What Cost Information Does Manufacturing Really Need?

Sept. 24, 2012
Resource-focused costing based on cause-and-effect modeling is the only approach that can effectively connect manufacturing metrics with costs and allow the real time calculation of marginal cost and profitability.

Manufacturing is not often asked what it needs for cost information.  Traditionally, manufacturing is told what cost objectives must be met. The measures typically revolve around product cost, and the computations typically involve a complex set of allocations that bear little resemblance to the operations and resources manufacturing manages.  There are three key information elements needed to achieve highly useable cost information for manufacturing.

Manufacturing managers strive to create a high visibility environment when implementing manufacturing enterprise solutions with the objective of identifying problems rapidly at the root cause, or ideally identifying indicators of potential problems in time to avoid the problem.

To support the visibility of operational data, the first need of manufacturing for cost information is granularity. Granularity is achieved by providing cost information that starts with the resources manufacturing employs. The problem that typically occurs is resource costs are determined using top down financial calculations, and in the process is loaded with overhead allocations. Resource costs must be determined from the bottom up to be meaningful at a granular level.

Reflect resource relationship
The second need is that manufacturing cost information must be clearly representative of the resources and the operations. Resources don’t act independently; they support or are supported (or both) by other resources. Cost Information must reflect the actual resources and relationships in operations.

A resource’s capacity provides output, which is consumed up to a maximum capacity by other resources. Unconsumed resource capacity represents a potential opportunity, depending on a variety of decision factors - to sit in a ready status, to do more work, or to move to other productive uses.

Costs need to reflect the characteristics of the resource’s relationship to the direct output they provide. Are resources busier as output increases?  Can the resources support a wide range of output without being increased or decreased?  Manufacturing knows these characteristics in their non-financial data, but seldom sees them reflected in financial information.

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The third need for manufacturing cost information is to present the case for improvements or the impact of problems in financial terms. Costing won’t help with understanding an increase or loss of revenue, but it is vital for determining profitability.

The toughest test for calculating profitability is determining marginal profitability for small scale improvements or the marginal cost for extra requirements, such as the impact of an additional order, the impact of unique customer demands, the investment in an operational enhancement, the use of outsourcing to meet a tight deadline, etc. It is often the day-to-day improvement decisions that suffer from top down costing where the cost information fails to reflect any semblance of the operational cause and effect relationships.

Costing should support manufacturing metrics. If manufacturing improves the efficiency of a resource that allows the entire operation to be more efficient, the manufacturing manager should see the cost of production decrease, the cost associated with idle/available resources increase, and take action to offer the available capacity to sales and marketing for generating increased revenue and profit.

The same is true if a new regulatory requirement or unique customer specification slows production.  The manufacturing manager should be able to see the cost of production increase and be able to project the cost of supplementing capacity (perhaps with overtime) to meet the planned schedule.

Resource-focused costing based on cause-and-effect modeling is the only approach that can effectively connect manufacturing metrics with costs and allow the real time calculation of marginal cost and profitability.  Costing approaches for internal decision making need to begin with an operational model, not a financial model.

Larry White, CMA, CPA, CGFM, [email protected], is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org), which seeks to connect cost information to operational business performance metrics.

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