Why Don't Financial Metrics Provide Operational Insights?

Dec. 1, 2010
It is said that accounting is the language of business.
On the typical plant floor, one has to wonder how so much business is conducted without any meaningful information from the linguists in accounting. In fact, financial accounting measures are widely recognized as a major risk to a lean initiative.What financial information is typically available about the plant floor? Material cost, labor, equipment depreciation, other direct expenses, overhead and the nearly incomprehensible variances associated with them. Compared to the information in the typical manufacturing enterprise system, this financial information is rudimentary. It was never meant for the plant floor. It is designed for external investors and creditors and thrust upon managers inside the company because it's often all the accountants have. Increasingly, it is all that they are taught to do.The crux of the problem for operational managers is that accountants make a huge assumption when turning everything into monetary values or costs. The monetary view assumes a cause-and-effect relationship between an output and its costs. When the cause-and-effect relationship between a cost and its physical resource is obscured, the usefulness of the monetary or cost information to someone managing those resources and processes quickly disappears. A typical example is the cost pools that accountants create for allocating overhead costs. The allocation formula becomes a high-level proxy for the outputs of the physical resources whose costs are in the pool. What managers doManagers make decisions about resources that impact costs—for example, employ resources more efficiently through process improvements, invest in capital equipment to be more efficient, or invest in training to make people more productive. Sometimes, resource decisions are driven by a goal or a requirement to reduce costs, but money is only saved when resources are reduced or made more productive.The key to effective cost management is to understand how resources interact to support each other in a production process. Modeling or understanding the quantitative, nonfinancial characteristics of resource flows is the first step. The second step is to apply the value or monetary measurement to the discrete quantitative resource flows, never losing the cause-and-effect relationship.The monetary view is important for establishing broad goals and constraints, but it is an abstraction. Insights to improve operations come from understanding the physical qualities and quantities of resources, processes, products and services. Savvy operational managers know they can find themselves on thin ice in any discussion that involves only financial numbers, which doesn't consider the impact on actual resources. Management is fundamentally an exercise in cause and effect. Managers seek to create, replicate or correct a monetary effect by managing the causal factors encompassed by resources in the production process.Finance and accounting should facilitate this effort by providing financial information for operating managers that causally links to resources and processes. Traditional accounting tools for generating financial reports aren't up to the task, because a logical principle, like cause and effect, is forced to take a back seat to generally accepted accounting principles. Operational managers need to actively assert their financial requirements and insist on clear links to the useful operational information contained in manufacturing enterprise systems.Management accounting approaches exist that that focus on supporting the information needs of operational managers. German management accounting, Grenzplankostenrechnung, known in the United States as GPK, does work to serve operational managers and has been used successfully for nearly 60 years. More recently, resource consumption accounting, or RCA, has merged the German GPK view of resources with a more detailed process or activity view.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 improved business performance.

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