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My guest for Episode #492 of the Lean Blog Interviews Podcast is Nick Katko, previously here in Episode 428 in 2021 with his co-author Mike DeLuca talking about their book Practicing Lean Accounting.
Today, Nick is here to discuss his book, The Lean CFO: Architect of the Lean Management Accounting System — now in its second edition — released back in February.
Nick also did a webinar earlier this year as part of the KaiNexus Continuous Improvement webinar series.
For over 20 years, Nick has worked at BMA, assisting clients in Lean management implementation by working closely with them to resolve the real-world issues they face.
He holds a BS in accounting and an MBA in finance, both from the University of Kentucky, and is a certified public accountant.
Questions, Notes, and Highlights:
- What makes a CFO a “Lean CFO”? Are there “degrees of Lean CFO”??
- Are there some wrong things to measure? Things we should start measuring?
- Viewing inventory as an asset? How does inventory reduction trip us up potentially?
- What is “lean management accounting”??
- Robbing Peter to pay Paul – ending that via Lean causes a problem then? Is there a way to ease your way out of that?
- Reducing inventory is an outcome of better processes?
- Is it better for Lean to be part of a growth strategy?
- Chapter 3 – “Lean is the strategy” — are you hearing that more often? Are they walking the talk?? How common is this?
- “Knowing what's possible” when you have experience with Lean – and the emotions people feel, regret?
- The virtuous cycle of using CI to drive CAPACITY (instead of cost reduction)?
- The Lean CFO: Architect of the Lean Management Accounting System — What's different in the 2nd edition?
- Tell us about your new BMA Lean Accounting Certification Program…
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Episode Summary
Lean CFO: Key Player in Lean Management Accounting
Lean CFOs are key players in architecting Lean Management Accounting Systems and driving lean strategies in organizations. The role of the CFO is transforming, with an increased emphasis on continuous improvement and cultural alignment within the strategic goals of the organization.
The Role of a Lean CFO
The Lean CFO's approach to financial management goes beyond traditional accounting practices and cultivates an environment that encourages innovation, continuous improvement, and efficient resource allocation. They actively participate in strategic decisions, collaborating closely with other functional areas to resolve real-world operational issues.
Their responsibility reaches far beyond crunching numbers. It involves connecting lean to financial success, identifying and interpreting the relevance of various financial measures, and communicating this understanding throughout the organization. Essentially, they are tasked with driving the organization's lean transformation, contributing significantly to its overall financial success.
Moreover, Lean CFOs need to demonstrate a comprehensive understanding of lean as a business strategy rather than merely a financial strategy.
Key Lean CFO Responsibilities
–Metrics and Measures: A Lean CFO recognizes that a company's financial measures should align with lean objectives for streamlined processes and enhanced productivity. They steer away from traditional measures that can mislead and have a deep understanding of the kind of measurements that reflect true lean performance.
–Educating Stakeholders: As part of their strategic role, Lean CFOs educate stakeholders, from internal teams to external entities like investors and regulators, on the impacts of lean strategies on financial performance. Therefore, they need to articulate these lean strategies effectively, ensuring alignment and support across all levels of the organization.
–Sales Growth and Inventory Management: Lean CFOs prioritize a growth strategy that minimally impacts inventory. Instead of focusing on reducing the value of inventory sitting on the balance sheet, they concentrate on the flow of materials and days of inventory in relation to growing sales.
–Lean Strategies: Lean CFOs are essential to developing lean strategies. They understand that lean should be viewed as a cornerstone of the overarching business strategy rather than a one-off change initiative. An integrated, organization-wide lean approach should be the primary focus for value-added activities, serving the ultimate goal of improving customer delivery.
–Relational Management: Building good relationships with key stakeholders, including suppliers, is a key part of Lean CFOs' responsibility. The aim here is to establish mutually beneficial relationships that encourage collaboration, improve resource allocation and ultimately reduce costs.
Undoubtedly, Lean CFOs extend their influence beyond the finance department. Their role requires them to channel their lean expertise and commitment into decision-making processes, encouraging a lean culture across the organization. And while Lean CFOs navigate their way through these complex responsibilities, they adhere steadfastly to one core principle: serve customers better.
Deepening the Understanding of Lean Accounting
The central tenet of lean accounting is treating waste elimination not as a means to cut back costs but to free up time, or “capacity”, which can be redirected towards processes that create value. This transformational shift calls for a development of a fresh lens for financial personnel–a move away from a cost-reduction perspective towards an in-depth understanding of capacity.
