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From Control to Optimization and Simulation

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The notion of finance providing control insights to operations is outdated. The real value of integrating financial and operational information has shifted from control to optimization, planning, and simulation.

The traditional accounting view is that cost accounting provides “control” over production operations. Those of you with sophisticated manufacturing enterprise solutions in place are surely chaffing at this perspective, but that’s the way it’s taught to accountants. The automation and sophistication of manufacturing information systems has made this perspective laughable. Traditional financial control over operations is at best high level, difficult to link in a cause and effect manner to operational events, and too late for any semblance of “control.”

The notion of finance providing control insights to operations is outdated. The real value of integrating financial and operational information has shifted from control to optimization, planning, and simulation. An upscale move like this often implies that the information needed can be higher level also. This may have been true several decades ago, but today’s dynamic business and operational environment requires deep insight to address the challenges of global supply chains, shorter product lives, greater product diversity, continuous process improvement, and greater investment in information systems.

Responsive cost system
Traditionally knowing how a resource responded to changes in product output quantity was sufficient information for decisions. That is the basis for breakeven and cost-volume-profit analysis taught in economics. In today’s production and business environment, resources are used in more complex and diverse ways. Costs can’t control operations, but they must respond to operations. If they can respond to actual operations, then they can respond to projected operational scenarios for optimization and planning.

>> Late in 2011, MESA updated its Metrics Guidebook and Framework. Read Larry’s White’s article on the update and how it shows the root causes in improving financial insights into operations. Visit bit.ly/awcolumn051

What’s required to create a highly responsive costing system?

First, a responsive cost system must be built on an operational model of the organization’s resources and processes. The costs have to reflect the resources in the process, and must respond to changes in the output of those resources in the same way the resources do. If a resource is idle, the associated costs must be identified as idle. If the resource is required in the same capacity whether output goes up or down, a fixed relationship exists for both resource consumption and cost. If a resource’s productive time increases as output rises, the resource’s consumption and cost have a proportional relationship with output changes.

Second, resource capacity information must be an integral part of the system. You can’t use resources you don’t have or can’t acquire in the time frame of a decision scenario. Third, resources and their costs should not be assigned without a causal relationship to a measured output. There should be no allocations except where strong cause and effect relationships exist. This includes idle capacity. If production isn’t responsible for sales, they aren’t responsible (in a negative way) for idle capacity. They should be rewarded for increased efficiency.

Fourth, costing has to be as dynamic as operations. Waiting one or two weeks for actual payroll data from accounting isn’t a good answer. Tying costs to resource use allows the creation of discrete standards for costs that have a clear relationship to a physical reality and can be imputed based on the resource use. Naturally, such standards will periodically need evaluation, but all standards—whether for cost, or machine operations based on engineering specifications—require review.

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Effective optimization and planning decisions need to be made with confidence. Modern manufacturing information systems provide resource inter-relationships, but the supporting cost data is often lacking. Production sees opportunities, but struggles to build the financial case to seize them. The necessary combination of operational resource modeling, causally linked costs and dynamic imputed cost standards is the foundation for establishing a Resource Consumption Accounting costing model that completely supports optimization and planning in today’s business environment.

Larry White, CMA, CPA, CGFM, [email protected], is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org) which seeks to advance management accountants’ ability to contribute to improving business performance.

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Comments

This article confirms what we have seen...that bringing the business and production systems together enables a closer approach to Business Optimization. Information is passed within these two environments in a seemless fashion to support business processes in context. This allows for numerous optimization opportunities across the enterprise from planning and simulation through supply chain and operations, that are either not accomplished, or poorly accomplished, today. This si the foundation for the journey to Busienss Optimization.

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