A-09
Michael Frichol, CPIM
Aligning Production and Financial Performance for
Lean Manufacturing
Most of the focus and activity related to lean
manufacturing has been in production opera-
tions—the physical factory. And for good rea-
son, factories have been operating based on
mass production methods while customer value,
competition, and markets have changed dramati-
cally. Applying lean methods have enabled man-
ufacturers to substantially improve their factory
operations and respond to customer service de-
mands and become more competitive. There is
no question that lean methods have had and are
having a profound effect on improving produc-
tion operations.
As production operations have evolved and
improved with lean methods, the accounting
operations have mostly remained unchanged
from the decades-old processes established to
support mass production operations. Many
manufacturers are still burdened with wasteful
accounting processes that are no longer
relevant to the current state of their production
operations. In some instances, accounting
methods are directly contradictory to the process
improvements accomplished by production
operations as discussed in part two of this
series of papers on rethinking manufacturing
performance. While manufacturers have
incurred vast amounts of effort and time to
eliminate waste and implement lean processes
in production operations, accounting operations
have continued to execute wasteful processes
with decreasing relevance and ability to reflect
the reality of the changed production processes.
What is needed is for manufacturers to
apply lean principles to accounting operations
with four primary objectives:
• Eliminate waste and streamline accounting
processes.
• Align accounting processes with production
processes.
• Provide meaningful financial information
that reflects the reality of production
improvements.
• Align accounting staff and processes with
customer value creation.
2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management
THE ACCOUNTING FACTORY
Most manufacturing companies have two fac-
tories—the physical factory that produces the
products that are sold and the parallel accounting
factory that produces transactions and account-
ing data. Everyone knows about and focuses on
the physical factory—that’s where all the lean
manufacturing attention is and where gains are
being achieved. The accounting factory is far
less visible—a parallel hidden factory that con-
sumes substantial resources and produces mil-
lions of transactions and vast amounts of data
to provide the financial reflection of the produc-
tion operations.
The typical baseline business processes of a
manufacturer would include
• sales, bid, quote process
• customer order processing
• demand and supply planning
• purchasing
• production scheduling
• production execution
• production support processes such as materials
handling, quality assurance, job tracking,
labor tracking, production engineering, cost
accounting, etc.
• packaging
• shipping
• transportation and delivery.
This is not a detailed, comprehensive list
of all the processes—it’s just an illustration of
the major business processes. Now think about
all the underlying transactions being processed
in each process, and the steps and operations
within each process, and you get the picture
of the parallel transaction-generating factory.
While most if not all of these transactions have
an accounting aspect attached to the business
process, many of them are processed solely for
accounting purposes.
A hypothetical but typical manufacturer with
$50 million in revenue, 250 to 300 employees,
five major product lines, 100 different end
products, and 2,000 items of purchased material
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 Aligning Production and Financial Performance for Lean Manufacturing
would generate at least three to five million
transactions per year. That’s 12,500 to more than
20,000 transactions a day! While your enterprise
resources planning (ERP) manufacturing business
system would effortlessly process this volume,
each transaction has to be originated, which
implies consumption of productive labor and/or
machine time for unproductive purposes. Data
is generated and accumulated as the transactions
are processed, and information about status,
progress, variances, output, and many other
activities is produced. This information is then
analyzed, monitored, and otherwise used by
people in various functional areas, particularly
in accounting. A typical $50 million-revenue
manufacturer could easily have the equivalent
of 25 to 30 full-time people’s time spent on the
transaction and accounting factory. Not all of
these people are employed in accounting—many
of them are in other functional areas that are
required to spend several hours per day or week
feeding the transaction and accounting factory.
Manufacturers have spent much effort
and attention on applying lean manufacturing
methods in the physical factory to eliminate
waste and reduce lead and cycle times. But what
does it cost to process a customer order? Do
you really know? I’ve asked this question many
times and typically get, “Oh, about $25” as the
glib answer. I beg to differ; I would contend that
it is several times $25 for many manufacturers.
