question 5: In Throughput Accounting, “Investment Turns” is defined as Throughput Contribution divided by Investment, expressed as a ratio (T/I). How does it help manage performance?

c) It encourages the finance team to use the longest possible asset life in their depreciation and amortisation calculations

d) It provides shareholders and investors with a proxy return on investment

a) Any action that improves this ratio will improve the profitability of the process

b) Keeping the ratio between 0.8 and 0.95 indicates that the process is stable

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Question 6: Which of the following is NOT one of the five principles of Lean?

c) Specify value in the eyes of the customers

d) Involve and empower employees

b) Identify and remove the constraint in the process

a) Make value flow to the pull of the customer

Question 7: In a lean process, cost is related to what?

c) The amount of inventory (work in progress) in the process

a) The level of overheads carried by the organisation

d) The rate of the flow of work through the process

b) The number of people employed in the process

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Question 8: Lean Accounting was developed to support the lean philosophy. Which of the following is NOT part of the focus of Lean Accounting?

d) Focus on customer value

a) Measure and manage flow with the aim of improving it

c) Greatly simplify variance analysis

b) Support continuous improvement

Question 9: Why are “In Process” performance measures used in Lean Accounting?

d) They accurately measure customer value at each step in the process

a) They help identify the person responsible for making a mistake

c) They are tracked through the day by the people that work in the process so that corrective action can be applied as soon as problems arise

b) They identify the cost of each step in the process, allowing great granularity in reporting

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Question 10: Relatively few of Lean Accounting’s “Process Output” and “In-Process” measures relate to cost. Why?

d) Customer value is something that cannot be valued in cost terms

a) Finance teams are typically too small to be able to collate and present all the data

b) Operational measures are directly linked to performance and are easier to interpret

c) Few managers truly understand cost measures and their implication

Lean Accounting 2: Improving Flow by eliminating constraints

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Profitability is maximised when the rate of flow is maximised

Managing and improving flow means managing by business process or, in lean terminology, by Value Stream

This is Value Stream Management

This Photo by Unknown Author is licensed under Creative Commons 3.0 CC BY

It’s all about flow

Control byValue Streams

Plan byValue Streams

Improve byValue Streams

Manage byValue Stream Teams

Organise by Value Streams

Organise by Value Streams

Value Stream Management

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What is a Value Stream?

“All of the actions, both value creating and non-value

creating, required to bring a product or service from concept

to launch and from order to cash collection. These include

actions to process information from the customer and

actions to transform the product/ service on its way to the

customer.”

Why do we manage by Value Stream?

Where the value is created

Identify value & waste

Focus on creating value for the customer

Identify flow & obstacles to

flow“See” the issues & make improvement

Create value, growth & profit

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Kinds of Value Stream

Current Customers

New Customers

CurrentProducts

NewProducts

OrderFulfillment

Acquiring NewCustomers

CustomerDevelopment

New ProductDevelopment

Lean Accounting should provide information to allow the constraint to be identified, and improved

Improving Flow by eliminating constraints

The process cannot go faster than the slowest step.

The capacity of the process is limited by the capacity of thebottleneck:

• Shared resources

• Long set-up times

• Slowest paced equipment

• Complex working procedures

• Unreliable steps/ equipment

• Machines prone to downtime

• Poor training

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How does Lean Accounting help improve Flow?

The lean performance measures covered in the previous section help identify

the constraint

• For example, WIP will build up at the constraint, which has the lowest

throughput

Timely reporting of performance data (weekly and daily) means that issues

can be promptly identified and worked on

The finance team provide the information that the Process Improvement

Team need to identify the root-cause of problems and identify solutions

Members of the finance team will be part of the Process Improvement Team

Lean Accounting 3: Support relevant, and timely decision making

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Time for the Lean Accounting tools

Lean Accounting uses two principal management accounting tools

for reporting and decision-making:

1. The Value Stream Profit and Loss Account

2. The Box Score

Both tools were introduced by Brian

Maskell, and Bruce Baggaley in their

2003 book “Practical Lean Accounting”

1) The Value Stream Profit and Loss AccountTimberpond Entertainment LtdThe Value Stream Profit and Loss Accounts

Business Process: Live Events Museums

and Displays

Touring

Shows

TV, Film and

Media

New Market

Development

Income: £000

Revenue 11,219.00 6,973.00 10,956.00 8,957.00 -

Commissions from

concessions

336.57 209.19 328.68 - -

11,555.57 7,182.19 11,284.68 8,957.00 -

Expenditure:

Wages and Salaries 6,744.54 3,948.53 6,670.52 4,853.77 2,250.00

Transport and

Accommodation

401.61 12.56 790.51 322.66 5.20

Materials and Costumes 203.86 6.38 231.27 63.78 19.40

Energy 57.34 19.80 25.90 11.20 6.70

Attributable Depreciation 609.00 612.00 629.00 625.00 628.00

Other attributable Costs 7.45 2.38 4.14 1.01 3.40

8,023.80 4,601.64 8,351.34 5,877.42 2,912.70

Value Stream Contribution 3,531.77 2,580.55 2,933.34 3,079.58 -2,912.70

% Contribution 30.6% 35.9% 26.0% 34.4%

9,212.53

2,256.00

6,956.53

17.8%%

Total Contribution to

Profit and Overheads

Corporate Overheads

Earnings before Interest,

Tax and Amortisation

The format and presentationof the Value Stream Profitand Loss Account is similarto a standard profit and lossaccount.

The difference is that itshows only the directlyattributable costs of theValue Stream, withoverheads and othercorporate costs beingreported separately (in a“Head Office” or “CorporateCosts” report).

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Rules for the Value Stream Profit and Loss Account Part 1

Only the directly attributable costs and revenues of the Value Stream are reported. Corporate overheads, therefore, arenot apportioned to Value Streams, but, rather, are kept as “corporate” costs.

