SAP Insight

Managing Value Stream Performance

Value Stream Performance Management

Through Lean Accounting

Performance Measurements That Matter in the

Lean Enterprise

In standard cost accounting, false precision often occurs in the way product costs are
represented. Since precision is a limit to accuracy, false precision leads to unjustified
confidence in the accuracy of the product cost.

CONTENT

^ 4 Executive Summary
^ 5 The Transformation from
Standard to Lean Cost
Accounting
5 Precision Versus Accuracy
6 Standard Versus Lean
6 Product Versus Value Stream
Costing
8 Changing Versus Not Changing
^ 9 Profitability and Cost
Management in the Lean
Enterprise
9 Aligning Lean Enterprise
Processes
9 One Application for a Lean
Transformation
9 Pulling the Lean Accounting
Profit Lever
9 Learn More Today

Dave Strothmann
Manufacturing Value Network Director
SAP America Inc.

About the Author

In his role as manufacturing value network director for SAP America Inc., Dave
Strothmann is responsible for building customer communities, providing thought
leadership, and influencing product strategy for SAP. Advancing state-of-the-art
software support for lean manufacturing is an area of special interest.
Strothmann has 24 years of experience in industrial manufacturing management,
software product management, and marketing. This includes 9 years in the
software industry for enterprise resource planning and 15 years in the industrial
manufacturing industry fulfilling a variety of roles and responsibilities.
Strothmann holds a bachelor of science in marketing from Northern Illinois
University.

Executive Summary

The Focus Is On Value

If your company is transforming into a lean enterprise

but you still rely on standard costing methods, your lean
initiatives could be in jeopardy. Standard costing focuses
on product costing and cannot support the value stream
costing that lies at the heart of lean accounting.
In fact, standard accounting methods
are actively antilean. They generate
wasteful variance reporting processes
that nourish endless hours of non-
value-added work. They foster batch
production and high inventory. They
are unable to identify lean improvements. And they provide reports that
are difficult for people to understand.

This SAP Insight explores the trans

formation from standard to lean cost
accounting via a lean profitability and

Instead of fighting against lean, the

challenge is to update your managerial
and financial accounting methods to
align with todays lean business processes. A comprehensive lean profitability and cost management solution
can overcome this challenge. It enables
value stream performance management
with lean accounting techniques that
support enterprise-wide managerial and
financial reporting for the lean enterprise.

A lean enterprise is focused

on increased value to the
customer, the elimination
of wasteful work and nonvalue-added activities, and
increased throughput to
create opportunities for
profitable growth. Because
the focus of lean is on value,
lean looks at costing from
the value stream.

This powerful tool for lean allows you to

create, maintain, and update agile and
adaptable analytical models that reflect
actual and direct value stream cost and
profitability, with little or no allocation of
overhead expenses. A lean profitability
and cost management solution provides
a holistic view of organizational performance based on the productivity and
profitability of lean value streams.

cost management solution and answers

the questions you are certain to ask
along the way, including the following:
What are the differences between
standard and lean cost accounting
methods?
What impact are my standard accounting methods having on my lean transformation efforts?

SAP Insight Value Stream Performance Management Through Lean Accounting

What challenges can we overcome

with a profitability and cost management solution?
What benefits can we expect to realize
by concentrating on the lean value
stream?

The Transformation from Standard to

Lean Cost Accounting
Enabling Change in the Lean Enterprise

Yesterdays accounting methods based

on traditional performance measurements and standard costing cannot
support efforts to transform your business into a lean enterprise. While lean
processes require relevant, easily understood information, traditional manufacturing accounting practices deliver nonrelevant financial and operational information to your managers. In addition, by
focusing on maximizing utilization and
absorbing overhead, standard costing
promotes nonlean behavior and tends
to grow inventory. Conversely, by focusing on improving throughput and cycle
time and building to actual demand, lean
behavior leads to inventory reduction
and improved cash flow.
Moreover, the information provided by
traditional costing methods, such as
variance reports, is usually delivered
several weeks after the fact and is
nonactionable, with no real cause-andeffect relationship. Lean, on the other
hand, relies on actionable information
based on cause and effect. Most significantly, lean requires accurate cost
and profitability information for betterinformed decision making. However,
product cost data provided by traditional accounting methods is often
inaccurate and can deliver misleading
information for decision support.
Furthermore, the basic assumptions,
motivations, importance, and measurements of traditional cost accounting
differ from those of lean enterprise
accounting. Standard cost accounting
assumes direct labor is a critical variable
conversion cost. On the other hand,
lean assumes it often is more of a fixed
expense, and profit comes from maxi-