Think about all the processes and transactions
that radiate from each customer’s order. Think
about the parallel transaction and accounting
factory you’re feeding. If you want to take the
next step in lean and waste elimination, stop
looking at the factory floor and look right here at
your hidden transaction and accounting factory.
WHAT IS THE ROLE
OF ACCOUNTING IN
MANUFACTURING?
Just what is the role and contribution of the ac-
counting function in a manufacturing company?
It’s surely not to be an accounting factory gen-
erating millions of transactions and accumulat-
ing oceans of data. We need to step back from
what has become an unquestioned assumption
and critically evaluate whether all those transac-
tions and collection of data are really necessary.
Are the accounting processes really adding val-
ue? Let’s explore the reality of the accounting
factory in most manufacturers to answer these
questions.
2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management
The accounting function in a manufacturer
serves three primary purposes:
• It tracks and reports on the state and
achievements of the business in financial
terms to owners, shareholders, and other
stakeholders.
• It provides statutory financial reporting for
tax filings and other regulatory requirements.
• It provides financial management guidance
for making sound business and investment
decisions.
The problem observed in most
manufacturers is that the statutory/regulatory
financial requirements take precedence
over everything else in the accounting area.
Processes, transactions, and data collection are
all established within the confines of generally
accepted accounting principles (GAAP) and other
statutory/regulatory specifications for providing
financial reporting. This is unquestionably
accepted as what the accounting function should
do. While it is necessary and obligatory to
provide accurate financial reporting according
to statutory and regulatory requirements, the
problem is that the process is wasteful and
does not contribute to business improvement
initiatives such as lean manufacturing. Analyzing
where resources are focused in the accounting
function in a typical manufacturer will reveal a
troubling profile:
• Approximately 60 to 70 percent of the
accounting function, processes, activity, and
resources are typically spent on bookkeeping
and statutory/regulatory financial reporting.
• Another 20 to 25 percent is typically spent on
routine administrative and support tasks.
• Five to 15 percent is typically focused on
financial management tasks and business
improvement initiatives.
I am not attempting to denigrate the
accounting function and role, but I do strongly
believe that the accounting function and role is
grossly misaligned and should be substantially
more valuable to the real business operations.
We need to change the resource allocation profile
to enable the accounting function to play a more
proactive and participatory role in the business
improvement initiatives:
• Approximately 30 to 35 percent should be
allocated for processes, activity, and resources
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 Aligning Production and Financial Performance for Lean Manufacturing
on bookkeeping and statutory/regulatory
financial reporting.
• Ten percent should be allocated on routine
administrative and support tasks.
• Fifty-five to 60 percent should be focused
on financial management tasks and business
improvement initiatives.
What if we could still meet all the statutory/
regulatory financial reporting requirements
with this resource realignment and have the
accounting function add substantial real value to
the business? Wouldn’t this be a more meaningful
role and valuable participation for the accounting
staff ? This can be accomplished by applying lean
principles to the accounting function.
FOCUS ON CUSTOMER VALUE
According to Lean Thinking by James P. Womack
and Daniel T. Jones, the first principle of lean
is customer value. However, most accounting
functions and systems in manufacturing com-
panies are focused on internal costs in support
of statutory/regulatory financial reporting. Just
as we introduced lean manufacturing to the pro-
duction processes, we need to introduce lean ac-
counting to the accounting processes.
Applying lean principles to the accounting
function is a rational and straightforward exercise
when you consider it within the context of the
accounting factory discussed earlier. Accounting
is a hidden factory producing transactions and
data in parallel with manufacturing and other
business operations. Many manufacturers
have successfully applied lean principles to
manufacturing and other business processes;
the same lean principles should equally apply
to the accounting factory with lean accounting
to produce additional value for customers and
ultimately for the business:
• Apply value stream mapping to determine
what accounting processes are really necessary
for supporting customer value creation.