The Intersection of Lean Accounting and Skepticism
Lean improvements tend not to show immediate financial results, which can make stakeholders skeptical about the process. This may be particularly true for accountants, who are often trained to maintain a “healthy skepticism”. A pivotal part of the Lean CFO's role is addressing this skepticism and illustrating the potential benefits of Lean. Notably, Lean results in high-value improvements that may not register in straightforward financial terms, such as heightened patient satisfaction in healthcare.
Transforming Accounting Processes through Lean
Lean practices can drastically improve efficiency even in traditional business sectors such as accounting. When Lean processes are implemented within an accounting team, the aim is not solely to enhance productivity but perhaps more importantly, to make the team's work easier. This reshaping of work processes can often eliminate unnecessary tasks, thereby freeing up more time for the team.
Interestingly, if an accounting team understands that Lean can make their work more manageable and give them more time, they tend to be more receptive to Lean transformation. Lean CFOs play a fundamental role in fostering this understanding and orchestrating the transformation.
Lean Accounting: Focusing on Capacity
In lean accounting, “capacity” means the available time that can be dedicated towards delivering value. By eliminating wasteful activities that consume time, Lean practices create more capacity. However, the lion's share of Lean's success depends on how the reclaimed capacity is utilized. Rather than engaging in overproduction, a Lean CFO uses this newfound capacity to maximize value-added activities.
The Lean Accounting Virtuous Cycle
If a Lean initiative can reduce the time taken for activities, such as changeover times on a machine, it accumulates spare capacity. This extra time can be used to meet additional demand, thereby enhancing revenue and contributing margin. It's crucial to note that the goal here isn't to lower costs, but to create more value. Lean accounting aids stakeholders in distinguishing between capacity and cost, helping them grasp that while labor cost gets you a fixed amount of capacity (or time), it's how you allocate that time that determines value production.
Transforming Management Accounting with Lean Accounting Principles
To support a lean transformation, management accountants need to develop a competency in Lean principles, practices, and tools. A structured roadmap can guide teams on how to apply these learnings to transform their management accounting systems. Similarly, certifications and training programs, like the Lean Accounting certification program from BMA, can offer valuable education and resources.
While Lean CFOs form the vanguard in this transformation, extending their influence beyond the finance department, the cooperation and support of the entire organization are required. This highlights how Lean principles foster an inclusive and engaged cultural environment, nurturing collective commitment to serve customers better.
Automated Transcript (Not Guaranteed to be Defect Free)
Mark Graban: Welcome back to Lean Blog interviews. I'm Mark Graban. Our guest today is Nick Katko. He was previously here as a guest in episode 428 back in 2021 with his co author Mike DeLuca, talking about their book, Practicing Lean Accounting. So I encourage you to go find that episode, episode 428.
Mark Graban: But today Nick is here to discuss his book, the second edition of it, the Lean CFO, architect of the Lean Management Accounting System that was released back in February of this year, 2023. I also want to thank Nick, and I'll point people to it. He did a webinar back in January around some of these topics of continuous improvement. And the bottom line, it was part of the Kinexis Continuous Improvement webinar series. It was excellent.
Mark Graban: There's a link to that in the show notes. But for over 20 years, Nick has worked at BMA, assisting clients in lean management implementation, working closely with them to resolve the real world issues they face. Nick holds a BS in Accounting and an MBA in Finance, both from the University of Kentucky. He's a certified public accountant. So, Nick, thank you for coming back on the podcast.
Nick Katko: How are you? Thanks, Mark. Glad to be here.
Mark Graban: Down in Lexington, Kentucky, that's sort of Toyota country. That's pretty close to Georgetown and the plant.
Nick Katko: It's been, there's been a lot of lean activity here since Toyota moved in.
Mark Graban: Yeah, you probably have gotten to know a number of the Toyota folks, or at this point, maybe even former Toyota.
Nick Katko: Oh, yeah, there's lots of former Toyotas, lots of lean consultants in this town.
Mark Graban: So let's talk about the book, Nick. Finance and Accounting. And boy, I have an MBA, but I always say I am the worst finance or accounting MBA graduate. That wasn't my thing. I was able to do courses in operations and supply chain.
Mark Graban: So it'd be a good opportunity to learn from you today, Nick, talking about the role of a CFO, of a chief financial officer, what makes them to the title of your book? What would make them a quote unquote Lean CFO? Are there degrees of leanness in that position? IT's probably not just yes.
Nick Katko: No. Yeah, I think one aspect of being a lean CFO is having an awareness of lean as a business strategy, as a way to operate, not necessarily becoming a lean expert, but the awareness of what it is, as opposed to, well, that's something manufacturing does. And then from there, after you develop that awareness, how can you support the transformation? That's really what it's about. And if you're the CFO or in a smaller company, you might be the controller, you're the senior financial person.
