by Sara Abel

It’s a familiar scene at monthly management meetings: the previous month’s financials are presented, explanations for variances are similar to those you have heard before, and the presenter’s voice begins to fade to the background of your mind. The management team leaves the room empty-handed when it comes to having timely, relevant information to make better decisions.

The absence of a direct connection between the financial information presented and current operations makes it extremely difficult to pinpoint the behaviors and activities that need to be adjusted to better support the strategic objectives of the organization.

In most companies, financial information is far too complex. We have overcomplicated our accounting systems and controls by trying to adapt to methods that were designed for mass production environments to our current manufacturing organizations which are, by and large, not mass producers.

The traditional accounting methods of allocating overhead based on labor or machine hours has become obsolete in an environment where more and more time is being spent collaborating, designing, problem solving, and customizing versus mass producing parts. Traditional standard costing practices are counterintuitive to lean manufacturing practices and leave a void in providing information to support aligned, proactive decisions at all organizational levels.

There’s more value in value costing

Value costing is a dynamic alternative to traditional standard costing, especially for lean organizations. It’s simple to understand, adaptable to different environments, and provides the necessary visibility to support timely decision-making. Through meaningful information, people are better able to understand how to adjust next-day and next-week activities and behaviors.

The value stream is defined by the entire flow of similar products from an organization’s front door to its back door, from order entry through cash collection.

Bear in mind, there is no distinction between direct and indirect costs. Value costing considers all the costs that make up the value stream including all employees working in the value stream whether they make the product, move materials, design the product, maintain machines, plan production, or generate sales.

The intent is to include only those costs that are controllable by the people in the value stream and to eliminate allocations. All costs that are not related to the stream are simply not included. For example, human resources and accounting functions are considered costs of running the business and not in the stream. They should be managed but the costs are not included in the value stream cost and are not allocated.

Companies therefore organize costs around value streams and focus on process excellence versus departmental excellence. They calculate the cost of operating the stream and challenge their teams to figure out how they will move the value stream to the next level while staying aligned with their strategies and objectives.

Focusing on the system

Value costing is a better reflection of the lean system. Lean organizations design their operational flows to minimize the consumption of resources at each step in the process. When the value stream is measured, the resulting information quickly draws attention to inefficiencies and makes it easy to eliminate excess with well-timed adjustments.

By contrast, mass production methods are designed to minimize unit costs, which can lead to all kinds of non-lean behaviors. Traditional accounting motivates these non-lean behaviors by rewarding large run sizes to spread setup costs, to produce as many parts as possible per labor or machine hour, and to maximize machine up-time while penalizing the creation of unused capacity. Without dynamic stream information, employees are powerless to make incremental improvements.

Value costing information is related to the flow of product through the value stream. The cost driver in value costing is the rate at which an individual product flows through the value stream. Thus the lean accountant’s focus is on cost management. It is more valuable to manage the costs of the business as a whole rather than to focus on job costing.

The right information for the right outcomes

Value stream costing becomes a key driver in an organization’s lean efforts, helping the teams know where to work next and providing information for organizations to make better decisions related to the redeployment of newly freed-up capacity.

Simplified financial and non-financial measures are readily available -- in real time or close to real time -- to allow those people working within the value stream to quickly recognize a good day or a good week and to understand their current condition as it relates to the utilization of resources within the value stream and financial and operational goals. These value costing measures might include the following:

• Revenue
• Material and conversion costs
• Operational measures such as on-time delivery, floor space, and sales per person
• Measures related to the use of resources in the value stream, for example, capacity measures

As value costing measures are implemented, job costing becomes obsolete. Lean organizations do not need job costing to make pricing decisions as pricing decisions are based on the market price. Timely and relevant value costing measures become more valuable than traditional accounting information when it comes to making decisions that are in alignment with the company’s strategic objectives.

Typically, value stream managers are appointed and will have profit and loss responsibility. Accountants are great candidates for these leadership roles; accountants are generally excellent process thinkers.

Sara Abel, a senior consultant in Wipfli’s Manufacturing and Distribution practice, specializes in integrating solutions into the business processes of an organization and in leading teams through process improvement to gain operational efficiencies. Sara can be contacted at Wipfli’s Green Bay office at (920) 730-7004 or sabel@wipfli.com.