• Eliminate waste by determining what is
really necessary to meet the minimum
statutory/regulatory financial requirements.
Remember, you’re not in business to feed
statutory/regulatory impositions. Do as little
as legally possible.
• Examine just what data and transactions are
really necessary to track the value stream in
financial terms.
• Eliminate control systems from accounting.
2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management
The control is in the lean operational
processes.
• Align costing methods with the value
stream—not with individual products.
• Shift the focus from financial reporting to
financial management. Empower accounting
people to truly add value to the business.
• Produce a relevant balanced value stream
scorecard for internal financial management
instead of using misleading regulatory
financial reports.
• Move from a high transaction volume with
control by inspection process to a low
transaction volume with control by prevention
process.
• Shift the focus of accounting from recording
results of the past to understanding and
correcting the causes that will inhibit future
growth and additional value creation.
The remainder of this paper will discuss in
more detail each point of the lean accounting
principles enumerated above.
TRANSITION TO LEAN
ACCOUNTING WITH VALUE
STREAM MAPPING
Lean accounting is a key area for developing a
comprehensive lean enterprise across the busi-
ness. Value stream mapping is the starting point
and primary tool for determining which account-
ing processes produce customer value. The key
objective is to recognize the revised lean process-
es in the production area and critically analyze
what accounting processes are really necessary to
support the customer value creation objectives.
In a lean environment, control is in production
operations processes—not in accounting. Elim-
inating waste in accounting is accomplished by
eliminating typical mass production costing and
control methods that are no longer relevant in a
lean enterprise.
Value stream mapping methods and tools
are used in much the same way as they are in
production processes to determine the true
accounting value stream. Every accounting
process, such as accounts payable, accounts
receivable, standard costing, variance reporting,
general ledger posting, etc., must be reviewed
to eliminate waste. The accounting transaction
and data factory volume must be reduced
substantially; potentially 80 percent of typical
mass production accounting transactions serve
no constructive or value added purpose in a lean
enterprise.
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 Aligning Production and Financial Performance for Lean Manufacturing
ELIMINATE ACCOUNTING WASTE
The first principle is to determine what is mini-
mally essential to meet the minimum statutory/
regulatory financial requirements for financial
reporting. Remember, you’re not in business to
feed statutory/regulatory impositions, so do as
little as legally possible. The first place to look is
the monthly close cycle: Why are you doing this?
In the previous mass production era of long lead
times and large batch sizes, it was necessary to
do month-end close cycles to reconcile extended
manufacturing processing times and large vary-
ing levels of inventory with periodic cost rec-
onciliation. However, with lean manufacturing
production, cycle times are executed in minutes,
and dock-to-dock times are measured in hours.
This, combined with low and stable inventories,
eliminates the need for monthly closes. Public
companies only have to do quarterly closes. The
objective would be to move from labor-inten-
sive monthly close processes over several days
or weeks involving millions of transactions to
a quarterly automated lean close process within
hours or one day maximum with potentially 80
percent fewer transactions.
Traditional accounts receivable and
accounts payable processes inherently have
a lot of wasteful activities, such as three-way
match, invoicing, etc. In a lean enterprise
with certified suppliers, payment can be made
automatically upon receipt or use of materials
without any additional transactions. Similarly,
since manufacturers are in turn suppliers to
their customers, they can negotiate the same
automatic, transaction-free payment process with
customers. Accounting should leverage the lean
processes established in production operations
to eliminate or substantially reduce accounting
processes and transactions to reflect the actual
operational processes in a lean enterprise.
The general ledger structure needs to be
critically reexamined within the revised lean
enterprise context. General ledger account
structures are traditional built on departmental
functional area hierarchical structures with many
hundreds of accounts. In a lean enterprise, the
general ledger structure needs to be reconciled
with supporting the value stream structure.
TRACK THE VALUE STREAM IN
FINANCIAL TERMS
The focus of lean accounting should reflect the
financial view of the physical value stream(s).