Nick Katko: You need to know what's going on in the company and not be oblivious to things. And I think the other part is connecting lean to financial success. What can this do for us? And that's where the numbers really come into play. What numbers are you looking at?
Nick Katko: What numbers are you using?
Mark Graban: So, to that point, and you covered a lot of this in the webinar, which again, I'll point people to. Some of it will probably come out again in the discussion here. When you talk about the measures, any company has a lot of measures, financial measures, of course, whether they're doing anything with lean or not. But for a lean CFO or people under that CFO, are there things we're measuring that are misleading, things that we should start measuring that we hadn't had visibility to?
Nick Katko: Yeah, I think that's one of the keys, is to understand what you just said. If you boil lean thinking down to its simplest terms, you want to serve customers better. How are you going to measure that in general, on time delivery, lead times, quality, if you want to. The other pieces, like if you look internally, you want to improve your productivity, how are you going to measure that? And then you have things like respect for people, safety, morale, things like.
Nick Katko: So it's taking a good look at what some companies call them KPIs, some companies call them metrics. It really doesn't matter what you call it, but how many of your current measures are true lean performance measurements? Then you have to do what you mentioned is you have to take the look at what are we measuring that maybe we need to stop measuring because it's going to give us the wrong information. There's plenty of traditional type measurements that can tell you lean is not working, especially if they're cost based. And this idea that everything drives cost reduction.
Nick Katko: Now, lean will reduce costs over time, but it's how right. It's sort of like that. Trying to fit a square peg in a round hole. The round hole are our existing measures. The square peg is lean thinking and we're going to force it in a way, and it usually doesn't work.
Nick Katko: Creates a lot of conflict between accounting, finance and operations.
Mark Graban: One of those traps is around inventory. It seems right, because inventory on the balance sheet. Okay, I've picked up a little bit in my MBA and accounting classes, but the balance sheet inventory is part of assets. And as we go and improve processes and improve flow and reduce work and process inventory, maybe we're actually able to reduce finished goods inventory without having a negative impact on the customer. Walk us through that conflict, that pickle of like, oh, we've reduced inventory, we've reduced assets, kind of trip things up, maybe even in the short term.
Nick Katko: Well, a lot of that has to do with if you have a line of credit at a bank and it's secured by your current assets. I guess if you reduce inventories, but you're not just writing inventories off, what you're doing is you're going to sell that inventory and turn it into cash. So on the balance sheet, it just moves from one current asset to the other current asset. But it's the getting there that's the hard part. You start with high finished goods inventory and Lean is going to basically say, we're not going to produce unless we have to.
Nick Katko: This gets into the standard costing world of absorption accounting, which means if we don't produce as much, then our absorption goes down and that has an apparent negative impact on profitability. And that starts freaking people out, basically. But it's easy to predict. You can model that. You can say, here's what's going to happen over time.
Nick Katko: What I always tell people that think like that is when you were building inventory and absorbing all that overhead, nobody complained, and now you're correcting it. But once you reach that equilibrium, then everything gets back to normal. So it's being aware of that. And as a CFO or controller, making sure that the people who may not understand that, you're basically coaching them and educating them on, here's what's going to happen.
Mark Graban: And are those people, let's say, if it's a public company, educating Wall street, educating owners. If it's a private equity owned company, I would be gentle about saying, I'm sure you don't understand.
Nick Katko: Yeah, gosh, those earning calls and such that the public companies do, I think there's probably a way to say it without actually, we're going to reduce inventories over time. And I think it's probably a lot of wordsmithing that's needed, but it's important for the senior leaders of the company to understand that again. But if you're talking about a large public company, that's a big turn. Turning a ship, that's going to take time in terms of reducing inventory as opposed to a smaller company that maybe just has one owner. Yeah.
Mark Graban: And back to this idea of, let's say, pre lean boy. We're running the machines. Just because you're supposed to run the machines, you're cranking out parts or product back in that old mass production mindset. But then like you said, there's this remembering a little bit of my overhead allocation and we talk about absorption accounting. If I made 1000 parts and let's say that was customer demand and I'm allocating this overhead, kind of fixed overhead across 1000 parts, if I can make 2000 parts, the allocated cost per part is now half of what it was, which that seems good, but it seems like that's partly the difference between, tell me if I have this right, like internal management accounting versus the financial accounting of what actually gets reported on different financial statements or financial reports.
Mark Graban: But that internal management accounting does that rarely get reported or doesn't have to be.