The rule is, if the manager of the process can control the costs or revenues (i.e. vary them, change suppliers etc) then theyshould be included in the Value Stream Profit and Loss Account

There are a couple of potential exceptions to the rule of only recognising directly attributable costs and revenues in theValue Stream Profit and Loss Account:

The depreciation of assets in the Value Stream is shown in the Value Stream Profit and Loss Account as the processmanager has responsibility for them.

In most cases, the process Manager is charged a “rental” fee for the space that the Value Stream occupies. The purposeof this is to encourage the Value Stream team to streamline their process, reducing their footprint and freeing up spacethat can be used for new products and services. The calculation of the cost of the space occupied should be a simpleone – the direct costs of running the premises (without allocation of corporate overheads) divided by the total area of thepremises, gives a cost per square metre. Each Value Stream is charged according to the space they occupy. As theyfree up space their charge is reduced, and the cost of the “surplus” space no longer required is shown in the corporatefinancial reports as an opportunity cost of unoccupied space to incentivise finding new activities for it.

Rules for the Value Stream Profit and Loss Account Part 2

The wages and salaries of the people working in the Value Stream are, of course, directly

attributable to it and are included in full (including pension costs and other benefits) in the

Value Stream Profit and Loss Account.

It is often the case that there are people who work part-time in a Value Stream. A Value

Stream may not require a full-time maintenance team, or full-time finance or HR person.

Such skills will normally be shared between several Value Streams, and the cost of these

individuals should be split on an agreed basis.

In many cases the Cost Centre structure of the organisation’s accounts will need to be

reconfigured to reflect the Value Streams. Each Value Stream will normally be a Profit

Centre with subordinate Cost Centres to reflect the relevant direct costs and revenues.

Such flexibility in coding and reporting is easily achieved in modern accounting systems.

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Performance data for the strategic lean measures also needed

How the Value Stream Profit and Loss Account is used

The Value Stream Profit and Loss Account is used for monthly performancereview at senior management level against Strategic Goals.

Each Value Stream has a manager who has full responsibility, andaccountability, for the revenues and costs within it.

£000 Consumer

Products

Value

B2B

Products

Value

Servicing

and Repair

Value

Spare Parts

Value

Stream

Corporate

Overheads

Company

Total

Sales Revenue 16,000 21,000 7,000 3,000 - 47,000

less

Sales Commissions - - - - - 940

Material Costs 6,400 10,500 1,400 1,200 19,500

Staff Costs 4,500 4,500 2,000 1,000 12,000

Energy Costs 800 1,050 200 150 2,200

Facilities Costs 1,600 2,100 400 300 1,600 6,000

Depreciation 300 450 150 150 750 1,800

Other Consumables 100 125 70 50 50 395

Value Stream Contribution 2,300 2,275 2,780 150 (2,400) 5,105

Value Stream Contribution % 14.4% 10.8% 39.7% 5.0% N/A 10.9%

-

Marketing and Advertising 1,200 1,200

Professional Fees 1,000 1,000

Other Head Office Costs 600 600

EARNINGS BEFORE

INTEREST AND TAX 2,305

EBIT % 4.9%

It is entirely normal for differentValue Streams to make differentlevels of return.

This reflects the different marketsthey serve, and the differentproducts or services that theyproduce

2) The Box Score

The Box Score is a weeklydashboard report prepared foreach Value Stream in anorganisation.

The Box Score comprises threeelements: operationalperformance measures; processcapacity; and summary financialperformance.

Because it is prepared weekly itallows issues to be identifiedpromptly and action to be takenas necessary.

Timberpond Entertainment LtdBox Score: Touring Shows

Week: Week 23 Week 24 Week 25 Week 26 Week 27 Week 28

Performance Measures:

Show set-up time (hours) 6.4 8.1 8.5 7.0 6.8 6.1

Equipment failures (no.) 0 1 2 1 0 0

Energy usage (Kwh) 5.8 5.6 6.0 5.9 5.4 5.2

Customer complaints (no.) 2 2 3 0 1 2

Customer satisfaction score 89% 92% 90% 88% 86% 87%

Process Capacity:

Current Capacity - 2 shows per day 14 14 14 14 14 14

No of shows presented in week 11 12 10 11 12 12

Productive Capacity % 79% 86% 71% 79% 86% 86%

Available Capacity % 21% 14% 29% 21% 14% 14%

Summary Financial Data: £000

Revenue 273.90 280.92 266.32 278.32 282.86 288.63

Commissions 7.83 7.83 8.22 7.83 8.02 7.83

281.73 288.75 274.54 286.14 290.87 296.45

Wages and Salaries 166.76 168.76 168.76 166.76 166.76 166.76

Transport/ accommodation 29.25 28.46 31.00 30.04 28.46 31.62

Materials/ Costumes 9.37 9.12 9.94 9.63 9.12 10.13

Energy 0.48 0.54 0.54 0.51 0.48 0.53

Other direct costs 0.17 0.16 0.18 0.15 0.15 0.19

206.04 207.04 210.42 207.09 204.97 209.24

Margin: Revenue less direct costs 75.69 81.71 64.12 79.05 85.90 87.21

% 26.9% 28.3% 23.4% 27.6% 29.5% 29.4%

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The Elements of the Box Score

1. Operational Performance Measures. These are the “Process Output” measureschosen for the Value Stream. Key “In-Process” measures may also be shown

2. Process Capacity. This reflects the “Throughput” of the Value Stream. “ProductiveCapacity” is that percentage of the total which is used for revenue generatingactivities in the Value Stream (i.e. producing products or services). “Non-ProductiveCapacity” is that percentage of the total which is “lost” due to waste – for example,breakdowns, rework, and other lost time incidents. The aim is to minimise non-productive capacity so that it becomes available for other work. “Available Capacity”is the amount of time that is available for other opportunities.