mizing flow on pull signals from customers. In traditional cost accounting,

the motivation is to absorb overhead
costs by making more product, but in
lean it is to eliminate barriers to flow
and make product only to the pace of
customer demand. What matters most
in standard cost accounting are utili
zation of resources and work orders,
which serve as the primary cost collector for products. What matters most in
lean accounting, though, is the process
itself, which serves as the primary cost
collector, and the value provided to the
customer. And, most obviously, standard
costing focuses on precision and measures product costs, while lean focuses
on accuracy and measures value stream
costs.

Precision Versus Accuracy

Product cost data based on standard
cost information is used to support
executive decisions on outsourcing,
offshoring, product rationalization,
staffing, and pricing. In standard cost
accounting, false precision often
occurs in the way product costs are
represented. Since precision is a limit
to accuracy, false precision leads to
unjustified confidence in the accuracy
of the product cost. Consider the following table showing a typical example
of false precision in standard cost
accounting:
Project Cost

Amount

Direct material

$2,502.12783

Direct labor

$151.43729

Overhead

$932.67215

Product cost

$3,586.23727

In the example above, we have calcu

lated the product cost to a precision
of five decimal places, but for almost
every manufacturer, product cost is
a function of volume. The significant
overhead cost that is allocated to this
product is based on a number of estimates, quotes, budgets, and forecasted
business volumes that may have little to
do with current conditions in the period.
Direct material costs may be based on
standards set at the beginning of the

A value stream can consist

of all the value-creating and
non-value-creating actions
required to bring a product
from concept to market
launch and from order to
cash collection.
year. And direct labor is treated as a
variable expense, but for most com
panies, direct labor is more fixed than
variable.
Given the product cost calculated in
the table above, assume you normally
produce 100 products per day, but
today you produce only 90. What would
the product cost be? Did you actually
reduce your direct labor workforce by
10%, or did your employees still show
up for work today? Did your overhead
expenses change? Are not costs nearly
always a function of volume? If so, then
how much of your plants costs are
truly variable, and how much are fixed
regardless of volume? Are they truly

SAP Insight Value Stream Performance Management Through Lean Accounting

represented properly in your current

data? Your product costs may be very
precise, but are they really accurate?

Standard Versus Lean

In many respects, standard accounting
methods could not be more opposite
than they are from lean accounting
methods. For example, standard costing methods help to drive large, workintensive, non-value-added, batch-driven
processes inevitably resulting in higher
inventory levels. Lean processes are
tight, focused, streamlined, and efficient
designed to result in lower inventory.
Standard cost reporting and lean reporting are different, too, and have different
objectives. Lean reporting is intended to
identify and analyze lean improvements,
small and large, happening throughout
the organization, whereas standard
accounting reports cannot identify the
financial impact of lean improvements.
Furthermore, because standard costing
still measures key performance indicators (KPIs) like utilization and overhead
absorption, the reporting actually works
against lean processes eventually driving up inventory instead of reducing it.
Another antilean characteristic of standard cost accounting is that few people
in the organization understand the reports
that are generated. The dichotomy is
that these are the very reports used to
make important decisions. Add to this
the fact that standard accounting uses
standard product costs that are inaccurate and misleading in decisions concerning many aspects of your business,
from quoting to pricing and profitability
to sourcing and product rationalization
all decisions that impact the bottom line.