Nick Katko: Well, here's what a standard costing system does, is it values inventory for financial reporting purposes, okay? And in the manufacturing process you start with raw materials and you end up with finished goods. And when you report completed production, it takes the cost of the raw material and then the labor and overhead and it costs the product as finished goods and that is what the absorption is. Okay. Now then when you sell that product, it all goes into cost of goods sold.
Nick Katko: It's an automated system that values inventory. Does it do a good job? Yes, but it's the level of detail of what are the overhead rates, what are the labor rates. And so every time you produce a product and put it in finished goods, you absorb labor and overhead, which means you reduce your expenses and increase your profits. And if you're producing more than you're selling and that's how the profits get reported.
Nick Katko: But then if it flips, it's the opposite. Yeah, and so there's the financial reporting piece and then there's the internal piece. And the internal piece is measuring performance in operations on things like overhead absorption and variances, which is terrible because it leads to what you just said, the more I produce, the better I'm going to look.
Mark Graban: And that could be suboptimizing within a company if you've got production manager, plant manager, some part of the company being measured on things like that, maybe not aligned with what the company needs as a whole, right?
Nick Katko: Yes, and this is especially true, and I experienced this many years ago at month end where oh, we're not getting the sales we need and we don't think we're going to hit our profit goal for the month. So we got some end of October, we got some orders for November, let's produce them now in October, absorb that overhead, we'll increase the profits. We can't increase sales. And then when it's time to ship the orders in November, we'll ship them and it's a game. And you can make profits look better by just producing and then the next month you just sell it.
Mark Graban: And is that part of the dynamic of accrual accounting versus cash accounting or is it not even a matter of.
Nick Katko: No, that's not about accrual accounting. This is just the way that a costing system values finished goods. It has to attach labor and overhead cost to that finished goods and it does it through this very complicated system that many people don't understand. That's the key.
Mark Graban: Yeah, I don't pretend to understand, but it sounds counterintuitive, if not just ridiculous, that you crank up more production. You can't recognize the revenue yet because you haven't sold it, you haven't shipped it, and that makes profit seem higher. Well, doesn't that then catch up with you in the next month unless you continue the game of pulling ahead?
Nick Katko: Yeah, because I'm using October and November. I take November orders, I produce them in October. Now unless I get more orders in November, it can be the opposite where I'm selling more than I'm producing. And then over two months it sort of evens out. But then that spurs people, well, let's just produce some more in November to hit.
Nick Katko: So like I said, I experienced this in my early career as a CFO and it really caused a whole lot of problems financially and really even within the management team. And at one level I was bound and determined to how do we end this? There is not one value added conversation around that. It's all waste.
Mark Graban: That strategy of robbing Peter to pay Paul. If someone comes in now as a lean CEO or lean executives, or we're going down this lean transformation and they say, okay, we got to put a stop to that. We're going to put a stop to the pull ahead and all the extra effort involved in not letting things kind of occur organically or naturally. Does that cause a problem or is there a way of managing that to kind of bring it in for a soft landing, if you will? Do you need to kind of ease your way out of it to not cause a problem in the financial statements?
Nick Katko: Well, the short answer is if you want to sort of reduce inventories over time, if you can keep selling more, rather then that sort of helps mitigate the financial impact as opposed to just we're going to sell out of finished. I'm being very extreme here. We're going to sell finished goods but not produce. It's really about the rising sales because again, that's something I experienced where we were at like four inventory turns. And within the space of about three years, we got up to like 24 inventory turns.
Nick Katko: And finished goods was basically what was on the dock going out the next day. But our sales grew because we were serving customers better. We had shorter lead times, higher on time delivery. And so that reduction in inventory didn't really impact the financial statements. And I think that's the real key.
Nick Katko: If you commit to a lean transformation, reducing inventories is more of an outcome of better management. Right. You ultimately are trying to create more value for your customers and serve them better. So you got to focus on the top line. If you come in just looking at Lean as well, we're going to reduce inventories.
Nick Katko: It could lead to bad habits.
Mark Graban: I've seen companies fall into a trap. This is going back to the early two thousand s of they thought lean was get rid of your inventory, and they didn't have the processes to support it. So it was kind of a form of, let's say cost cutting is a primary lever instead of as you talk about. And I think this is good lean thinking, cost reduction being an outcome, an end result of these other things. And they slashed their inventory, and then they were having trouble meeting commitments to customers.
Mark Graban: Yes, because the whole flow didn't support that. And there was a Japanese lean consultant that was on site with me in conjunction with something else I was doing through a software company back at the time. And he was pretty blunt. I never forget this. I can kind of picture it was a large capital equipment manufacturer.
