Unlikely Allies: Aligning Accounting and Operations on the Lean Journey

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1 Unlikely Allies: Aligning Accounting and Operations on the Lean Journey Jerry Solomon Retired - Vice President of Operations MarquipWardUnited, Hunt Valley; A Division of Barry-Wehmiller, Inc.

years Well-balanced and financially solid

2 Barry-Wehmiller Cos. $2.3 billion annual revenues One of the largest capital goods producers in the Western Hemisphere More than 11,000 team members Over 65 locations worldwide 19% compound annual revenue growth for 21 years Well-balanced and financially solid company Privately held by 400+ shareholders with an outside Board of Directors

4 4

5 Video of Machine 5

Investment in R&D Team members Inventory

Functional/silo organization Focus on Lean

6 MWU Hunt Valley, Then & Now Orders Revenues Operating income Investment in R&D Team members Inventory Turns Working capital investment Functional/silo organization Focus on Lean tools Standard cost system Up 110% Up 90% Up 400% Up 550% Up 20% Up 100% Negative working capital Value stream organization Focus on culture Lean accounting

7 What is Lean? Elimination of Waste Respect for People Utilization of Lean tool kit in pursuit of perfection in safety, quality, delivery, & cost! Inspirational leadership, profound cultural & organizational change required! Solomon and Fullerton All rights reserved. 7

8 How is Lean Typically Implemented? Elimination of Waste Respect for People Drive by Kaizens Focus on Shop Lack of Alignment Layoffs Command & Control Silos & Local Optimization Middle Mgmt. Struggling Managing Solomon and Fullerton All rights reserved. 8

9 How Should Lean be Implemented? Respect for People High Level VS Mapping Meaningful Area Narrow & Deep Link all Kaizens Hoshin Kanri Continuous Improvement No layoffs C-Level Support Value Stream Org. Recognition, empowerment, coaching, & training Inspirational Leadership Lean Accounting Solomon and Fullerton All rights reserved. 9

10 Are Your Financial Reports/Information Respectful To All Customers? It s all about RESPECT! Do the financial statements and reports Make the numbers easy to understand? Promote Lean behavior? Illustrate Lean benefits? Provide actionable information in a timely manner? Promote alignment between manufacturing and accounting? Solomon and Fullerton All rights reserved. 10

11 Why is this Important? Lean improvements will initially be invisible to accounting Typical manufacturing metrics are outdated and promote non-lean behavior The greater the initial success with Lean, the more likely earnings will be negatively impacted, and Accounting is often one of the biggest roadblocks to a successful Lean journey! Solomon and Fullerton All rights reserved. 11

13 Improvements Are Invisible Setup Time Machine Run Time Lot Size Number of Different Part Numbers Produced 2 Hours 6 Hours L 1 Hour 6 Hours E 30 Minutes 6 Hours Minutes 6 Hours 64 8 A 7.5 Minutes 6 Hours N 3.75 Minutes 6 Hours Seconds 6 Hours Seconds 6 Hours Seconds 6 Hours Seconds 6 Hours L. Rubrich & M. Watson, Implementing World Class Manufacturing, (Ft. Wayne, IN, WCM Associates, 2000) p

14 Lean is... Not a cost reduction program, it is a Cash flow generator, Customer service program, Capacity generator, and most of all, a People system Benefits of Lean based on how these improvements are utilized! Solomon and Fullerton All rights reserved. 14

15 Traditional Cost Accounting Practices Full/Absorption Costing All costs incurred in the manufacturing process are assigned to specific products System of choice for most companies Solomon and Fullerton All rights reserved. 15

16 Derivation of Standards Sales - Standard Cost + - Variances = Gross Margin Prior year or Quote Estimate Guess Estimate Std Cost = Mat l + (Dir. Labor + Set-Up/Lot Size) * Budgeted Dir. Labor $ s/budgeted Hrs.) + Overhead Multiplier Forecasts Allocations Variance = Actual Expense - Standard 16

19 Potential Standard Cost Deficiencies Direct labor is treated as a variable input that changes in lock step with production In reality closer to a fixed cost Overhead also treated as a variable input when it s a multiple of direct labor, yet it also behaves like a fixed cost Most people do not understand a full cost P & L, especially those charged with improving results on the shop floor Solomon and Fullerton All rights reserved. 19

20 How Accurate Are Your Costs at the SKU Level? What goes into the rates? How are the costs spread? How accurate are they? Cost Category Weighting Accuracy Weighted Accuracy Material 60% 90% 54% Direct Labor 10% 60% 6% Overhead 30% Totals 100% Solomon and Fullerton All rights reserved. 20