Standard

Lean

Work-order focus
Efficiency and utilization

Process focus
Availability and overall equipment
effectiveness
Cycle time and throughput
First-pass yield
Payroll expense
Actual cost
Direct cost
Value stream cost and profitability
Hourly, daily, weekly, and monthly
reports
Accurate summary-level information

Variance analysis
Quality assurance
Direct-labor tracking
Standard cost
Overhead allocations
Product cost and profitability
Month-end reports
Precision without accuracy

Lean accounting experts have written

many articles and entire books on the
differences between standard and lean
accounting methods, but the above
table quickly sums up the differences
in focus between standard and lean
cost accounting.
There are many clear-cut distinctions
between standard and lean cost
accounting; yet many manufacturing
companies that are going lean have not
addressed their performance measurement systems, opening the door to future
frustrations. By aligning your accounting systems with your lean processes,
you can properly evaluate the impact
of lean improvements, control lean processes, understand the true drivers
of profitability, and instill a new way of
thinking lean thinking.
On a global scale, lean thinking has
developed from the lean production
methods used by Toyota and has been
embraced successfully around the world.
The lean enterprise is an organization
that uses the methods of lean thinking
to transform its business into a set of

SAP Insight Value Stream Performance Management Through Lean Accounting

highly effective and profitable processes.

It constantly pursues perfection and
empowers its people to think lean. As
a matter of course, a lean enterprise is
focused on increased value to the customer, the elimination of wasteful work
and non-value-added activities, and
increased throughput to create opportunities for profitable growth. Because
the focus of lean is on value, lean looks
at costing from the value stream.

Product Versus Value Stream

Costing
Value stream costing is based on actual
costs being charged directly to the value
stream with little to no allocation. The
fundamental difference from traditional
product costing is that costs are associated to the value stream as opposed
to work orders for specific products.
A value stream can consist of all the
value-creating and non-value-creating
actions required to bring a product from
concept to market launch and from order
to cash collection. This includes actions
to process information from the customer

Direct material
purchases

Machine costs

Facility and
utility cost

Figure 1: Inputs to
Value Stream Cost1

Value Stream

Labor
expense*

Subcontract
cost

Other direct
value stream
costs

*Production, quality, shipping, maintenance,

industrial engineering, sales, purchasing, and so on

used to transform the customers product during the manufacturing process.

In value stream costing, all costs that
can be directly associated to the value
stream are assigned to the value stream
(see Figure 1). Since many lean companies organize their resources by value
stream, this often includes direct costs
for functions like material handling, indus-

trial engineering, plant maintenance, and

other groups that are typically included
in overhead costs. The idea is that costs
that are within the control of the value
stream manager are charged as direct
and actual costs to the value stream in
the period they are incurred. Costs for
shared services support for example,
costs for HR and IT are still accounted
for, but are not allocated to the value
Figure 2: The Value
Stream Profit and Loss
(P&L)

stream as they are usually not within

the span of control of the value stream
manager. The goal is to minimize or
eliminate allocation of costs to the value
stream.
While there is a strong argument that
product costs are not really needed in
a lean environment, someone in the
organization usually claims they cannot
function without them. Value stream
costing uses simple methods to arrive
at product costs that are based on
dividing the total value stream costs by
the number of units produced to arrive at
an average cost per unit for the period.
There are more complex scenarios for
arriving at a product cost in mixed-model
flow lines. In this case, the actual value
stream conversion costs may be allocated to products based on the total
product cycle time or the amount of
capacity a product consumes in a bottleneck work center, along with the products actual material costs.
Value stream profit and loss (P&L)
statements are prepared (see Figure 2)
by comparing the revenue generated for
the period to the actual value stream
costs incurred in the period. Actual value
stream costs include material purchases,
conversion costs, and other direct value
stream costs. This provides a cash flow
based view of value stream performance
that behaves differently from standard
cost-based methods. If you sell from
inventory without having to buy mate
rials and incur conversion costs, you
look highly profitable. But if you build
products to inventory, you incur additional material purchases and conversion
costs without the associated revenue,
and you appear less profitable for the

1. Based on work by BMA Inc.

SAP Insight Value Stream Performance Management Through Lean Accounting

period. The value stream and consolidated plant-level P&L statements include
a return-on-sales calculation that is
the primary measure of value stream
performance.
Also shown on the consolidated plantlevel P&L statement are support costs
and any non-revenue-generating value

A profitability and cost

management software
application such as the
BusinessObjects Profit
ability and Cost Management application is one
of the cornerstone applications in building the lean
enterprise. Such an application delivers the costing and
value stream performance
measurements that matter
to your organization.
streams, such as new-product development. These costs are accounted for
without being allocated to the value
stream. In addition, the change in inventory value from the beginning to the
end of the period is shown, as well as
any corporate overhead tax the plant
incurs, which leads to plantwide profit
and return on sales percentage.

