Shop Floor to Top Floor: Methodology Matters

If little about the financial view of operations has improved despite achieving shop floor to top floor integration, consider developing a cost model built from an operational model of your organization’s resources.

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Connecting the shop floor to the top floor is a worthy objective, and many software vendors are selling solutions to make it happen. Making the connection has many dimensions, but the two key informational components are operational quantities and metrics and financial information.

All top floors focus on financial information, and you may even be fortunate enough to have a top floor that also focuses on operational information. The question that needs to be asked, and often isn’t, is how effectively the two types of are information connected. Can a top floor decision maker link monetary effects to specific operational causes? And will operational decisions and changes be accurately projected and reflected in the monetary view?

Many manufacturing managers find that little about the financial view of operations has improved when shop floor to top floor integration is theoretically achieved. The most common reason for this failure is most financial professionals only know one way to calculate costs—the method used in financial statements. The accounting profession, as a whole, isn’t very focused on costing, and it labors under the myth, perpetuated by accounting education, that it is possible to turn financial statement cost data into information relevant to operations.

Costing for financial reporting is governed by fundamentally different principles than cause and effect, the principle that is needed to reflect resources and operations for internal decision-making. The conceptual frameworks for financial reporting standards are very clear that information for external reporting is focused on investors and creditors; and while it may be useful for some internal management decision-making, it is not designed to be sufficient or complete for that purpose. The simple fact is that acceptable and auditable product costs for financial statements can be massively distorted for internal decision-making.

Connecting the shop floor to the top floor with information that will reflect operational resources and support effective long- and short-term decision-making requires developing a cost model built from an operational model of the organization’s resources. Trying to connect with an existing general ledger that supports an external financial reporting model can only be marginally effective. An operational model starts with modeling resources or groups of resources that produce a homogeneous output. That output is consumed in a productive process that eventually results in a final product.

Each input resource has a quantifiable relationship with the level of output it produces that is fixed, proportional, or some of both. Modeling and understanding these relationships are critical to the many marginal and incremental decisions made daily in operations. Unconsumed or unused resource quantities must be identified and not pushed through the process, as occurs in allocation-based cost systems. Idle capacity represents an opportunity—whether it is from lack of demand for a product or from increasing the efficiency of operations. Idle capacity should always be identified and understood.

Additionally, not all resource costs that impact product cost are on the shop floor. Sales discounts, sales commissions and salaries, distribution costs, market research and advertising costs, product and process R&D investments, and customer-specific financing costs should all be integrated to present a comprehensive picture to the top floor and keep manufacturing costs in the proper perspective.

Advanced managerial costing models, such as Resource Consumption Accounting, capable of creating a cost system based on an operational model of resources need to take a very different look at the economics of a company on and beyond the factory floor. Depreciation of capital resources, capitalization rules, amortization of goodwill, cost of capital, and conventions for selling, general and administrative expenses, to name a few, will all need to be examined for their causal impact on the company’s strategic goals.

>>Larry White, CMA, CFM, CPA, CGFM, lwhite@rcainstitute.org, is executive director of the Resource Consumption Accounting Institute (www.rcainstitute.org), which trains and advocates for improved cost information connecting operations to business performance.

 

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