21 Traditional Accounting Typical performance measures Financial Historical, not predictive Late Motivate inappropriate behavior Do not identify waste Do not identify obstacles to flow Do not demonstrate Lean improvements Solomon and Fullerton All rights reserved. 21

22 Traditional Cost Accounting 2 Minutes Drill Assemble 6 Minutes Production Lot Size = 3,000 Pcs. 4 Minutes 3 Minutes. Mill Pack Direct Labor Rate/Hr. = $30 Overhead Multiplier = 3X DL Material Cost per Unit = $10 Product Cost Metrics Avg. Inventory 5,000 Lead time 8 Weeks OTP 75% Solomon and Fullerton All rights reserved. 22

24 After Kaizen/Traditional Costing Pins (Mill slots) Dots (Drill holes on manual machines) 4 Minutes 4 Minutes 6 Minutes 4 Minutes Taping (Assemble components) Pack Out (Inspect & pack) Direct Labor Rate/Hr. =$30 Overhead Multiplier = 3X Material Cost per Unit = $10 Solomon and Fullerton All rights reserved. Product Cost Production Lot Size = 300 Pcs. Metrics Avg. Inventory 500 Lead time 2 Weeks OTP 95% 24

25 What Really Happened Besides Co-locating Activities In a Cell, Right Sizing Equipment, and Balancing the Process? Metric Before After % Improvement Inventory 5, % Lead Time 8 Weeks 2 Weeks 75% On Time Performance 75% 95% 27% Batch Size 3, % Sq. Footage 8,000 3,000 63% Quality 50 PPM 15 PPM 70% # of Transactions Many Few Dramatic Throughput Flexibility & Teamwork Poor Improved Dramatic Unit Cost per Cost Acctg.??? Solomon and Fullerton All rights reserved. 25

26 What Really Happened Besides Co-locating Activities In a Cell, Right Sizing Equipment, and Balancing the Process? Metric Before After % Improvement Inventory 5, % Lead Time 8 Weeks 2 Weeks 75% On Time Performance 75% 95% 27% Batch Size 3, % Sq. Footage 8,000 3,000 63% Quality 50 PPM 15 PPM 70% # of Transactions Many Few Dramatic Throughput??? Flexibility & Teamwork Poor Improved Dramatic Mill Drill 4 Minutes 4 Minutes 6 Minutes 4 Minutes Unit Cost per Cost Acctg. Assemble Pack Solomon and Fullerton All rights reserved. 26

27 What Really Happened Besides Co-locating Activities In a Cell, Right Sizing Equipment, and Balancing the Process? Metric Before After % Improvement Inventory 5, % Lead Time 8 Weeks 2 Weeks 75% On Time Performance 75% 95% 27% Batch Size 3, % Sq. Footage 8,000 3,000 63% Quality 50 PPM 15 PPM 70% # of Transactions Many Few Dramatic Throughput Flexibility & Teamwork Poor Improved Dramatic Unit Cost per Cost Acctg. Solomon and Fullerton All rights reserved. 27

28 Traditional Metrics Promote Non-Lean Behavior Variance Absorption Variance Machine Utilization Purchase Price Variance Direct/Indirect Labor Ratio Direct Labor Variance Analysis Overhead Variance Analysis Solomon and Fullerton All rights reserved. Non-Lean Outcomes/Behaviors Building of unnecessary inventory Reluctance to change over equipment Reluctance to change over equipment Reluctance to perform necessary PM procedures Promotes buying excess inventory due to quantity discounts May compromise quality and delivery over price considerations Promotes increase in # of suppliers Use direct operators for indirect purposes Minimizes the importance of indirect labor activities Moves significant costs to overhead pools Use of lowest cost resource regardless of skill set Piece rate encourages the building of unnecessary inventory, and compromised quality Favorable variances interpreted as good regardless of continuous improvement trend Encourages production regardless of demand 28

29 Accounting for Lean Value Stream Costing 29

30 Why Accounting for Lean? "It was not enough to chase out the cost accountants from the plants. The problem was to chase cost accounting from my people's minds" Taiichi Ohno, founding father of the Toyota Production System LA Summit

31 Value Stream Costing Labor (Salaried, Hourly, Benefits, etc.) Materials Value Stream Fixed Costs of Value Stream Conversion Costs (Consumables) Allocated Costs are Excluded Solomon and Fullerton All rights reserved. 31

32 Value Stream Costing Sample Product Costing using Value Stream Costing Labor $ 10,000 Conversion (Consumables) $ 3,000 Materials $ 25,000 Fixed costs $ 6,000 Total cost $ 44,000 Units produced 4,000 Average cost per box $ Solomon and Fullerton All rights reserved. 32

33 Value Stream Costing 12 Minutes 12 Minutes 0 Minutes Pins (Mill slots) Dots (Drill holes on multiaxis CNC machine) 4 Minutes 6 Minutes 6 Minutes 6 Minutes 2 Minutes 8 Minutes Taping Pack Out 6 Minutes (Assemble 4 Minutes (Inspect & pack) 10 Minutes components) Units/Hour = Value Stream Cost/Hr = $200 Material Cost/Unit = $100 Units/Hour = Value Stream Cost/Hr = $200 Material Cost/Unit = $100 Units/Hour = Value Stream Cost/Hr = $200 Material Cost/Unit = $100 Cost/Unit = Cost/Unit = Cost/Unit = 33 Solomon and Fullerton All rights reserved.