3. Financial Performance. The key cost and revenue elements from the Value StreamProfit and Loss Account. As the report is weekly some of these figures may beestimates

By improving the flow of work through the process, we reduce its cost, and increase its capacity to do more profitable work

How the Box Score is used

The Box Score is the core tool of weekly performance management withthe focus on improvement.

It is used by the Value Stream Manager and his or her team to identifyproblem areas, institute focused improvement activity and makeoperational decisions as required.

The team work together to resolve problems and improve the performanceof the Value Stream

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The Box Score provides an easy-to-understand dashboard to examine the impact of decisions on performance, capacity and contribution

Notes on Lean Decision Making

1. We might reject a decision which generates a positive contribution because itdamages the operational performance of the value stream;

2. We might accept a decision which is contribution neutral if it providesbenefits for operational performance – flow, quality and/or customer service –which provide the foundation for future growth.

3. We might accept a decision which, in the short term, generates a negativecontribution, if it will improve operational performance and create availablecapacity for future profitable opportunities.

Questions for Process Improvement

What is the purpose of theprocess, and what outcomes dowe need?

How does the process currently work? Where do the delays, errors and risk points occur?

How can we improve the process, and reduce risk, errors and delays

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A Box Score Example

Operational Performance Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10

End-to-End Flow Time (mins) 127 124 129 116 115 110 108 100 98 92

Inventory Days - Finished Goods 80 73 75 83 76 74 74 70 68 65

Inventory Days - WIP 19 18 19 18 17 17 18 11 12 12

Inventory Days - Raw Materials 68 88 90 66 63 60 65 89 72 66

Scrap and Rework - no of items 43 39 32 30 27 35 25 24 20 17

Supplier on-time % 100 100 100 100 100 97 100 100 100 100

Wait List - £ value of orders 0 0 0 0 0 0 750 600 400 250

Capacity at Bottleneck Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10

Productive Capacity % 43 55 51 50 50 52 47 46 46 48

Non-Productive Capacity % 35 28 34 33 31 21 26 25 24 29

Available Capacity % 22 17 15 17 19 27 27 29 30 23

Financial Performance £ Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10

Sales Value of Production 48,786 62,401 57,863 58,997 61,266 61,266 49,921 47,652 47,652 51,055

Materials used 17,075 19,968 17,359 20,649 21,586 22,056 16,375 15,725 15,378 16,467

Staff Costs 17,241 16,089 18,055 16,721 17,752 17,069 16,003 17,263 19,357 17,217

Energy and Facilities 1,464 1,872 1,736 1,770 1,838 1,838 1,498 1,430 1,430 1,532

Consumables and other costs 976 1,248 579 1,770 1,225 613 998 477 477 1,532

Value Stream Contribution 12,031 23,224 20,134 18,087 18,865 19,691 15,047 12,757 11,010 14,308

Value Stream Contribution % 24.7% 37.2% 34.8% 30.7% 30.8% 32.1% 30.1% 26.8% 23.1% 28.0%

Material Usage % of Sales 35.0% 32.0% 30.0% 35.0% 35.2% 36.0% 32.8% 33.0% 32.3% 32.3%

The Box Score in ActionLederLux is a manufacturer of luxury branded goods. The Value Stream team arereviewing performance over the last 10 weeks. What are the issues?

1

1

2

3

4

5

6

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The Issues for LederLux: 1

1. The End-to-End Flow time has steadily decreased over the 10-week period showingthat improvements have been made to the process to streamline operations. This isalso reflected in the reduction in non-productive capacity over the period as wastefulor unnecessary process steps have been removed. Available capacity, therefore, hasincreased. The challenge is for the company now to find profitable uses for thatavailable capacity created.

2. Finished Goods and Work-In-Progress Inventory has also reduced significantlyduring the period as the process has streamlined. However, raw materials inventoryhas remained relatively static suggesting that there is opportunity for furtherimprovement work.

3. Scrap levels also show a reduction, perhaps as a result of improving in-processquality.

The Issues for LederLux: 2

4. The rise in the value of orders on wait list is of concern and its root cause should beidentified.

5. Productive Capacity has remained steady at around 50%. Non-Productive Capacityhas reduced during the 10-week period as a result of the improvement activityundertaken to reduce end-to-end flow time. This non-productive capacity has nowbeen made available for other work and is reflected in Available Capacity. The financialbenefit of selling this extra available capacity is yet to be realised.

6. The financial results don’t yet fully reflect the improvements in the process that havebeen implemented. This is because the additional available capacity created bystreamlining the process has not yet been used productively to generate additionalsales income. Indeed, sales have tailed off in recent weeks. This may simply be aseasonal issue, but it should also be high on the agenda for investigation.

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Lean Accounting 4: Eliminate unnecessary accounting transactions

Taiichi Ohno, “The Toyota Production

System

The question is, how do we reduce the number of transactions whilst maintaining financial control?

Revisiting the Definition of Lean

The sad news for us accountants is that all the transactions thatwe do are “waste”, since that they add no value for either

customers or the business.

“All we are doing is looking atthe time-line, from themoment the customer givesus an order to the point whenwe collect the cash. And weare reducing the time-line byreducing the non-valueadding wastes.”

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E.g. Accounts Receivable and Accounts Payable

Why do we use transactions for Accounts Receivable and

Accounts Payable?

What does Lean Accounting suggest?

Purchase order authorises delivery Use automatic electronic delivery requests or Just-In-Time

methods

P.O.s and invoices form part of the legal contract One single legal agreement between the parties. Individual

contracts are only necessary for single high-value purchases

To record and track material costs In a well-run system, recording is only needed on receipt

and at a few key points in the process. Price and quality

specified in contract so only need to track usage.