Mark Graban: And that consultant told them very directly, job one is to meet customer demand. Job Two is low inventoRy. And they had violated that, and they were trying to recover from that mistake, if you will.
Nick Katko: Yeah. And when people say, reduce inventory or lien reduces inventory, it's not necessarily the value on the balance sheet. It's really the flow of materials. It's about inventory turns or inventory days. That's the measurement.
Nick Katko: You want fewer days of inventory. But if your sales are growing, that value might have to go up. But it's okay if it's going up and your days are higher or lower. I'm sorry.
Mark Graban: Right, relative to sales.
Nick Katko: Yeah, because I even had a discussion with a person in a company who was in charge of operations but really didn't have experience, and I was trying to explain their inventory issues to them, and that person was interpreting what I was saying as just get rid of it. And I was saying, no, measure the days. So again, it's something that a CFO can explain to people. What does this mean in terms of inventory reduction. Right.
Mark Graban: In looking at that kind of in context of other measures, one thing I hear you saying loud and clear is it's better if Lien is part of a growth strategy as opposed to being in a shrinking, declining business.
Nick Katko: Because the.
Mark Graban: Impact in those financial statements or the ability to not have some of these measures and outcomes look so bad because we're growing out.
Nick Katko: And a real key, especially in a manufacturing company, is to get the new numbers in place in terms of performance measures and how you look at the financials internally, get that information in place and incorporate it into analysis and decision making. Then deal with the costing issues, because people need to see, you have to demonstrate how the numbers of lean accounting are superior than what you're using today.
Mark Graban: And one other thing that comes to mind when we talk about the value of inventory in dollars terms. When I was working for Dell Computer, Gosh, almost 25 years ago, late ninety s one of the challenges there, and I think part of why Dell designed its supply chain and operations the way they did with this build to order strategy, was the rapidly declining value of parts. Just because of just the rapid change. New processors come out as newer, bigger, faster hard drives coming out. If you're in a situation where the inventory you're holding is really declining in real market value, does anybody, I can't imagine people go and mark to market, if you will, or actually restate.
Mark Graban: Okay, we had $10 million worth of parts and now they're really only worth two in terms of what they can contribute to revenue. What are some of the things to look out for in a situation like that?
Nick Katko: Well, from the financial viewpoint, that's where, again, I'm going to get into financial accounting. That's where you have a reserve for obsolescence. You're booking every month a reserve. You're basically charging the income statement and amount every month. And you're building this reserve such that if you have to write inventory off, you've expensed it over time.
Nick Katko: But again, that's just the financial accounting exercise. I think from an operational standpoint, it's the CFO or the controller working with operations about to understand how can we basically have less of this inventory? How can we have a lean supply chain and buy what we need so we don't get into this obsolescence.
Mark Graban: And part of the Dell strategy, it wasn't even so much a lean supply chain. They would basically force suppliers to hold the finished goods. Dell, at their whim, at their convenience, could pull to order from the supplier. And then if Dell stopped mean at some point that ends up impacting your suppliers. And it seems like some of that cost in different ways is going to come back eventually.
Mark Graban: But Dell, in my experience, there was very, in a lot of ways, very short term driven. Make the quarterly number. I don't like to characterize them as a quote unquote lean, meaning like a TPS type company. It was almost just its own strategy that arguably was working well for its circumstances back at that time. And it's a very different company.
Mark Graban: Even ten years later, it became a very different company with very different circumstances.
Nick Katko: Yeah, I think you mentioned something interesting about making the suppliers hold the inventory. And what's really important is to have good relationships with your suppliers and how can you partner with them to both of you, have a mutually beneficial relationship and not beat up your suppliers. I just find it very interesting how I'm the company and I'm beating up my suppliers, but would I do that to my customers? No, you want the good relationship with the customers, but it's sort of like looking in the mirror. Yeah, it's the same relationship.
Nick Katko: You're just playing, you're on different mean.
Mark Graban: There's power mean. I'm thinking back to times at like the only two suppliers I think that Dell did not have a lot of leverage over were intel and Microsoft because of their market positions. And at the time Dell was only buying processors from Intel. Now the only leverage Dell had was maybe we'll start buying from AMD. That was about the only balancing force.
Mark Graban: But I remember some of the dynamics where basically intel would say, here's what you're getting from us in terms of different chips, different processor speeds. Dell did not have the opportunity to pull the order based on actual demand. Intel was basically saying, here's what you're getting. And Dell would probably say, okay, thank you, we'll figure out how to sell. See?
Mark Graban: But Dell had figured out, given those circumstances, a good strategy for the moment of how to deal with that. Now with pricing, saying like, oh, I know you want the slower processor because it's cheaper, but we'll give you a deal on the one that's faster. I mean, trying to make something win, win out of it. Kind of an interesting situation. I don't know if they had a lean CFO, but they had a strategy and it was kind of an integrated strategy.
