Business exists to pay profits to its owners. Logically then, financial measurements are important in understanding where a business stands with respect to its own viability. Profit is the most important measure for any business. When the current costing methods were developed in the 19th century the price was set by the producer, so the equation, profit = price – cost, was appropriate. In the modern 21st century economy, the price is set by the market, therefore, the more relevant equation has become, price = cost + profit. Labor content was also considerably higher in those early years than it is now with our ever-increasing levels of automation. These and other paradigm shifts have made standard costing an outdated relic. Modern value stream costing, however, stands as an applicable approach for the costing of the goods or services that a system delivers.
Standard costing made labor content the relevant factor in measuring profitability, whereas, value stream costing focuses more on the time used to add value and lost to unproductive activity. Since value stream costing is designed to account for time, time based performance measures should be used to drive profitability.
Some of the drawbacks to standard costing are: (1) indirect activity costs are allocated by machine hours and direct labor hours, (2) overhead costs are organized by departments, (3) overhead rates are aggregated, and (4) standard costing is not responsive to dynamic changes in the manufacturing environment. Even modern software systems like ERP, based on standard costing and materials resource planning, provide less than desired results due to an excess of wasted transactions tracking individual operations designed for large batch production and their resulting accumulated inventories which in turn drive delays in matching revenues and related expenses for the associated long conversion cycles. ERP’s historical reliance on internal accounting controls (non-value added activity) for accuracy, therefore, runs counter to improvement.
If, per chance, your organization has adopted activity based costing (ABC), it is – at least – a step in the right direction. ABC’s weakness, however, is its focus on the activities within departments or parts of a system, not the congruous end to end continuum that value stream costing provides. Alternately, if your organization has adopted throughput accounting, you’re way ahead of the game since throughput accounting uses the same tenets of value stream costing and expands it to all value streams simultaneously.
Once value stream costing has been embraced by an organization, the consistency between applicable performance measures and costing methods can be leveraged to drive profitability.
The performance measures that drive value must start at the top with the organization’s value proposition and the associated key performance indicators (kpi) that result. From there, the kpi’s can drive value stream objectives, value stream critical success factors, and eventually value stream measures. The value stream objectives are also useful in driving cell objectives, cell critical success factors, and cell measures.
This article is only the tip of the iceberg. Value stream costing lends itself wonderfully to feature and characteristic costing as well as target costing with its associated value engineering and continuous improvement activities.
All in all, the benefits of Lean accounting and value stream costing far outweigh the headlong rush many manufacturers are making into codifying their archaic costing methods with ultra expensive software systems. Be Aware!
About the contributor: Conrad Soltero has 20 plus years of industrial extension experience through his association with TMAC. He is a NIST certified Lean instructor, Six Sigma and IEMS Black Belt and an authority on quality management systems. He is one of only a handful of TWI Institute Certified Instructors in all 5 TWI courses globally. He authored the book, The 7 Kata: Toyota Kata, TWI and Lean Training in 2012 which subsequently was awarded the 2013 Shingo Prize for Professional and Technical publications.