To authorise payment Pay according to contract once receipt is recorded.

To provide information on terms and/ or delivery

requirements

Terms specified in single contract along with any specific

delivery requirements.

To show exact product specification of items

delivered

Request data sheets for each product. Bar-code on item

links to specification information.

It ensures separation of duties There are other ways of ensuring separation of duties

“Three-Way Match” ensures financial control with

checks of price, quantity and quality

Three-Way Match not necessary. Price paid is set by

contract. Quantity and quality inspected when receipt

recorded

Accounting transactions are only really useful for reports at the period-end showing the cost of losses, returns, or wastage. This means that

we only need the minimum of transactions that allow costs or revenue to be recorded

Accounting Transactions do not offer control

The main problem with the type of control that accounting transactions offer is that theinformation is available too late.

It is no good thinking that purchase orders and delivery notes provide control if they aren’tprocessed for a week or more after delivery.

Problems of quality and quantity need to be dealt with immediately they arise by the teamhandling the materials or dealing with the supplier/ purchaser.

The teams working with the goods or services need their own control processes.

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A Structure for Transaction Elimination

Reducing accounting transactions is an iterative process. Moretransactions can be eliminated as the process team get better atunderstanding and controlling financial processes.

Map the process and identify wheretransactions occur

Use problem-solving tools to identify alternative ways to achieve control but reduce accounting transactions

Test the revised controls and implement the best. Review the process again in a few months

Making a Start Getting There Highly CompetentPreferred supplier selection process with

single contracts and quality/ specification

schedules

Operational processes managed directly by their

teams – direct ordering from preferred suppliers with

auto-pay once quality and quantity checked on

receipt

Electronic tracking of goods and materials

using bar-codes or similar methods. Very

few checks needed.

Blanket purchase orders with release

schedule

Just-in-time techniques begin to be applied. Supplier-

managed inventory with the operation drawing and

recording only what it requires.

Operational processes becoming very “lean”

with rapid flow of work and lower levels of

inventory/ work in progress.

Electronic/ online ordering, invoicing and

payment for regular purchases

Extension of portal/ online processes to wider range

of goods and services.

Portal/ online system covers most suppliers

and customers

Purchase cards/ blanket authorisation for

low value consumables

Portal/ online ordering extended to consumables

Fewer points in operational processes at

which checks are required

Improvement techniques applied to operational

processes to streamline them, reducing inventories

and the risks of loss/ damage. Operational controls

easier and more efficient.

With streamlined operational processes and

low inventories accounting transactions

become unnecessary. Electronic ordering,

with recording at a few key points, provides

automated reporting.

Fewer levels of authorisation Move to just-in-time and preferred supplier status,

along with rigorous checks on receipt reduces need

for authorisations.

The Transaction Elimination Maturity Path

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Lean Accounting 5: Highlight the impact of process improvement

What is the purpose of Lean Accounting?

Lean Accounting was developed toprovide management accountingsupport that complimented thelean philosophy.

Improving the speed and efficiencyof a process creates capacity to domore profitable work

The time and financial investmentin improvement is justified by theincrease in contribution that usingthis additional capacity brings

Measure and

Manage Flow

Focus on Customer

Value

Support continuous

improvement

Support decision

making and planning

Apply lean principles to accounting procedures

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The cost of running the process remains the same – same people, same equipment –apart from the marginal cost of materials and energy

1) Valuing the Increase in Capacity from Improvement

• Lets say a process currently costs $100,000 a month to run, delivering sales of$150,000 per month. That’s a contribution of $50,000 per month (33%)

• We have the opportunity to expand sales – new customers, new markets – to $200,000per month but we do not currently have the capacity in-house

• We could invest in new capacity, but we may not have access to capital, or may not wishto add to overheads and gearing

• The alternative is to improve the capacity of the process to absorb the extra work.

• If the end-to-end time of the process (order entry to delivery) is currently 10 workingdays, and, through our improvement efforts, we can reduce this to 6 days, we will beable to cope with the order in-house

• Contribution will increase to $66,600. Our investment in improvement generatesnearly $200k additional contribution per annum

We do not attempt to reduce headcount. That would stifle the improvement culture. Who wants to improve themselves out of a job?

2) Other Benefits of Improvement (there are cost-savings)

• Reduction in the cost of scrap and rework = material costs saved; energy costssaved

• Reduction in inventory: a swifter process means less WIP and less finished goodsas we satisfy customer orders more quickly. This has a cashflow benefit.

• A streamlined process takes up less space – freeing up space for other revenuegenerating activities. Estimate the opportunity cost of the space freed.

• Fulfilling customer orders more quickly means better customer satisfaction = moreorders. It may mean more premium-priced “express” orders too. Can you estimatethe value of these additional orders?

• A more engaged and involved workforce means less employee turnover whichmeans less recruitment and training costs

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The Box Score can be used to show the impact of Improvement

Operational Performance

Latest

Quarter - In-

House

Production

Impact of

Outsourcing

LoVal

Impact of

introducing

HiVal Pro

Notes

End-to-End Flow Time (mins) 60 60 60 This is the flow time of the HiVal, unaffected by the HiVal Pro

Inventory Days - Finished Goods 42 85 85 The company still needs to carry additional safety stock for the LoVal's long supply chain

Scrap and Rework - no of items 140 66 70 Quality issues are being tackled

Customer Returns - no of items 24 54 25 Quality issues are being tackled

Customer Satisfaction % 96 89 96 Quality issues are being tackled

Capacity at Bottleneck %

Productive Capacity % 80 60 70 Capacity is no longer required for the LoVal

Non-Productive Capacity % 20 20 20

Available Capacity % 0 20 10 Only some of the Available Capacity is required for the HiVal Pro.

