Fiume points out that nothing about lean accounting violates generally accepted accounting principles. In fact, lean accounting uses the same venerable standards of materiality, conservatism, consistency, and matching. But simplifying a complex company is tough, warns Fiume, and old accounting practices die hard. How hard?
All Hands, Brace Yourself for a Hit to the P&L
TBM’s Sharma explains that CFOs who adopt lean accounting should brace themselves — they will see lower profits, temporarily. They’ll need to put a little faith in the folks on the factory floor, and in the corporate commitment to go lean.
Alan Dunn, a self-described “factory rat” for 25 years and now the president of GDI Consulting and Training Co., explains how it goes down: When a company trims inventory to prepare for the transformation to JIT manufacturing, factory overhead isn’t reduced at the same pace. It takes more time to shrink overhead costs, such as warehouse space, utility fees, and salaries. The mismatch causes overhead costs to spread across lower production volumes; in a standard cost accounting environment, this creates a temporary negative variance. Only as the company moves through the lean transition does the accounting system catches up to the new, JIT manufacturing system.
The standard accounting system hides the cost of carrying inventory, says Sharma, and management has to be patient with JIT-style improvements as they ripple through the organization. Getting lean is a long-term goal, adds Sharma, and it’s not for the fainthearted.
CFOs from some public companies, however, know first-hand that patience is not always considered a virtue by Wall Street or by shareholders. When dealing with these constituents, it’s difficult to defend the lean transition — and those negative variances — according to one CFO of a midsize company who asked not to be identified. “Wall Street is less long-term-oriented than they like to tell you,” says the finance chief.
Despite reduced inventory and increased cash flow over a year’s time, claims the CFO, the temporary negative variances contributed to a 10-point slide in the company’s share price. While the stock has recovered and management’s lean strategy has proved successful, the finance chief cautions that “Wall Street and institutional investors are not forgiving or patient.”
Other public-company CFOs, who note similar reactions, contend even that preparing stakeholders for bad news doesn’t necessarily reassure them. One finance chief (who also asked not to be identified) categorized the negative variances as a one-time event, estimated that margins would be depressed for two quarters, and encouraged analysts and investors to consider the annual gains — which, again, included lower inventory levels and improved cash flow. Some institutional investors disdained the waiting game and sold the stock, while Wall Street frowned on the quarterly setbacks and punished the share price — albeit temporarily.
Internal support for lean ideas seems more likely. One company’s executive team gave up their raises and bonuses during the first year of implementation — in the short term, they realized, there would be less cash to go around — and board members gave the green light, agreeing that the transition “was the right move for the company.”