Lean—the practice of minimizing waste to maximize value—made its first big impact in business with Henry Ford in 1913, before being improved on by a team at Toyota in the 1930s. And while it’s wildly obvious why lean is beneficial to manufacturing, the evidence is not as blatant when it comes to lean in accounting. And yet, lean accounting is becoming a valuable movement for companies to consider.
What’s interesting about lean is that it can create an interesting irony in the financial metrics: When a company implements lean accounting, the financial metrics can actually look worse in the short term, even if the company is in better financial shape than ever. This is because traditional methods of cost accounting create multiple ways to make the numbers look good, despite the actual financial health of the business.
Lean accounting, on the other hand, focuses on cash flow, anchoring financial metrics to value streams. Small businesses naturally tend toward lean accounting, already trying to keep things simple and focus on the cash flow. But lean accounting has incredible value for larger businesses as well.
It’s not an easy move, though. Plenty of myths about lean accounting can stop the lean movement before it gets off the ground with many companies. Identifying those misconceptions ahead of time can make them easier to overcome so you can get on your way with lean.
Myth 1: GAAP Requires Cost Accounting
If you’re stuck in cost accounting because you believe that the Generally Accepted Accounting Principles (GAAP) require cost accounting, it’s time to make some changes. Three of GAAP’s four basic tenets are no problem with lean accounting. The first is materiality, or, what makes accounting information worth including. If leaving the information out changes a judgment or decision, it’s material. Which translates into leaving out the insignificant stuff. Which is, fun fact, what lean is all about.
Next is conservativism or reporting information in a way that minimizes cumulative income. Lean is also conservative. The third tenet is consistency or treating transactions the same way for consecutive periods. Lean follows standard work principles, and thus, consistency.
The fourth tenet, matching, might present some trouble for hardcore cost accounting teams. Matching means that accounting must match costs with revenue. This could slow down accounting if the date of the cost is weeks or months before the customer pays for the work. However, lean manufacturing can create faster inventory turns, reducing that issue. And even if that doesn’t solve the problem, lean accounting teams can instead take a new approach to some timing.
Myth 2: You Need A Faster Time to Close
Many companies rely on month-end close results in order to make decisions about where the company is going next. The faster they can close the books, the sooner they have information to make decisions and move forward. Still, even if month-end close only takes 2 weeks to complete, information is already more than 2 weeks old by the time decision makers are using it.
Lean accounting allows companies to be nimbler by adding a soft close process to every day, creating a quick view of both profit and loss and cash flow. Soft close information also puts the most recent numbers in front of teams every single day, which means the results they see at a designated hard close (be that month- or period-end) are less surprising. Companies don’t fail because revenue is not precisely matched to expenses in every financial report, but because teams are moving forward without current financial data and don’t learn about financial issues until it’s too late to course correct.
Myth 3: Inventory Must Be Categorized as an Asset
In lean approaches to anything, less is always more. This includes inventory. While cost accounting categorizes inventory as an asset, doing so can be surprisingly problematic. Material costs consume cash, and while it is well recognized that manufacturing needs inventory in order to function and be ultimately profitable, too much can eat into cash stores. This is especially evident when practicing lean accounting which, as stated above, focuses on cash flow.
Inventory is not a bad thing, but it does need to be controlled. Less is more. Too much inventory can end up a liability, and while cost accounting might show more inventory as profits on paper, a company can’t actually pay its bills (or its payroll!) with inventory. If inventory is no longer counted as an asset and instead more accurately listed as an expense in lean accounting, you’ll have a clearer picture of your actual cash flow, which will provide a more accurate profit.
Myth 4: If You Make (or Buy) More, You’ll Save More
It might seem logical that making more products or buying more inventory will result in savings down the line: Making more products reduces the cost of creating each one, allowing for larger profit, and buying supplies in bulk reduces materials spend, and creates a larger profit.
Running smaller batches and producing only what is needed means a company doesn’t have to spend cash on as much material. It reduces the need to hire more employees or pay overtime, and it reduces storage costs from excess inventory. Similarly with material, even though a significant discount on a bulk of material may seem like a good idea initially, if the cost to store and manage the material is more than the savings in purchasing it all at once, your company’s cash flow may not be as positively impacted as you believe.
With lean accounting focusing on cash flow, your company gets a clearer picture of the true costs of every expenditure, empowering smarter decision making, and ultimately improving profits.
Be A Lean Accounting Myth Buster With ASI
Are any of these myths impacting your current accounting processes and stopping the transition to lean? If these are already impacting your company’s path to profits, it could be time to reevaluate your approach to accounting.
Since 1986, ASI has offered business and accounting software solutions to help businesses implement the right processes for growth and profitability. We can create a system molded to your exact needs, no matter how complex. It’s a myth that moving to lean accounting needs to be difficult. Give us a call and we’ll show you how easy it can be.