Mark Graban: So kind of coming back to the idea of a lean CFO. Chapter three in the book is about Lean is the strategy. How often are you seeing companies with that integrated view of Lean not just being this little operations thing that's dElegated. But Lean being the strategy for the CEO, the CFO becoming more common.
Nick Katko: I would say about 50 50 in the companies I work with.
Mark Graban: That's higher than I might have guessed.
Nick Katko: Yeah, but even if people say it's the strategy, are they walking the talk? They might say it, but are they doing it? And there's a lot of companies that are like that. I'm just going through some of the companies that I've worked with over the years in my head, and it's easy to see the ones that really believe. They might not say it's their strategy, but it's almost like it's a cornerstone of their strategy.
Nick Katko: Right. I noticed that those companies are very structured and disciplined in terms of their lean system. They have a senior leader or someone close to senior leadership who basically is like, the global director of Lean. And they have very systematic ways of how they deploy various tools and practices rather than sort of like every person for themselves.
Mark Graban: And, I mean, I think one, when you talk about being the strategy versus being a cornerstone, is this a program or is it a commitment? I mean, one CEO who's made very public comments about this, including at the 2022 AME conference, I forget. Were you there last year in Dallas?
Nick Katko: No, I didn't go. Okay.
Mark Graban: But Larry Culp, who's been CEO of GE now for five years, was talking about how I'm paraphrasing him. I think pretty closely that he can't help it. Lean is the way he manages, and I think that's becoming more and more embedded. It seems to flow downhill. That's the way he's managing.
Mark Graban: That's the way he wants leaders under him to be managing. That seems to be, at least to me, one of the higher profile cases of a CEO. If he's not using the words Lean is the strategy. Lean is a core. It's not something they're doing well.
Mark Graban: I mean, it's more of how they are, how they're acting and behaving every day.
Nick Katko: Yeah, I agree with that. And I think that's really the same for what a lean CFO is. It's the way you are. It's not like you talk lean or use tools and practices at your convenience or when you think it's most beneficial. It's just the way you are.
Nick Katko: That's one thing I learned in my first CFO job. When we really went on a lean transformation, we, as a management team, we were all on the same page with that. We didn't argue about it. We understood what it was what it meant to the company and where it could take us. And I think that's really the key.
Nick Katko: There's an aspect of lean now. If you have experience with it, it's easy because it's knowing what's possible.
Mark Graban: Right.
Nick Katko: And I think that's what's hard for people who are inexperienced with Lean is they can't picture it. Right. The company I was at, we were solid. We were profitable. Sales grew 5% to 7% a year, and we were happy with that.
Nick Katko: It was a 75 year old company at the time, but then all of a sudden, we have better on time delivery, shorter lead times, less inventory. Sales are growing at 20% a year, and, and profitability is beyond the expectations that we had three to five years before that. And this is the ability of a financial person to be able to model that in a very simple way. Here's what can happen. You don't have to get into a whole lot of detail, but if sales go up 20% a year instead of 5% a year, if your costs stay at like 5% a year, what does that look like in five years financially?
Nick Katko: Right. That's what Lean can do. Yeah.
Mark Graban: And you raise a point that really resonates with me about this. Knowing what's possible, like, when somebody's brand new to lean, I'm going to convert it into more operational turnarounds or operational improvements, including in healthcare. I can understand a healthy skepticism of someone saying, well, I haven't been through this before, and let's say early in my lean healthcare experience, a lot of that work was in hospital laboratories. And you could go in with a quick assessment and pretty much guarantee we can rearrange some machines, we can improve the layout, we can improve some processes, we can reduce batching, and we can reduce your turnaround time 70% and improve your productivity and quality is going to go up. And people's eyes get wide because part of them says, yeah, I would love to have that improvement, but then, look, we're all human.
Mark Graban: And then the part kicks in of like, oh, God, that's going to somehow make me look bad that I didn't do that before. And trying to kind of coach and manage people through, not only trust us and we can show you, or we can go visit and we can go talk to people, this is very doable. But then trying to coach people through, okay, he's just had been done. Please don't feel bad that you didn't do it before. And hopefully their leaders are more happy about, hey, okay, great.
Mark Graban: Let's celebrate the improvement instead of fretting over why we didn't do it before. I mean, have you run across kind of that similar human dynamic of the emotion?
