Value stream costing

1. Value stream costing Lean reporting & control

2. Value stream costing • Traditional cost accounting is harmful to lean enterprises. • Motivates non-lean behavior and is complex & wasteful. • Value stream costing supports lean enterprises. • Motivates lean thinking, is understandable, and simple.

3. VALUE STREAMS New Product Support TOTAL Motors Systems Spare Parts Design Costs DIVISION Sales £326,240 £748,894 £453,215 £1,528,349 Additional Revenue £0 £0 £12,422 £12,422 Material Costs £111,431 £232,774 £149,561 £87,909 £12,764 £594,439 Conversion Costs £57,628 £70,406 £81,579 £203,769 £37,645 £451,027 Outside Process Costs £32,433 £22,991 £22,661 £7,531 £85,616 Other Costs £16,040 £57,816 £29,459 £72,721 £176,036 Tooling Costs £4,843 £12,544 £6,588 £23,975 Value Stream Profit £103,865 £352,363 £175,789 (£364,399) (£57,940) £209,678 ROS 31.8% 47.1% 38.8% -23.7% -4.0% 13.7% £925,314 Opening Inventory £918,807 Closing Inventory (£6,507) Inventory Change £51,147 Corporate Overhead Division Profit £152,024 Division ROS 9.9% Plant-wide income statement We need to change the -3.8% to -4.0%

4. Value Stream Labor Value Stream Materials Value Stream Machines VALUE STREAM Outside Processing Facilities & Maintenance All Other VS Costs Value stream costing Actual cost of labor, machine, materials, support services, and facilities charged directly to the value stream. Little or no allocation.

5. Calculated, as far as possible, on a “cash” basis: Revenue of Value Stream – actual value of production delivered to customers in period. Material cost – actual cost of material purchased in period. Direct production costs in period. Other costs. Only assign costs that can be managed in Value Stream – e.g. energy, space, depreciation. Can we assign support personnel to Value Stream ? Indirect costs. We do not apportion indirect overheads to the Value Stream ! Value Stream Costing

6. Sources of actual value stream costs

7. Monument costs • Support Function Monuments • Make the costs direct with very little allocation • Assign full people – names & faces – not “equivalent heads”. • If in the short term you must allocate people, include them in the value stream cost only if you plan to include a real name & face in the future. • Process Monuments • If the value stream shares a monument with another value stream – allocate it. • Use simple allocation. Do a study; don’t track it on-going.

8. Step 1 – Identify & map value streams

9. Outside Employee Facilities Value Stream Process Steps Material Costs Machine Costs Tooling Costs Other Costs Total Cost Process Costs Costs Costs Sales & Marketing £10,150 £0 £1,012 £11,162 Customer Service £1,848 £0 £1,848 Purchasing £616 £0 £616 Materials handling £1,576 £0 £1,576 Parts Fabrication £63,544 £3,322 £1,529 £2,011 £70,405 Machining £4,728 £0 £2,466 £7,194 Anodizing £32,433 £0 £0 £32,433 Assembly £47,887 £15,297 £6,584 £366 £70,134 Shipping £630 £0 £101 £731 Maintenance £1,576 £0 £1,576 Product Engineering £2,448 £0 £2,448 Quality Assurance £2,448 £0 £2,448 Cost Accounting £816 £0 £816 Managers & Supervisors £4,060 £0 £12,750 £2,177 £18,987 TOTAL £111,431 £32,433 £49,515 £8,113 £12,750 £4,843 £3,290 £222,375 Step 2 – Collect actual costs based on value stream map resources

10. Cost of the Value Stream Totals Material Costs £ 111,431 Outside Process Costs £ 32,433 Employee Costs £ 49,515 Machine Costs £ 8,113 Facilities Costs £ 12,750 Tooling Costs £ 4,843 Other Costs £ 3,290 Total Cost £ 222,375 Conversion Cost £ 110,944 Quantity Shipped to Customers 1,876 Average Material Cost £ 59.40 Average Conversion Cost £ 59.14 Average Cost per Unit £ 118.54 Profit Per Hour £ 346.22 Contribution Per Hour £ 716.03 Conversion Cost Per Hour £ 369.81 Cost Per Hour £ 741.25 Step 3: Calculate average costs for the value stream

11. Profit & Loss Report Percentage of 5-May-05 Per Unit Sales Sales £326,240 £173.90 1,876 Units Additional Revenue £0 Material Costs £111,431 £59.40 34.16% Employee Costs £49,515 £26.39 15.18% Machine Costs £8,113 £4.32 Outside Process Costs £32,433 £17.29 9.94% Other Costs £16,040 £8.55 4.92% Tooling £4,843 £2.58 1.48% Value Stream Profit £103,865 £55 31.84% ROS 31.84% 31.84% 42.00% Hurdle Rate Cash Flow £221,163 8.9 days Inventory £2,348,928 36.0 days Accounts Receivable (£624,014) -28.0 days Accounts Payable Step 4- Value stream P&L

