The power of monetary metrics to motivate performance is huge when properly focused and, unfortunately, even when poorly focused. Accounting is called “the language of business” because it places a standard measure—money—on otherwise incomparable resources and activities. Most manufacturers have seen this effect, but often the results can appear confusing. Examples include product costs that fluctuate with volume and mix, illogical allocations of overhead, fixed budget targets that impair operational flexibility, bizarre return on investment calculations and so on. Let’s examine two scenarios where well-designed monetary metrics take performance to an improved level.
Scenario one presents poorly designed monetary metrics. Let’s say a factory has two production lines that make the same products. One line is 20 years old and fully depreciated. The second line is new, and depreciation is charged at an accelerated rate to match the tax depreciation. The new line is more labor efficient and higher quality. These factors lead sales personnel—who are compensated based on order profit margin—to jockey to have their orders filled by the old line. Consequently, the new line has a great deal of idle time.
The fix: Decouple the depreciation driving decisions over product cost from tax and financial reporting. Use a consistent, logical capital preservation allowance or replacement cost depreciation charge for all equipment. Revise metrics for sales staff so they focus on selling strategically, rather than on manipulating production. Use the older line to handle orders only when the new line is fully utilized. The result will likely be improved profitability, product quality, customer satisfaction and reduced maintenance costs.
Our second scenario examines great but confusing operational metrics. Imagine a company that implements real-time operational metrics for all of its production processes, as well as a dashboard that allows shift managers to see how well production is doing against stretch targets in all processes. Despite all this, it is unclear which of the individual process metrics have the greatest impact on cost and profit performance, leading shift managers to take different approaches.
Solution: The company instead uses resource consumption accounting to develop a cost model that reflects its operational model, and captures the cost of resource use (and non-use) in all processes. The cost model recalculates every 15 minutes during production, and is also run for assumptions made in the stretch performance targets for each process. As a result, in addition to a dashboard of operational process performance, supervisors will also have a dashboard of the opportunity cost that tells them how much money they are leaving on the table by not meeting all the stretch goals. They can clearly see what impact focusing on different processes will have on the overall opportunity cost.
Two primary factors create poor financial metrics. First is the “one version of the truth” myth common among executive management and accounting. The usefulness of regulated financial statements has been dramatically oversold. They have an important, but limited purpose, which is to provide baseline, audited information for investors and creditors in capital markets who lack the power to demand specific information. Regulated financial statements are not designed to be used to manage a company internally. Rather they simply show the public standardized results of management decisions and efforts.
The second factor is simple laziness by the accounting profession and individual professionals. The profession doesn’t really publicize the limitations of accounting standards or situations where those numbers may be inappropriate. Individual professionals can become so indoctrinated and isolated by financial accounting tasks that they often don’t take time to learn the operations of their company.
Manufacturers need to push for greater relevance in the financial information used to show their internal performance and to support their decisions. Monetary metrics are powerful. They get people’s attention for better or worse, and can take performance to the next level when used effectively.
>>Larry White, CMA, CFM, CPA, CGFM, email@example.com, is executive director of the Resource Consumption Accounting Institute, which trains and advocates for improved cost information connecting operations to business performance.