Why are financial people assessing apples and oranges?
Is often gets bought to oneâ€™s attention that not all businesses are created equal. You might have noticed this yourself as you notice the traits of a successful company versus those of the unsuccessful ones. I have made this activity a professional pastime of mine and it has been fun over the years.
One area that is more fun than any other is how companies decide how to calculate their profits over the year. If the organization has applied Lean principles to improve their business processes, they are often struggling with the problem of reducing profits. Why is this?
When an organization implements a Lean process, they will start to see changes in their inventory, work in process and finished goods throughout their facility. These reduced levels translate into dollars in the bank instead of sitting on selves waiting for customers to purchase them. So, this all sounds like a great position for any company to be in, right?
Well apparently, for many CFO types it is not a good place. The reduction in levels of inventory, work in process and finished goods affects the profit side of the balance sheet because they are considered company assets. Products that are in the form of raw materials, partial built or completed are all converted into a cash value. In the world of accounting, â€œcash valueâ€ has a worth, it is used to determine the value of a business. The worth or cash value is entered onto the balance sheet as an asset and can be used to calculate profit levels. Â Therefore, reduce the asset value and you will initially reduce the profits. However, overtime the role will be reversed as the business learns how to meet demand with lower inventories and process improvements. This is when profits will improve and be real.
Would you prefer assets value or cash flow? This is the $64,000 question. Accountants prefer assets. Lean people prefer lower asset value in the form of lower inventory levels. The discussion will continue to go on for some time.