34 Accounting for Lean Plain English P & L s 34

35 Traditional Company Profit & Loss Statement $(000) % Sales 1, % Cost of Standard % Purchase Price Variance 20 2% Material Usage Variance 30 2% Labor Rate Variance 10 1% Labor Usage Variance 15 1% Overhead Variance 50 4% Total Cost of Sales % Gross Margin % Operating Expenses % Operating Income % Solomon and Fullerton All rights reserved. 35

36 Lean Company Plain English Profit & Loss Statement $(000) % Sales 1, % Conversion Costs Cost of Sales Material % Shop Supplies 67 5% Shipping & Receiving Supplies 5 0% Equipment Repairs 22 2% Hardware 32 2% Sub-Total Variable Cost of Sales % Variable Margin % Labor Costs % Fixed Costs 42 3% Cost (To)/From Inventory 37 3% Sub-Total Fixed Costs % Total Cost of Sales % Gross Margin % Operating Expenses % Operating Income % Solomon and Fullerton All rights reserved. 36

37 Lean Company Plain English Profit & Loss Statement $(000) % $(000) % Sales 1, % % Conversion Costs Cost of Sales Material % % Shop Supplies 67 5% 80 6% Shipping & Receiving Supplies 5 0% 8 1% Equipment Repairs 22 2% 25 2% Hardware 32 2% 35 3% Sub-Total Variable Cost of Sales % % Variable Margin % % Labor Costs % % Fixed Costs 42 3% 42 3% Cost (To)/From Inventory 37 3% % Sub-Total Fixed Costs % % Total Cost of Sales % % Gross Margin % % Operating Expenses % % Operating Income % % Solomon and Fullerton All rights reserved. 37

38 Accounting for Lean Standard costing, labor reporting and variances replaced with actual costs and performance metrics Metrics maintained by employees at the work cell and form basis for continuous improvement Metrics reinforce Lean activities and promote continuous improvement Solomon and Fullerton All rights reserved. 38

40 Inventory Over Time at ANY Company How much labor and overhead resides on your Balance Sheet today will determine the hit to profit resulting from improved inventory management/turns! Overhead $ Inventory Labor Material Start Up Today Solomon and Fullerton All rights reserved. 40

41 When Improving Inventory Turns it s Payback Time! The reduction in labor and overhead must flow through the P & L! $ Inventory Overhead Labor Material Today Future Solomon and Fullerton All rights reserved. 41

43 How Do We Make Lean Improvements Visible? As we physically change processes during the Lean journey, manufacturing & accounting must work together to transition to Lean Accounting. New financial statements In Plain English No standard costs, absorption or variances Easy for everyone to understand - RESPECTFUL Box scores Illustrate improvements in Lean operating metrics and capacity Value stream costing Focus on cash flow Solomon and Fullerton All rights reserved. 43

44 Partner with Accounting Develop new metrics & reporting that align with and promote Lean behavior Local Maintained by shop Daily & weekly Non-financial as well as financial Include accounting associates in events from day one Help with kaizens in accounting Build a partnership!!! Solomon and Fullerton All rights reserved

45 Summary - Why Companies Need an Alliance Between Manufacturing & Accounting to Execute Strategy? To create a scoreboard that is both supportive of the Lean journey and is understood and owned by all associates To have accounting and manufacturing jointly anticipate financial impact of Lean initiatives - no surprises To better understand & celebrate wins together To highlight and understand the full value of Lean improvements To be one team and respect each other! By aligning accounting & manufacturing, and having easily understood scorecards, the ability to support and execute the business strategy will be greatly enhanced! Solomon & Fullerton 07. All Rights Reserved 45

46 For Further Information Available at or Amazon.com Cell:

Bridging The Gap Between Accounting and Operations

Bridging The Gap Between Accounting and Operations Jerry Solomon Retired - Vice President of Operations MarquipWardUnited, Hunt Valley, A Division of Barry-Wehmiller, Inc. 1 Barry-Wehmiller Cos. $2.4 billion