Financial Performance £000

Sales Revenue 475.0 475.0 565.0 The quality of the outsourced LoVal has been addressed

less

Material Costs 127.5 87.5 110.0 The bought-in cost of the LoVal is now in the "Outsourcing Costs" line

Staff Costs 225.0 225.0 225.0 The staff cost remains the same

Depreciation 2.0

Quality Correction Cost 10.0 The one-off cost of correcting the quality problems with the outsourced LoVal

Outsourcing Costs - 75.0 75.0 This is the cost of buying the LoVal in

Value Stream Contribution 122.5 87.5 157.0

Value Stream Contribution % 26% 18% 28%

Lean Accounting 6: Drive the growth of the business by increasing customer value

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The Voice of the Customer

This Photo by Unknown Author is licensed under Creative Commons 3.0 CC BY-NC-ND

The customer defines the Purpose of the process

In lean, we seek to maximise value to the customer

Understand the customer’s true demand in price, delivery and quality – not what can be supplied

What is Customer Value?

Value Proposition = + +

Function Quality Price Time Choice

Product/Service Attributes Image/Brand Relationship/Experience

Value is the combination of attributes

which the customer perceives as beneficial

It is important that we know which activities add value for the customer

What do they want from your process?

What do they like about the process and your service?

What do they dislike about the process and your service?

The right quality, at the right time and the right price, in the right place

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How effectively is your organisation’s culture focussed on customer value?

Questions for the Voice of the Customer

Who are your major customers?

What do they actually want from your processes?

What features of the process are most important to your customers? How (if at all) does each step in the process add value for them?

What features of the process cause frustration or annoyance to your customers? Which steps in the process cause those issues?

How Lean Accounting helps focus on Value

Align performance measures with issues that customers value – e.g.order to delivery time; quality; delivery performance; returns/complaints; etc

Use these metrics in the weekly Box Score. Over time we see howimproving the metrics impacts on financial performance

Customers who feel they are getting excellent products and services at“reasonable” prices are more likely to repeat purchase and refer theorganisation to others

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Lean Accounting 7: Create strategic growth by planning by Value Stream with the focus on improvement

Why Plan by Value Stream?

Improving customer value generates more demand from customers

Improving the rate of flow of work through a process creates capacity todo more work

Greater demand + more capacity = increased profitability

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How Lean Accounting helps you plan

Collecting “In-Process” and “Process Output” metric data weekly willsoon provide a large bank of data

Analysing the data as a time-series will show trends and anomalies toinvestigate. It will also help determine process stability:

• Where the spread of data is close to the mean, the process isrelatively stable, and its operating cost will be stable

• A wide spread of data indicates an unstable process with variableperformance and, therefore, variable operating cost

Our course on “Problem Solving and Decision Making Creatively” may help

How we Plan in Lean Accounting

1. Identify what your customers value (speak to them) from yourprocesses

2. Set performance measures that reflect customer value and flow

3. Map and analyse each process to identify where value is created(and lost), plus other constraints, risks and problems

4. Work with the process team to identify improvements

5. Implement “easy” improvements immediately. Prepare a businesscase for those which require investment

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Lean Accounting and Investment DecisionsAlthough investment decisions are more complex, requiring a large number ofelements to be modelled over a longer period, the Box Score still provides agood dashboard for the decision

Box Score - Investment Decision Model (extract)

Operational Performance H1 H2 H3 H4 H5 H6

End-to-End Flow Time (mins) 120 110 90 90 90 80

Inventory Days - Finished Goods 90 75 60 40 40 30

Scrap and Rework - no of items 200 160 120 80 50 50

Customer Satisfaction % 96 96 96 96 96 96Capacity at Bottleneck %

Productive Capacity % 25 25 30 35 40 45

Non-Productive Capacity % 25 25 25 25 25 25

Available Capacity % 50 50 45 40 35 30Financial Performance £000

Sales Revenue 2,000.0 2,400.0 2,800.0 3,200.0 4,000.0 4,800.0

less

Material Costs 800.0 960.0 1,120.0 1,280.0 1,600.0 1,920.0

Staff Costs 400.0 480.0 560.0 640.0 800.0 960.0

Depreciation 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0

Energy and Facilities 140.0 168.0 196.0 224.0 280.0 336.0

Other Costs 50.0 60.0 70.0 80.0 100.0 120.0

Value Stream Contribution (390.0) (268.0) (146.0) (24.0) 220.0 464.0

Value Stream Contribution % -20% -11% -5% -1% 6% 10%

Year 1 Year 2 Year 3

1

2

3

4

Using the Box Score for Investment Analysis

1. The initial investment creates Available Capacity giving plenty of flexibility in

targeting new markets and customers. Over time this capacity is filled as sales

come on board. By the end of Year 3, there is still 30% Available Capacity

2. The company is expecting sales to grow as the business becomes established in

the market it is targeting with this investment

3. Materials, staffing and other costs (except depreciation) have been forecast at a

fixed proportion of sales, but productivity improvements suggest costs should fall

4. Productivity improvements are projected to improve end-to-end flow time, inventory,

and scrap and rework (quality) significantly over the period.

5. Inflation, exchange rate changes, taxes and other complicating factors have been

ignored to keep this model simple

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The Theory of Constraints, Throughput Accounting and Lean Accounting: Summary

What have we learned?

• The Theory of Constraints, Throughput Accounting and Lean Accounting are all

concerned with measuring and managing the flow of work through business

processes

• If we increase the flow we increase the opportunity for profit

• Every business process has at least one constraint: resources/ equipment; policies

and procedures; people and skills; the market

• The Theory of Constraints and Throughput Accounting focus on identifying and

removing constraints.

• The concept of “flow” suggests that a business should be organised by process

(Value Streams)

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What else have we learned?

