Financial information is necessary to run an organization. Financial statements are required by law for public investors and creditors in capital markets, and private equity and financing generally impose similar demands. There are many useful, and even vital routine financial tasks to operate a business like maintaining cash levels, paying vendors and employees, collecting from customers, and so on.
But how useful is financial information to improving manufacturing processes and outcomes? Frequently, it is not that useful, and sometimes it can even be dangerous. Financial reporting conventions and rules can distort manufacturing performance insights with illogical cost assignments, product costs, depreciation, and other metrics that don’t reflect the reality of operations on the factory floor.
The critical factor for financial information to be useful for manufacturing is that it must accurately reflect the causal relationships seen and experienced by process owners and operators.To achieve this, it must possess three key qualities: transparency, defensibility and timeliness.
Transparent financial information means the cost figures clearly show the cause-and-effect relationships within operations. Without this transparency, most managers will be inclined to ignore cost information. The relevance and reliability of a costing system’s information must directly connect to operating resources, processes and decisions. Managers will tend to second-guess opaque cost information, and the resulting discussions or arguments might undercut efforts to improve decision-making, profitability and processes within organizations. Transparently causal cost information will satisfy financial and manufacturing managers who demand evidence that relates directly to production resources and operations.
Defensibility means that cost information can help both financial and manufacturing personnel to build and evaluate business cases, explain results, support and explain decisions, and advocate ideas. Transparency of operational causal relationships makes cost information defensible to challenges from either finance or manufacturing about its accuracy and applicability.
Defensibility becomes truly useful when managers and employees outside finance can readily apply cost information to investigate operational problems or evaluate operational solutions without worrying that finance will find fault with cost figures used in the analysis. At that point, managerial costing becomes an enabling tool for making better decisions about the employment of resources or investments that will improve the organization’s performance. The key to making costing information defensible throughout the organization is to apply the principle of causality and its supporting concepts from the Institute of Management Accountants’ Conceptual Framework for Managerial Costing when designing the processes and systems to create the information.
Timeliness means cost information is recent and consistently available. Depending on the situation, “recent” may be defined by seconds, minutes, hours or days to reflect current and ongoing operations. The concept of real time should be the objective. Consistently available cost information requires an effective managerial costing system to generate information on demand for managers and employees. A cost study—no matter how effectively done, no matter how quickly completed, no matter how well-guided with policy and procedures—is never as useful as having information available for day-in, day-out measurement and evaluation. Only through continuous observation and evaluation can cost information be understood to a degree that gives managers confidence the model reflects the cause-and-effect relationships of the resources, processes and operations they manage.
It is important to recognize when costing information isn’t designed to be useful for manufacturing decisions. Further, no matter how “useful” it is for other purposes or how well audited it is, it should not be used for decisions it wasn’t designed to support.
>>Larry White, CMA, CFM, CPA, CGFM, [email protected], is executive director of the Resource Consumption Accounting Institute, which trains and advocates for improved cost information connecting operations to business performance.