12. REVENUES Gross Sales £32,332,000 Less Adjustments (£162,000) Net Sales £32,170,000 VARIABLE COSTS External Sales Force (7.5% of ns) £2,428,000 7.5% Material Purchases £7,853,000 24% Margin After Comm & Matrls £21,889,000 68% MANUFACTURING CONVERSION COSTS Wages-Mfg £5,778,000 Fringes-Mfg (41.4% of wages) £2,393,000 Supplies & Tooling £991,000 Depreciation-Mfg £380,000 Utilities-Mfg £247,000 Outside Services £1,072,000 Scrap & Warranty £468,000 Other Coversion Costs £426,000 Total Mfg Conversion Costs £11,755,000 37% Total Matrls & Conversion Costs £19,608,000 61% Margin Before Support Costs £10,134,000 32% SUPPORT COSTS Wages £2,142,000 Fringes (28.9% of wages) £618,000 Supplies £131,000 Travel & Entertainment £158,000 Professional Services £69,000 Outside Services £82,000 Depreciation £85,000 Rentals £118,000 Advertising & Exhibits £27,000 Employee Recruiting £28,000 Other Support Costs £402,000 Total Support Costs £3,860,000 12% OPERATING PROFITS £6,274,000 20% Real example of a “plain English” P&L format.

13. Step 5 - Plant-wide income statement VALUE STREAMS New Product Support TOTAL Motors Systems Spare Parts Design Costs DIVISION Sales £326,240 £748,894 £453,215 £1,528,349 Additional Revenue £0 £0 £12,422 £12,422 Material Costs £111,431 £232,774 £149,561 £87,909 £12,764 £594,439 Conversion Costs £57,628 £70,406 £81,579 £203,769 £37,645 £451,027 Outside Process Costs £32,433 £22,991 £22,661 £7,531 £85,616 Other Costs £16,040 £57,816 £29,459 £72,721 £176,036 Tooling Costs £4,843 £12,544 £6,588 £23,975 Value Stream Profit £103,865 £352,363 £175,789 (£364,399) (£57,940) £209,678 ROS 31.8% 47.1% 38.8% -23.7% -4.0% 13.7% £925,314 Opening Inventory £918,807 Closing Inventory (£6,507) Inventory Change £51,147 Corporate Overhead Division Profit £152,024 Division ROS 9.9%

14. VALUE STREAMS New Product Support TOTAL Motors Systems Spare Parts Design Costs DIVISION Sales £326,240 £748,894 £453,215 £1,528,349 Additional Revenue £0 £0 £12,422 £12,422 Material Costs £111,431 £232,774 £149,561 £87,909 £12,764 £594,439 Conversion Costs £57,628 £70,406 £81,579 £203,769 £37,645 £451,027 Outside Process Costs £32,433 £22,991 £22,661 £7,531 £85,616 Other Costs £16,040 £57,816 £29,459 £72,721 £176,036 Tooling Costs £4,843 £12,544 £6,588 £23,975 Value Stream Profit £103,865 £352,363 £175,789 (£364,399) (£57,940) £209,678 ROS 31.8% 47.1% 38.8% -23.7% -4.0% 13.7% £925,314 Opening Inventory £918,807 Closing Inventory (£6,507) Inventory Change £51,147 Corporate Overhead Division Profit £152,024 Division ROS 9.9% Step 6 - Calculating the hurdle rate THE VALUE STREAMS MUST MAKE A MINIMUM OF 46%

15. Example: Italian Client

16. Example: Italian Manufacturer - All Value Streams

17. What must be in place for value stream costing to be effective? • Reporting should be by value stream - not by department • Ideally everybody assigned to a single value stream with little or no overlap • Few (or no) shared services departments. Try to eliminate monuments • Production processes reasonably under control and low variability. • Thorough tracking of “out-of-control” situations and of exceptions like scrap, rework, etc. • Inventory must be under control, relatively low, and consistent Lean Thinking: Make it simple by eliminating the causes of complexity

18. Traditional Manufacturing Starting Lean Manufacturing Lean Manufacturing Lean Manufacturing Traditional Accounting Traditional Accounting Lean Accounting Lean Accounting Traditional Financial Reporting Traditional Financial Reporting Lean Financial Reporting Lean Financial Reporting Lean Supplemental Statement Traditional Financial Reporting Value stream P&L maturity path TRADITIONAL LEAN COMPANY LEAN PROGRESS STARTING LEAN

19. Value stream costing • All costs are considered direct and are posted to the value stream profit center on the General Ledger. • Very few cost/profit centers • All value stream costs are included • Productive, Non-productive, available capacity • Direct, support, administrative • No overhead costs are allocated; direct costs only. If they are in the value stream they are direct; if not they are excluded. • Average Cost used as a primary value stream performance measurement.

20. Value stream costing • Almost all costs are assigned directly to the value streams. The value stream manager has P&L responsibility for his/her value stream. • Costs not associated with the value streams are small and assigned to a business support cost center. They are budgeted and controlled. • Plant or division P&L consolidates the value streams and the business support costs.

21. What are the advantages of value stream costing? • Simple and very little work • Timely – weekly • Relevant & actionable financial information • Very few transactions • Focus attention on value stream issues, problems, & opportunities • Teamwork, ownership, accountability • Presents the “real” financial information • Everybody understands it • Does not require a CPA to do it !!

22. Karol Warnock, Value Stream Manager, Marquip Ward United Corporation • Visual Inventory Management • Transaction Elimination • Value Stream Costing