Comments on: Profits aren’t cash

By: Bill Waddell

Bill Waddell — Wed, 22 Feb 2006 21:49:00 +0000

… but the accountants do say that you can overbuild and create inventory, take overhead expenses off of the P&L and put them on the balance sheet in the assets column, and look more profitable. And conversely, they say that if you get lean and cut inventory in half, there will be a severe hit on the P&L when all of that old overhead comes back off the balance sheet and hits the bottom line. Accountants are not that innocent, Mike, when they run a system that says building inventory is profitable and reducing inventory is unprofitable. Worse, they mislead management into thinking that absorption accounting and the matching principle are the only way to comply with the SEC, SOX and the rest and therefore act as the number one hindrance to American manufacturing becoming lean.

The problem is not that manufacturng does not understand the basics of accounting, Mike. It is that accounting does not understand the basics of manufaturing. The only aspect of manufacturing that has not changed in response to the new global and technology realities is accounting. They still send management into a battle for survival with the hand Donaldson Brown dealt them in 1923.

By: Mike C

Mike C — Wed, 22 Feb 2006 19:14:50 +0000

It goes back to understanding the basics of accounting.

Accountants do not recommend that you boost the amount of inventory that you carry because its an “asset” any more than they recommend boosting your “receivables” asset by asking customers to delay their payments to you.

Accountants recommend keeping both inventory and receivables to the minimum possible. They don’t ascribe “good to have” as part of the general definition of assets.

By: Bill Waddell

Bill Waddell — Wed, 22 Feb 2006 17:10:42 +0000

Mike’s comment is certainly valid so long as we can be sure to include the caveat that a standard, GAAP approved, IRS and SEC approved balance sheet that includes inventory as an asset does not reflect the ‘reality of the business’. The terms “asset” and “waste” are antonyms – opposites. Every lean principle is built around the fundamental point that inventory is waste – and that cannot co-exist or be rationalized with calling inventory an asset on a balance sheet.

By: Mike C

Mike C — Wed, 22 Feb 2006 15:19:44 +0000

Entrepreneurs need to understand the basics of accounting. At the heart of every “profitable” company that’s gone bankrupt is either a) a misunderstanding of what working capital is and how much is needed or b) fraud.

Cash flow statements are nice, but they can be manipulated to achieve short term results and can mask underlying problems with a business just as a P&L can.

There are great moral hazards involved with how business account for their activities
and smart entrepreneurs need to realize that their financial statements (*all of them*) need to reflect the reality of their business rather than be goals in and of themselves.

By: Joe Ely

Joe Ely — Wed, 22 Feb 2006 13:41:52 +0000

Preach it, Kathleen!!!

You are so right. And this is so misunderstood. Bill does a great job at continually hammering this fact.

Profits are a result of assumptions. About allocated costs, depreciation schedules, probability of collecting debts, yield on inventory, etc etc.

Cash is reality. What comes in has to be greater than what goes out.

Thus, cash flow is a better measure of our real results than profitability. This offends the accountants, yet is real.

For entrepreneurs, it is even more crucial. Cash is the life blood. Profits are an illusion.

And Lean provides a proven method of freeing up cash.

By: Bill Waddell

Bill Waddell — Wed, 22 Feb 2006 02:24:50 +0000

Thanks for the kind words about the book Kathleen.

When asked what the Toyota Syatem was, Taichi Ohno said, “All we are doing is looking at the time line, from the moment the customer gives us an order to the point when we collect the cash. And we are reducing the time line by reducing the non-value adding wastes.” He could not have made it any plainer that lean is all about cash flow.