• Throughput Accounting is defined as “a management accounting system

that seeks to maximise the return on bottleneck activities” (Accounting

Dictionary)

• Throughput Accounting argues that a business process can be managed

with just three measures combined into four KPIs

• Lean Accounting offers a broader palate of tools and a more holistic

outlook

• Lean Accounting aims to support the lean philosophy with particular

emphasis on customer value, flow, and engaging the people in the process

in continuous improvement

What more have we learned?

• Lean Accounting argues that financial measures and tools must be simple

to collect, analyse and understand since the people who work in the

process are the ones best placed to improve it

• As well as lean performance measures, the two key tools of Lean

Accounting are the weekly Box Score and the Value Stream Profit and

Loss Account

• The Box Score provides a “Balanced Scorecard” view of a process and is

used in performance management, improvement and planning

• The Box Score is a tool of weekly performance improvement

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Most Importantly …

• In Lean Accounting we argue that cost is related to the rate of flow of workthrough a business process (Value Stream)

• If we can stabilise the flow, we stabilise the cost of operation

• By improving the flow, we reduce costs and create capacity to do moreprofitable work

• Thus Lean Accounting emphasises measures of flow and process stability

• Lean Accounting provides a structure to justify the investment inimprovement by showing the increase in contribution that improving thecapacity of a process brings

The Heart of Lean Accounting

♥ 6. Management focussed on the key drivers of cost and value

♥ 2. Aligned cost centres

♥ 5. Empowered improvement teams

♥ 4. Weekly reporting of key process measures: flow, quality and service

♥3. An understanding of flow, value, process performance and their impact on cost

♥ 1. Defined processes with clear customer purpose

♥ 7. An understanding creating capacity + increasing

demand = increased profitability

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Lean Accounting and Throughput Accounting vs Financial Accounting

Throughput Accounting and Lean Accounting are not Financial Accounting. They provide a different approach to

management accounting and decision making based on the philosophy of flow. They do not prevent the

organisation preparing its Financial Accounts in any way it wishes.

Nevertheless, the same accounting system needs to serve both masters, and this raises a number of issues:

1. Changing the cost-centre structure of the organisation to reflect Value Streams means that the routines for

preparing Financial Accounts will have to be reviewed;

2. The Value Stream Profit and Loss Account is not the same as a P&L Account prepared under Financial

Accounting rules. Corporate overheads and other unattributable costs do not appear in the Value Stream

Profit and Loss Account for each business process;

3. The Value Stream Profit and Loss Account and Box Score are not intended to be financial statements (they

are designed to drive action). The financial statements should be prepared from source systems rather than

from these tools of performance management and improvement.

Test your Knowledge Part 2

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Question 1: What is a Value Stream?

a) The most valuable customers of the business

b) The most profitable products or services of the business

c) A business process and everything that happens in it from customer order to delivery

d) The rate at which the business attracts new customers

Question 2: Why should we manage by Value Stream?

c) It allows senior management to judge the performance of the process and line managers

b) It allows us to assign people to the process they are best skilled for

a) It enables us to focus on customer value and work to improve it

d) It enables us to calculate the profitability of products and services, and eliminate the least profitable

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Question 3: What sort of issue would constrain the capacity of a Value Stream?

c) Planned Preventative Maintenance

b) Highly trained staff

d) Unreliable equipment

a) Supplier managed inventory

Question 4: What tool of Lean Accounting is used for weekly performance management and improvement?

c) The Balanced Scorecard

b) The Value Stream Profit and Loss Account

d) The Box Score

a) The Wicket Score

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Question 5: Which of the following is a correct statement for Lean Decision Making?

c) We will reject any decision which is contribution neutral even if it provides benefits for operational performance

b) We will accept any decision which generates a positive contribution even if it damages the operational performance of the Value Stream

a) We might accept a decision which generates a negative contribution if it will improve operational performance and create available capacity for future profitable opportunities

d) We will accept any decision that brings new customers to the business

Question 6: Why does Lean Accounting not like accounting transactions?

a) They are difficult for the people who work in the process to understand

b) They are too focused on cost, rather than on measures of flow and stability

c) They add no “value” for customers or the business

d) They are a constraint to the flow of work through the Value Stream

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Question 7: Why do accounting transactions not provide good process control?

a) The information they provide is too complicated for most staff to understand

c) Costing information in the accounting system is almost never up to date

b) The information they provide is available too late for timely action

d) The system is too paper-based

Question 8: Why does Lean Accounting focus on Customer Value?

a) Improving customer value improves the flow of work through the Value Stream

b) The most profitable customers are new customers

c) Improving customer value increases demand

d) The primary goal of management is to increase customer value

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Question 9: Which of the following formulae does Lean Accounting hold to be true?

a) More capacity + more investment = increased profitability

b) Greater demand + increased flow = more capacity

d) Greater demand + more capacity = increased profitability

c) Greater demand + more capacity = increased flow

Question 10: When the data from lean performance measures is presented as a time-series, how do we know that the cost of operating the process is likely to be stable?

b) The data will be widely spread indicating flexibility in meeting performance challenges

d) Performance targets reflect the Voice of the Customer

a) The data will be clustered closely around the mean

c) The data will meet the target set by the customer most of the time

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Question 11: What (possibly) is the single most important lesson from this course?

b) That presenting data in a time-series provides far more information about the stability of, and issues in, a process than a “traffic light” RAG report

d) That data from lean performance measures represents the Voice of the Process

c) That improving the flow of work through a business process creates available capacity that can be used for more profitable work

a) That cost-plus pricing is never the profit-maximising price

Lean Accounting Assignment

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© ACCA PUBLIC

Lean Accounting Assignment, Part 1

Logletrite make pre-fabricated log cabins for retail and commercial use.