Nick Katko: Yeah. That whole idea of, why didn't you deal with this before? Well, first, that's a regret. A lot of times, though, what I always do is I always stress it's the process, not the people. The people are just put in, and they probably know what's wrong, but they don't necessarily have the guidance on how to solve the problem.
Nick Katko: Sure. And that's what lean does, is it gives you the guidance to solve the problems and make the improvements. When you were talking about that, it raised another point in my head about accountants, especially if you get an accounting degree. One thing you learn in the accounting profession, and this is mainly based on getting your accounting degree and working for a CPA firm first or career, there's something called healthy skepticism. If you want to be a good auditor, you have to have that healthy skepticism.
Nick Katko: Right. If you work in public accounting and then go into company, you usually maintain that healthy skepticism. So this is where it sort of gets in the way of understanding lean, and it's sort of like, oh, okay, yeah, I get it, but I want to see it. I want to see the financial results, then I'll believe it. And it takes time to see the financial results to prove it until people.
Mark Graban: Come around to believing. Right. Some small steps and some progRess.
Nick Katko: Right. And especially if you're in healthcare, that's a different financial model. And what are we getting out of it? Are you going to see your costs go down 20%? Well, probably not.
Nick Katko: It doesn't work that way. But you have better patient experience. Right. And that goes a long way. And this is where financial people sometimes will say, okay, well, here's cost reduction.
Nick Katko: You have to show me cost reduction with any improvement that you're doing. Yeah. And then the people doing continuous improvement, their heads explode over that.
Mark Graban: And what I've seen, especially in healthcare, that doesn't engage any of the frontline staff, not in the least. When you can point them toward making your work easier, improving the patient experience, improving safety and quality, that'll engage people. Now, you might have to convince them, like, they might have their skepticism of, well, people have convinced themselves certain problems are unsolvable, which is one coping mechanism of all these infections or these falls or, it's sad, but, boy, if it was solvable, we would have solved it already. Well, again, so there's the emotion of kind of feeling bad about these things.
Nick Katko: Yeah. And it's the same way I've noticed in any other service business, even like in the accounting function. Well, we just deal with these problems and we get good at dealing with the problems, but we don't really take a step back to figure out how to solve them. If I'm working specifically with an accounting team, in terms of improving accounting processes, one of the things I don't really say, but stress in terms of the work, in terms of the improvements, is this is going to eliminate some work for you and give you more time. And once you make it personal to them, then they start really thinking about it.
Nick Katko: Yeah.
Mark Graban: One of the things you went through in the webinar that you did back in January was kind of an illustration of a virtuous cycle, if you will, using continuous improvement to drive capacity, to increase capacity instead of reducing costs. And it seems like this would apply many ways in healthcare.
Nick Katko: Yes, as well.
Mark Graban: But maybe even just generally, or even if you want to talk through it in terms of manufacturing, can you kind of talk through that cycle a little bit and why that is kind of core, it seems to. Lean accounting.
Nick Katko: Yeah, capacity. In lean accounting, we use the word capacity, but what we're really talking about is time. And so the basic, through continuous improvement, if you eliminate any waste because wasteful activities consume time, you create capacity or time. Yeah. And then it's a matter of what do you do with that time.
Mark Graban: Let's not overproduce.
Nick Katko: Yeah, we're not going to overproduce, but there's lots of opportunities. And so in the webinar and other training and working with companies, time does not show up in the financial statements, doesn't show up anywhere. And that's one of the measures that we talk about in lean accounting is to start measuring capacity and measuring how much time are you creating. Because, for example, if you're doing a continuous improvement event, reducing change over time on a machine, you're going to create more time, more availability of that machine. That's all you're doing.
Nick Katko: What are you going to do with that time? You're not going to reduce costs, but if you have demand and you can produce and sell more, you're going to generate revenue and contribution margin. And so it's really teaching people, lean accounting is teaching people about understanding capacity and not confusing capacity with costs. Yeah. They're two different animals.
Nick Katko: The only relationship, like labor. You hire me for your company, I'm giving you 40 hours a week of capacity. What do you want me to do, right? You want me to create value or am I going to be spending time on non value added activities? Right.
Nick Katko: And that's true whether you're in a manufacturing operation or in healthcare or in an office setting. A friend of mine when I was trying, he's not a lean person, and I was trying to explain capacity, and she basically said, oh, you just need to know what yOu're spending your time on.
Mark Graban: It's just that simple and not confusing activity with value.
Nick Katko: Right.
Mark Graban: Effort and outcomes.
Nick Katko: Yeah. In fact, I was working with a company last week and I have dinner with the owner. He started the company almost 50 years ago. I think he's 81 years old. He's still active in the business.