The principle is to provide supporting- and de-
cision-making financial information about the
2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management
value stream(s) to determine the financial reflec-
tion of the value stream(s). The perspective is
substantially different and requires a major mind
shift from traditional cost and absorption ac-
counting. The accounting function should not
introduce any additional transactions to the pro-
duction value stream but should merely capture
the financial view of existing value stream pro-
cesses and transactions.
ELIMINATE CONTROL SYSTEMS
FROM ACCOUNTING
Traditional accounting systems use standard cost
and variance tracking methods to impose finan-
cial controls. These methods have never been
effective to solve root causes of problems. At
best, the accounting control processes were able
to highlight the result of an unknown cause in a
particular resource long after the event occurred.
These accounting control processes are wasteful
in many ways—in the vast amounts of transac-
tions and data required to produce the infor-
mation and in the wasted time spent badgering
production people to provide reasons why some-
thing did not meet accounting control standards
last week or last month. This is all unproductive
waste that must be eliminated.
In lean manufacturing, the control processes
are, in the lean operational processes, monitored
in real time relative to the cause, with corrective
action inherently part of the lean processes
improvement methodology. There is no need
for any accounting control processes, since the
operational control processes and improvements
will be automatically reflected in the financial
value stream.
ALIGN COSTING METHODS WITH
THE VALUE STREAM
In most industries today, costs are not what de-
termines selling price. Prices are determined by
the market—by customers, competitors, supply,
global capacity, etc. There is no need to know
what individual products cost based on tradition-
al cost accounting methods of allocating every
possible element of factory costs such as labor,
overhead, indirect, machine amortization, etc. to
each product. All you need to know about cost,
as it relates to products, is the throughput mar-
gin, i.e., selling price minus totally variable costs
(usually direct materials only). Knowing the
throughput margin by individual product may
not be necessary for individual products either;
knowing by product families would be sufficient
in most cases.
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 Aligning Production and Financial Performance for Lean Manufacturing
All other costs (i.e., everything that is not
totally variable related to unit production) are
value stream costs. The cost accounting process
therefore shifts to costing the value stream(s)
independent of the products. It’s the value
stream(s) that contain the resources and processes
for which all other expenses are incurred.
This provides a much simplified and
more powerful view managing costs, as seen in
Figure 1.
As illustrated in Figure 1, profitability is
based on optimizing the value stream rather
than the cost of individual products. The value
stream cost doesn’t change according to product
volume—costs like labor, utilities, rent, etc. are
sunken costs, and you’re going to pay all or most
of them anyway. By focusing on throughput
margin for product profitability comparisons
and value stream costs for processing costs, you
can make more informed and realistic business
and profitability decisions.
SHIFT FOCUS FROM FINANCIAL
REPORTING TO FINANCIAL
MANAGEMENT
Eliminating wasteful and unnecessary processes
in accounting and realigning accounting process-
es with the physical value stream will result in a
substantial reduction in accounting resource and
labor requirements. The question is what hap-
pens with accounting staff who are no longer
fully utilized. While some attritional cost savings
are possible, the first option should be to rede-
ploy these skilled resources to process improve-
ment and value added activities for the company.
2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management
The objective is to essentially move a substantial
amount of accounting resources from primarily
reactive financial reporting and cost accounting
in a traditional mass production environment to
a proactive financial management role in a lean
enterprise.
BALANCED VALUE STREAM
SCORECARD
Traditional cost accounting methods use finan-
cial measures that are not aligned with lean en-
terprise objectives:
• Build to inventory with inventory accumulating
all material process costs and then sell from
inventory. Since a key principle of lean is
to build to demand based on a pull process,
inventory is reduced significantly. GAAP
accounting principles and treatment of
inventory reflects favorable financial results
for inventory increases and unfavorable
financial results when inventory is reduced.
This contradiction is discussed in detail in
part two of this series of papers on rethinking
manufacturing performance.
