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Putting Financial Value on Lean Transformation

by Jean Cunningham
May 8, 2015

Putting Financial Value on Lean Transformation

by Jean Cunningham
May 8, 2015 | Comments (4)

As a full-time lean coach these last 10 years, many people have asked me questions like, “What is the ROI on a kaizen event?” or they have looked at Lean as an initiative to be compared against another initiative. For instance, comparing lean practice to a new market expansion initiative.

To me, these questions and perspectives reflect a very incomplete and superficial understanding of the application of lean principles to enhance enterprise performance. So for years I resisted the pressure to provide information on how to put financial value on a company’s lean efforts. I wanted to ensure that manufacturing executives understood, for example, that a typical presentation of financial profit results provides a misleading indicator of progress due to the generally accepted accounting principles (GAAP) related to inventory measurement. Lean-based results in manufacturing are hard to interpret from a value perspective using standard cost accounting. This is especially true when a company is used to building up inventory and suddenly, with application of lean principles, finds inventory plunging.

Accounting methodology is also poor at measuring things that do not happen, and Lean is based on eliminating waste, meaning it saves time and money by causing things not to happen. Using lean methods eliminates many activities (e.g. rework, expediting, scrap, excess production) and therefore, the traditional accounting data crunch is not helpful in measuring these types of value enhancing changes. 

However, the questions about financial value continue to this day, and not just from people with only a cursory interest in Lean. I hear them all the time from people who think deeply about the issues and concerns of creating enterprise-wide engagement through lean thinking. So, I’ve grudgingly concluded that lean practitioners cannot get around “executive must have numbers”, and have started working to provide some insights that helped me evaluate my team’s lean efforts during my CFO tenure at Lantech in the 90s.

I talk with practitioners about seeing the value in monitoring both the quantitative and qualitative benefits of Lean. I try to help organizations develop their own methods to evaluate the financial impact of their lean improvement activities and waste reduction efforts. My goal is to show how use of accounting information can effectively present the value realized by lean activity throughout the company. Much of the challenge has to do with how to present accounting information in non-traditional ways so that non-accountants in the organization can understand it. This is important as you want to be able to share the positive impact lean changes are producing.

In the end, understanding the real value of lean practice is also about anticipating the benefits of future process changes and linking not just tools to organizational strategy, but impact to financial performance. Unfortunately there is no rigid rulebook about how to look at the performance of your business in a holistic way, but there are ways to fill the gap in the current thinking being offered on the subject for deep lean thinker. What questions do you have on lean and financial performance?

 
The views expressed in this post do not necessarily represent the views or policies of The Lean Enterprise Institute.
Keywords:  accounting,  finance,  manufacturing,  waste
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4 Comments | Post a Comment
Sabine Gowsy May 08, 2015
3 People AGREE with this comment

Hi Jean!

I'm very happy to read your article. A great and important one!

Even just-in-time because I needed your Lean Finance point of view ;)

I totally agree with you that we have to find a way to financially show the positive impact lean changes are producing.

Seeking the real value now and in the future and its impact to financial performance, is a good first step for finance department to make visible the gap.

 

Thanks for this sharing :)

Reply »

Sabatha May 08, 2015
2 People AGREE with this reply

Interesting article.  You can't avoid the need to demonstrate value in every intervention, even if the benefits are intuitively obvious.  

Instead of accounting meetrics, perhaps you should look more at corporate finance.  For example, inventory reduction reduces working capital, which is value-enhancing.  Think also of risk reduction, flexibility (think real options), reduced waste (higher raw material yields), etc.

These are only a few examples of how one could capture the value of a lean intervention.

 

Regards

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Jean Cunningham May 08, 2015
3 People AGREE with this reply

Thanks for your comments to the article.  

As a finance/accounting person, I totally agree that elemets of risk reduction, improved material utilization and working capital are important values.  (Even more so are the focus as a learning organization by all team members.)  

The challenge is measurement....think aobut measuring risk reduction and measuring material utilization...where do you find those numbers?  How much is the value?  

Even working capital, which seems to be so straightforward, is counterintuitive for many in operations and sales....less inventory is a risk for many non-lean thinkers....and can be a true risk if the overall processing time is not low enough to meet customer expectations.  

And then there is the real stumper for many finance people...what happens to my bank covenants when inventory reduces?  Hard to remember that the need for debt reduces as inventory is converted to cash!  

Thank you both for you thoughtful comments!  

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Patrick May 18, 2015
2 People AGREE with this reply

Great article Jean, thank you! Loved your performance in Amsterdam in April.

I guess part of the problem is also generating the numbers when needed for decision making (i.e. up front). Obviously after individual Lean initiatives we can calculate the benefits per initiative (either tangible or not, we are usually able to identify them), we are obviously also capable in making a business case for a project, but a forecast on ROI for a decision to implement a Lean philosophy and culture into our organization is really something else.

So far my colleagues and me "sell" the methodology internally project by project, by using our track record. As soon as anyone has the answer to your challenge, I'd be very intersted to hear more!

I am looking foreward for the day when we can define the "selling part" as waste ;-)

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