Nick Katko: And we're having dinner, and he started talking about, everybody talks about capacity. And then I explained it to him similar to way I just explained it here, and he was like, oh, okay, I get it now. He goes, they got to stop doing this stuff. I said, yeah.
Mark Graban: Well, again, we've been joined today by Nick Katko, the books in the second edition now, the Lean CFO, architect of the Lean Management Accounting System. What's different in the second edition of.
Nick Katko: The Know I, when I was writing practicing lean accounting with Mike DeLuca, I looked back on the first edition and then I realized, number one, the way I teach and coach Lean management accounting has changed since I wrote the book. So this is sort of like trying to do it started out, easiest way is I thought this was going to be a short, continuous improvement event. Yeah. And I was going to add a few chapters. And then the more I looked at the book, I just decided basically to rewrite it.
Nick Katko: And I wrote it more for everybody rather than just manufacturing. I sort of the manufacturing piece. I created a few chapters at the end and also sort of the sequence. If you want to transform your management accounting system, what are the steps? And that's the way I structured it.
Mark Graban: And working with the publisher, there's usually certain requirements of what percentage of the book needs to be different. It sounds like you exceeded that by good measure. Not starting from scratch or, I mean, it's like really heavily editing and reworking.
Nick Katko: There were some things I kept and some things I just didn't keep. It did not please my wife because we just finished practicing lean accounting. And then I said, I'm going to do this, but I'm only going to write a couple of chapters. And I was like, no, anyway, it was good.
Mark Graban: It was consuming a lot of your own capacity.
Nick Katko: Yes.
Mark Graban: Well, it's good if your wife is fighting for some of that capacity, that's a good thing. Celebrate that. So we'll link to the book in the show notes. And one other thing I wanted to ask you to share with us, and I'll put a link to this in the show notes as well. The New Lean Accounting certification program from BMA.
Mark Graban: Tell us about that. Who do you think might be interested in that, and what would they get out of that certification?
Nick Katko: Well, this is an idea that I had for many years. It was a matter of figuring out how to do it. And it's more than just a one way webinar, because there's two certifications, lean management accounting and lean accounting process improvement. Each of those has five 1 hour classes, basically, and it's sort of webinar style, but at the end of each class, you got to take a quiz. So it's a matter of not just listening, but it's a matter of recall.
Nick Katko: It's a better way to prepare yourself or prepare a team of people for a transformation. And you can do it on your own. It's somewhat self paced, and if you are a certified public accountant, you can also get continuing education credit for it. So you could get two things, and it's something I've wanted to do. It's a way to engage people, develop competency in the principles, practices and tools, and get you ready for a transformation.
Nick Katko: In fact, two people who took it recently, I met with them yesterday, and they already have created a value stream income statement. Okay.
Mark Graban: And that's something you shared about in the webinar, I'll point out.
Nick Katko: Yeah. So they took what they learned and they put together a value stream income statement. They wanted to run it by me, and I gave them some ideas. But it gives you a way to get started, and it can be shared. Teams can do it.
Nick Katko: Doesn't have to be just individually. Yeah.
Mark Graban: Well, again, well, I hope people will check that out. If they've listened to a good long discussion here about Lean accounting, they have probably kind of qualified themselves that they probably have the interest or would benefit from this. So I'll put a link to that in the show notes, and again, a link to that webinar. People can combine all of that, the certification, and then as a final question, who are the people in what situations that would reach out to you and BMA for kind of deeper coaching and support?
Nick Katko: Yeah. In smaller companies or like privately held companies, many times it's the CEO or lean leader. Sometimes it's the CFO or the controller. In public companies, it's usually lean leaders, but I've had all kinds of people reach out for the years. Most of the time, everybody I've talked to that is like non accounting.
Nick Katko: They never really say there's anything wrong with accounting. It's just, it's more collective like. We know we have to do something, but we're not sure how to approach it. That's really the key. But if you're an owner, a CEO, president, lean leader, obviously CFO and Controller, those are the people who really recognize the problems and issues.
Nick Katko: Yeah.
Mark Graban: So define the problem together with you and you can talk about countermeasures and. Well, Nick, thank you for coming back on the podcast again, congratulations on the release of the new edition, the Lean CFO. I hope people will also check out practicing Lean accounting. And you can hear more from Nick back in episode 428. Again, he was together here with Mike DeLuca, the co author of that book, Practicing Lean Accounting.
Mark Graban: So, Nick, thank you. This has been helpful. You're kind of shaken the cobwebs out of some of the things I learned a long time ago, but clearly a lot more to learn. And thank you for sharing and kind of helping us learn here today.
Nick Katko: Thanks, Mark. I appreciate it. Had a good time. Thanks.
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