Increasing environmental awareness means that commercial business-to-business sales are increasing. The commercial cabins sell for $5,995 eachcompared to $3,995 for the retail cabins.

However, the commercial cabins have a higher specification which makes themharder to make

Both types of cabin are made in the same process and the company’s BoxScores for the last 12 weeks is shown on the next slide.

© ACCA PUBLIC

Logletrite: 12 weeks Box Score

Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10 Week 11 Week 12 Average

Performance MeasuresNumber of units output: Retail 16 17 17 15 15 12 15 12 15 14 13 16 14.8

Number of units output: Commercial 12 14 14 16 16 15 17 18 18 18 19 19 16.3

Order to Delivery End-to-End time

(hours) 10.0 8.0 9.0 9.0 11.0 11.1 11.3 11.6 13.5 12.5 11.9 14.1 11.1

Right-first-time quality %: Retail 99.9 97.1 96.9 97.0 99.0 97.3 99.9 96.9 97.9 97.3 99.2 98.8 98.1

Right-first-time quality %:

Commercial 88.0 87.5 87.0 87.5 86.9 87.4 86.8 86.6 86.8 85.9 86.0 85.7 86.8

Work in Progress (Days) 38 38 34 43 44 47 47 46 46 48 48 49 44.0

On-Time Delivery %: Retail 98 96 99 99 100 100 98 98 100 97 98 97 98.3

On-Time Delivery %: Commercial 90 88 90 89 92 90 89 87 91 86 85 85 88.5

CapacityProductive Capacity % 56% 62% 62% 62% 62% 54% 64% 60% 66% 64% 64% 70% 62%

Non-Productive Capacity % 25% 26% 23% 24% 25% 30% 27% 25% 25% 26% 25% 22% 25%

Available Capacity % 19% 12% 15% 14% 13% 16% 9% 15% 9% 10% 11% 8% 13%

Financial PerformanceRevenue $: Retail 63,920 67,915 67,915 59,925 59,925 47,940 59,925 47,940 59,925 55,930 51,935 63,920 58,926

Revenue $: Commercial 71,940 83,930 83,930 95,920 95,920 89,925 101,915 107,910 107,910 107,910 113,905 113,905 97,918

Material Cost %: Retail 47 50 49 50 49 52 51 51 48 52 52 49 50

Material Cost %: Commercial 53 56 53 54 54 55 57 54 56 55 57 57 55

Value Stream Payroll 26,347 26,018 26,121 25,529 25,707 25,392 26,607 25,799 26,031 26,691 25,651 26,297 26,016

Energy Cost 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000

Other attributable costs 4,685 2,941 4,450 3,080 2,963 4,600 4,336 3,383 2,552 3,841 4,048 2,656 3,628

Value Stream Contribution 31,657 36,928 38,513 40,477 41,015 28,485 37,244 38,947 45,058 39,874 39,209 47,625 38,753

Value Stream Contribution % 23.3% 24.3% 25.4% 26.0% 26.3% 20.7% 23.0% 25.0% 26.8% 24.3% 23.6% 26.8% 24.6%

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© ACCA PUBLIC

1) Identify Three Issues for Logletrite to address

© ACCA PUBLIC

2) Prepare an Action Plan for Logletrite

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© ACCA PUBLIC

Model an average week's Box Score to decide whether the company should purchase the machine.

Lean Accounting Assignment, Part 2

To address the manufacturing problems with the commercial cabins, thecompany is considering the purchase of a new cutting and forming machine.

The machine would have a depreciation cost of $2,000 per week and willallow the company to produce an extra 10 commercial units per week -although there is only demand for 6 at present

The machine will lift the right-first-time quality of the commercial units to 96%or higher and will reduce the average end-to-end production time by 2 hours

On-time delivery for the commercial units would increase to 96% or better,with WIP reduced by 4 days

Other costs are unaffected.

© ACCA PUBLIC

Lean Accounting Assignment, Part 3

If there were no additional commercial cabin sales available at present, wouldyou advise the machine to be purchased?

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© ACCA PUBLIC

Assignment, Part 4 – Throughput Accounting

Prepare the Throughput Accounting metrics for the “current state” of theoperation (using annualised average figures) and compare them for those withthe proposed investment. Annualise the weekly figures, using 50 weeks

The only variable cost is the material cost.

Assume that the level of “investment” is $1m in the current state, with theproposed new machine costing $500,000

“Throughput Contribution” (T) = Net Salesless Total Variable Cost.

“Investment” (I) = money tied up in theprocess

“Operating Expense” (OE) = other directcosts associated with the process excludingany allocations or external overheads.

Net Profit (NP) = T – OE).

Return on Investment = NP/I %

Productivity = T/OE %

Investment Turns = T/I

Lean Accounting AssignmentAnswer

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© ACCA PUBLIC

Logletrite: 12 weeks Box Score

Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Week 9 Week 10 Week 11 Week 12 Average

Performance MeasuresNumber of units output: Retail 16 17 17 15 15 12 15 12 15 14 13 16 14.8

Number of units output: Commercial 12 14 14 16 16 15 17 18 18 18 19 19 16.3

Order to Delivery End-to-End time

(hours) 10.0 8.0 9.0 9.0 11.0 11.1 11.3 11.6 13.5 12.5 11.9 14.1 11.1

Right-first-time quality %: Retail 99.9 97.1 96.9 97.0 99.0 97.3 99.9 96.9 97.9 97.3 99.2 98.8 98.1

Right-first-time quality %:

Commercial 88.0 87.5 87.0 87.5 86.9 87.4 86.8 86.6 86.8 85.9 86.0 85.7 86.8

Work in Progress (Days) 38 38 34 43 44 47 47 46 46 48 48 49 44.0

On-Time Delivery %: Retail 98 96 99 99 100 100 98 98 100 97 98 97 98.3

On-Time Delivery %: Commercial 90 88 90 89 92 90 89 87 91 86 85 85 88.5

Capacity

Productive Capacity % 56% 62% 62% 62% 62% 54% 64% 60% 66% 64% 64% 70% 62%

Non-Productive Capacity % 25% 26% 23% 24% 25% 30% 27% 25% 25% 26% 25% 22% 25%

Available Capacity % 19% 12% 15% 14% 13% 16% 9% 15% 9% 10% 11% 8% 13%

Financial PerformanceRevenue $: Retail 63,920 67,915 67,915 59,925 59,925 47,940 59,925 47,940 59,925 55,930 51,935 63,920 58,926

Revenue $: Commercial 71,940 83,930 83,930 95,920 95,920 89,925 101,915 107,910 107,910 107,910 113,905 113,905 97,918

Material Cost %: Retail 47 50 49 50 49 52 51 51 48 52 52 49 50

Material Cost %: Commercial 53 56 53 54 54 55 57 54 56 55 57 57 55

Value Stream Payroll 26,347 26,018 26,121 25,529 25,707 25,392 26,607 25,799 26,031 26,691 25,651 26,297 26,016

Energy Cost 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000

Other attributable costs 4,685 2,941 4,450 3,080 2,963 4,600 4,336 3,383 2,552 3,841 4,048 2,656 3,628

Value Stream Contribution 31,657 36,928 38,513 40,477 41,015 28,485 37,244 38,947 45,058 39,874 39,209 47,625 38,753

Value Stream Contribution % 23.3% 24.3% 25.4% 26.0% 26.3% 20.7% 23.0% 25.0% 26.8% 24.3% 23.6% 26.8% 24.6%

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3

3

4

© ACCA PUBLIC

1) Identify Three Issues for Logletrite to address

1. Sales of the retail cabin are relatively stable while sales ofcommercial cabins are increasing. Why is the retail market flat?

2. End-to-end time is increasing significantly, presumably caused by thecomplications in making the commercial cabins. Work in Progress isalso increasingly – probably a reflection of the increasing process time

3. Right-first-time quality and on-time delivery for the commercialcabins is also markedly below that for the retail cabins

4. In spite of increasing commercial sales, the Value Stream Contribution isstatic. This seems to be related to the increasing material costpercentage for the commercial cabins, and reflects the increasingproblems of manufacture associated with the commercial cabins

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© ACCA PUBLIC

2) Prepare an Action Plan for Logletrite

The issues affecting the commercial cabins of increasing order to delivery production time;reducing quality; reducing delivery performance; increasing WIP and increasing materialcost percentage are all symptomatic of production problems.

The process for producing the commercial cabins would appear to be unstable.

My action plan, therefore, would focus on improving process stability:

1. Map the production process for the commercial cabins in detail to understand wherethe problems arise

2. Analyse the root causes of the problems. Devise and test possible solutions

3. Select the best solutions, revise working procedures and train all staff accordingly

4. Continue to monitor performance weekly, instigating additional improvements asrequired

© ACCA PUBLIC

Lean Accounting Assignment, Part 2

The additional capacity allows more cabins to be sold

Process performance KPIs are improved

Sales increase by nearly $30,000 per week

Other costs are increased by the depreciation chargeThe benefit of the proposal is $14.2k additional contribution per week ($710k per annum)

The material cost percentage probably needs further attention

Current

State

(without

machine)

Potential

Future State

(with

machine)

Performance Measures

Number of units output: Retail 14.8 14.8

Number of units output: Commercial 16.3 22.3

Order to Delivery End-to-End time

(hours) 11.1 9.1

Right-first-time quality %: Retail 98.1 98.1

Right-first-time quality %:

Commercial 86.8 96.0

Work in Progress (Days) 44.0 40.0

On-Time Delivery %: Retail 98.3 98.3

On-Time Delivery %: Commercial 88.5 96.0

Capacity

Productive Capacity % 62% 62%

Non-Productive Capacity % 25% 25%

Available Capacity % 13% 13%

Financial Performance

Revenue $: Retail 58,926 58,926

Revenue $: Commercial 97,918 133,888

Material Cost %: Retail 50 50

Material Cost %: Commercial 55 55

Value Stream Payroll 26,016 26,016

Energy Cost 5,000 5,000

Other attributable costs 3,628 5,628

Value Stream Contribution 38,753 52,958

Value Stream Contribution % 24.6% 27.5%

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© ACCA PUBLIC

Lean Accounting Assignment, Part 3

If there were no additional commercial cabin sales available at present, wouldyou advise the machine to be purchased?

The operational performance measures for the production of the commercial

cabins would improve. Additional available capacity would be created

BUT …

Contribution would reduce by $2,000 per week – the depreciation cost of themachine

SO, WOULD YOU ADVISE PURCHASE?

YES! The key aim of lean is to improve the flow of work through the process.Additional capacity is created. The company can then work to develop newcustomers and new products

© ACCA PUBLIC

What are your thoughts on the Throughput Accounting approach compared to that of Lean Accounting?

Assignment, Part 4 – Throughput Accounting

Throughput Accounting Metrics

(based on average)

Current

State

(without

machine)

Potential

Future

State (with

machine)

Throughput per annum 3,672,239 4,480,065

Operating Expense per annum 1,732,188 1,832,188

Investment 1,000,000 1,500,000

Throughput Accounting Ratios

"Net Profit" (T-OE) 1,940,051 2,647,878

Return on Investment (NP/I) 194% 177%

Productivity (T/OE) 212% 245%

Investment Turns (T/I) 3.672 2.987

Throughput is increased

Net Profit is increased

Productivity is increased

ROI is reduced

Investment Turns is reduced

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Ross Maynard FCMA

www.ideas2action.co.uk

Thank you

Slide design by EAM

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