• Accruals are accounting methods that establish
intermediate holding accounts before an
activity is finalized. The reason for accruals
is eliminated with lean manufacturing—cycle
times are very short, dock-to-dock times
don’t run over multiple accounting periods,
and inventory holding is low and consistent.
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 Aligning Production and Financial Performance for Lean Manufacturing
The above is just an example of the types
A single measure of financial profitability of scorecard measurements. The key would be
skewed by GAAP inventory and accrual period-to-period comparisons and trends. The
rules is inappropriate or even irrelevant and balanced value stream scorecard is used for all
potentially contradictory for measuring financial internal financial performance management, but
performance in a lean enterprise. A balanced not the statutory/regulatory financial reports.
value stream scorecard approach covering the
broader performance measures of the value
stream is required as per the following example: MOVE TO LOW TRANSACTION
VOLUMES WITH CONTROL BY
• Financial performance PREVENTION PROCESS
O sales/revenue (throughput) This goal is part of what was discussed earlier.
O totally variable costs The key principle for moving to a lean account-
O throughput margin ing process and using value stream mapping is
O value stream cost to focus on transitioning from a high transaction
O value stream profit volume with control by inspection process to a
O cash flow. low transaction volume with control by preven-
tion within the operational processes.
• Operational performance
O dock-to-dock time MOVE AWAY FROM THE FOCUS
O cycle time OF RECORDING PAST RESULTS
O performance to takt time
O inventory $ (raw materials (RM), work in This goal is to shift to a value creation mode
process (WIP), finished goods (FG) by focusing on proactive financial management
O inventory velocity/turns (RM, WIP, FG) rather than reactive reporting of past results.
O demand forecast accuracy Basically, you want to stop driving the financial
aspect of the business by looking in the rear-
O operating equipment efficiency (OEE)
view mirror. The key is to shift the focus of
for constrained resources where demand
accounting to understanding and correcting the
exceeds capacity causes that will inhibit future growth and addi-
O system of record accuracy. tional value creation in a financial context.
• Quality
O first pass yield CONCLUSION
O defects per million. You may not have specific answers for action
items from this short paper, but hopefully I have
• Customer service highlighted an area of interest and triggered your
O on time delivery performance curiosity to examine your manufacturing busi-
O lead time ness from the perspective conveyed in this paper.
O customer satisfaction index If you are a cost or financial accountant, I’m not
O return ratio. trying to denigrate what you do; I’m trying to get
you to rethink what you do and consider how
• Employee satisfaction you can create more value for your customers
O labor turnover rate and ultimately benefit your business.
O absenteeism
O training hours per period REFERENCES
O process improvement suggestions.
Lean Thinking, James P. Womack & Daniel
• Supplier performance T. Jones.
O delivery performance The Goal, Eliyahu Goldratt & Jeff Cox.
O defect rate. The Theory of Constraints and Throughput
Accounting, Monte Swain & Jan Bell.

2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management 6
 Aligning Production and Financial Performance for Lean Manufacturing

b. Part 2 – How Cost Accounting is Stifling

The Theory of Constraints and its Implications
for Management Accounting, Eric Noreen, Debra
Smith & James Mackey.
Throughput Accounting, Thomas Corbett.
Practical Lean Accounting, Brian Maskell,
Bruce Baggaley.
Dynamics of Profit-Focused Accounting, C. Lynn
Northrup.
Rethinking Manufacturing Performance, Mike
Frichol.
a. Part 1 – Key Production Performance
Improvements that Drive Manufacturing
Business Success.
your Business Success and What to do
About It.
c. Part 3 – Aligning Manufacturing Performance
Metrics with Business Objectives.
ABOUT THE AUTHOR
Mike Frichol has more than 25 years of infor-
mation technology and manufacturing industry
experience in various management, informa-
tion technology, and business analyst roles. He
is currently the director for global manufactur-
ing industry solutions and strategy at Microsoft
Business Solutions.

2005 International Conference Proceedings, © 2005 APICS—The Association for Operations Management 7