How lean accounting can drive step change in small businesses: Part two

In the second of this two-part series, adviser and cash flow expert Hayley Chiba explores how the concept of lean accounting can drive real change and efficiency within small businesses.

In part one of this series, I explained how I first heard about lean accounting as finance manager of a £75m manufacturing site.

Now many years later I use many of the lean accounting concepts I learned during my time at big corporations to apply to smaller businesses in a practical way.

So why should small businesses look to a concept used by some of the biggest corporations in the world? Lean accounting, I feel, has a vital role to play with smaller businesses. Many of the principles of lean accounting can be very powerful in helping to shift the mindset of the operational parts of a business. Finance is working with them both striving to find business improvement, not trying to ‘catch them out’!

Targeting departments using traditional accounting measures can lead to poor performance, as these targets do not focus on removing waste. In fact, these measures can often encourage waste where sale targets drive the business to make or sell more.

Far better first to focus on breaking down the costs of each value stream and comparing this to the actual final price received for this work. This will show the true cash build and cash profit from each type of sale. Ideally, implementing lean accounting into a business first will drive better performance in the operational parts of the business.

Costing out any business into value streams or providing a simple breakdown to gross margin level can give enormous insight to that business. Identifying loss-making areas of a business can enable it to restructure or tackle these areas quickly so as not to harm its overall growth.

Furthermore, by analysing the value stream for a loss-making product or service allows us to understand where to focus on if we want to turn this area around. Comparing value stream costs as well can give us valuable insight into where we need to make the changes.

We only show to management what costs are within their control. This is far more motivating and can drive better decision making. Allocating or apportioning overheads to managers only leads to frustration and lack of buy-in to targets.

Removing waste not cutting costs

Forcing a business to cost out its value stream gives insight into where there could be waste in the value stream.

What is it doing that it doesn’t need to be doing? What type of waste is there which is causing the cost of the stream to be higher? What resources are being used that are disproportionate to the end price?

I often use the seven wastes defined below to help me approach and investigate waste in the business. It provides a simple and clear definition to both finance and non-finance people. It is much easier to visual waste by defining it in this way. Once people see these definitions, they are better able to consider their own workflows and how they may be wasteful in these terms.

The seven wastes:

Overproduction: applying too much resource than is necessary for the same output.
Waiting: bottlenecks and wait times which increase lead time.
Transporting: moving the service or product too much through the business. The fastest route is the most direct route.
Over-processing: overworking the process with no additional value.
Unnecessary inventory: building stock or making or creating too much.
Unnecessary motion: excess movements or action on the process.
Defects: scrap and waste.

This vital concept of removing waste can be applied much more quickly to smaller businesses. Their systems are less integrated and complex, and should be able to be adapted and changed.

Finance department waste removal

I have used the identification of waste extensively in the finance departments I work in. By evaluating the workflows in the department and asking simple questions like:

Who uses this report?
What decisions are made from these reports?
What is this financial process trying to achieve?

Believe it or not, reconciliations in accounting departments can be done to death in some areas for no purpose at all. Reconciling the balance sheet accounts, of course, is important but reconciling two sets of data that will never match is a complete waste of time.

My favourite saying in terms of management reporting is: “if we don’t use these reports to either help us make a decision, to take a specific action or confirm a decision to not take action, then the information is not needed.”

Or in simpler terms, after reading the report ask ourselves the question “and so what?”

Be customer focused

Think about what each of the financial processes is trying to achieve in terms of:

Who is the customer?
What does the customer value?

For finance there are two main customers:

Compliance: external regulatory bodies like HMRC, Companies House or the UK government. These require end-of-year returns and accurate reporting for taxation purposes.
The business itself: Internal management, the MD, heads of departments, even those who are tasked with controlling some part of the business. They all need measures that support and help them to see where they are working in a way that is wasteful. They also need figures which highlight where they are not operating in a commercially viable way.

In one construction-based company I worked for, I wanted to highlight how one part of the business was draining it of cash.

We identified the areas where cash was withheld through retentions, late payments, contra charges and underpayments. We then categorised these by customer to give the business insight into where a quotation appeared to be high margin, but in fact due to the actual activities was high risk due to the cash-withholding tactics by this customer.

Small businesses need better commercial information to highlight where there is a variation from expectation of profit versus the ‘real’ cost of delivery of the product.

Traditional profit and losses are far too generalised. They don’t split down, identify, highlight or even quantify poor commerciality, and in what parts of the business.

The challenge for finance

The challenge for those who work in finance is to find a way of measuring these types of waste in a business and show how they can be reduced.

This type of reporting needs to identify and highlight where there is waste.

Set targets for their removal and then monitor and track progress toward this.

Applying the concept of lean accounting, redirect your focus to look at your internal customer (don’t forget it is the business who pays for you). The business is your customer, so what is it prepared to pay for the products and services you provide?

Lean accounting moves the emphasis on comparison from being internally focused to externally focused.

You must spend less time on analysing and accounting for variances which explain the past, and more time on looking at costs and value to help drive future improvement. Finance must give better value to its internal customer whilst ensuring the business is financially compliant.

This will only be achieved by reducing the waste first in your finance department so that you have more time to serve the real needs of the business.