A lean enterprise is focused on increased value to

the customer, the elimination of wasteful work and
non-value-added activities, and increased throughput
to create opportunities for profitable growth. Because
the focus of lean is on value, lean looks at costing
from the value stream.
Changing Versus Not Changing
To be relevant and support todays
technology and business complexities,
traditional financial performance measurements of companies that invest
in lean need to change. Your standard
cost variance reports do not deliver
the kind of meaningful and actionable
information you need to drive lean
processes. They actually work against
your lean efforts and promote antilean
behavior.

SAP Insight Value Stream Performance Management Through Lean Accounting

There is a better way to manage and

control processes and move away
from being measured by standard cost
variances. A profitability and cost management software application such
as the BusinessObjects Profitability
and Cost Management application
is one of the cornerstone applications
in building the lean enterprise. Such
an application delivers the costing and
value stream performance measurements that matter to your organization.

Profitability and Cost Management in

the Lean Enterprise

Enabling a Holistic View of Organizational

Performance

Without a profitability and cost management application, it is difficult and

frustrating for many companies to develop useful costing and value stream performance measurements for reporting
and decision support that are consistent
and sustainable across the enterprise.
This is true even for companies with
successful lean enterprise transformations. A comprehensive profitability
and cost management application must
support value stream performance
management in your organization with
lean accounting tools for relevant,
timely information that promotes lean
behavior.

Aligning Lean Enterprise Processes

BusinessObjects Profitability and Cost
Management enables you to control
cost and profitability, and therefore your
business. With it, you can maximize
profit through superior business information and agility. The applications
costing models surface the true drivers
of profitability in your company. It offers
intelligent optimization of all cost and
profitability drivers down to the granular level and effective and accurate
measurement of internal service cost
and value stream, product, channel,
and customer profitability. It can also
greatly reduce your IT overhead with
Web deployment.

One Application for a Lean

Transformation
The BusinessObjects Profitability and
Cost Management application combines
customer and channel profitability with
value stream performance management
using lean accounting principles in one

application. It includes a sophisticated

costing engine and built-in reporting
functionality for direct and actual value
stream costing, resource consumption
costing, and customer and product profitability, together with a predefined data
model that allows for lean accounting,
and value streamoriented reporting.
BusinessObjects Profitability and Cost
Management also provides advanced
decision support functionality with multiple concurrent scenarios. Scenarios can
be quickly created to simulate the effect
on value stream profitability from product rationalization decisions, offshoring
decisions, process improvements, and
changes in business volume.
The application can be implemented
and used at any point in a lean trans
formation even prior to your organi
zational changes. The application integrates easily with Microsoft Office and
third-party reporting and analysis tools
and is designed to work across multiple
enterprise resource planning solutions
and data sources.

Pulling the Lean Accounting

Profit Lever

stream cost and profitability. It promotes

lean behavior and enhances the efficiency of cost reporting. And it can deliver
accurate product costs based on actual
value stream costs for a given period.
Finally, transitioning from standard to
lean cost accounting really comes down
to business benefits. A profitability and
cost management application helps you
see the drivers of your business with a
lean eye including your value stream,
your customers, and your distribution
channels. It improves the alignment
of your processes by matching your
operational requirements with flawless
execution of strategy. Ultimately, a profitability and cost management application gives you incisive control over cost
and profitability with the performance
measurements that matter most in a
lean enterprise.
Learn More Today
For more information about value
stream performance management
through lean accounting and how it
can transform your lean enterprise, call
your SAP representative or visit SAP
on the Web at www.sap.com/solutions
/performancemanagement/index.epx.

Today, across the manufacturing landscape, the focus is on value and away
from standard cost accounting methods
that focus on product instead of value
stream costing. For many manufacturing
companies, the time to pull the lever on
lean accounting is now.
A comprehensive profitability and cost
management application helps you meet
the challenges of lean accounting. It
improves your visibility into true value

SAP Insight Value Stream Performance Management Through Lean Accounting

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SAP Insight Value Stream Performance Management Through Lean Accounting

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