Finding Common Ground for Financial Metrics

Oct. 1, 2010
In the normal course of business planning, the manufacturing manager is assaulted with a barrage of top down measurements—improve return on investment (ROI), maximize cash flow, cut unit product costs, reduce overhead, explain labor and material variances, and the like.
Disconnects frequently occur because financial accounting and reporting principles often don’t reflect the reality experienced in the plant, where the scientific method and cause-and-effect rule.Financial reporting is guided by generally accepted accounting principles that often don’t align with logical operational cause-and-effect conclusions. For example, highly aggregated overhead cost pools and depreciation often make new, highly efficient machines look more expensive than older machines.Discussions with finance need a more logical starting point than the financial statement; something tangible and discrete enough for the financial accounting characterization and the logical view from the plant floor to be understood without unraveling multiple layers of abstraction. Such a logical starting place is resources—people, equipment, supplies, utilities, contracted services and the like. Resources are the fundamental source of all costs and activities in a company (and eventually revenues).  Individual resources are organized into resource pools or work units and execute productive processes to create value.Resource characteristicsResources create outputs. In most cases, individual resources (or resource pools, if resources are grouped) don’t provide a final product, but provide a semi-finished component or support service to another resource pool or pools. For example, a machine maintenance group may service a number of machines in production, and support departments with its output of maintenance man-hours.The individual resources consumed by a resource pool relate to the output of the resource pool. That relationship either varies with the output level or is a fixed relationship. For example, the machine maintenance pool has six technicians, a supervisor, equipment (i.e., depreciation) and an operating budget for supplies. The technicians are more or less busy based on the demand for maintenance man-hours—their relationship is proportional to the output of maintenance man-hours. The supervisor’s level of activity, the depreciation, and the operating budget changes relatively little based on the demand for maintenance man-hours—their relationship is fixed in regard to the output level.A second important characteristic of resources is capacity. Capacity is normally defined by time; for example a piece of equipment or a building is owned and available 7x24x365, an employee is contracted for 8 hours/day 5 days/week. Capacity is composed of productive activity (the central activity the resource was acquired to perform), non-productive activity (maintenance, set-ups, training, administration, inspections, repairs and the like), and idle time (lack of work or a decision not to use a resource during a period of time).The reason cost hasn’t been discussed thus far is because the application of cost needs to logically follow the application of the resources, which requires a thorough understanding of the nature of resource consumption. Knowledge of the fixed and proportional consumption relationships of resources to intermediate and final outputs is the basis for making effective cost reductions, expanding or growing efficiently, and understanding marginal cost and profit. Idle capacity and its cost can represent a huge opportunity—the ability to produce more with only material and power as incremental costs—or it can represent a significant distortion if allocated thoughtlessly onto product or operating cost.When resource consumption and the associated costs are properly modeled for decision support, cost provides critical economic insights on the efficiency of resource use, and becomes an effective and flexible tool for planning and simulation to meet operational and financial strategic objectives.Larry White, CMA, CPA, CGFM, [email protected], is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org).

Subscribe to Automation World's RSS Feeds for Columns & Departments

Sponsored Recommendations

Why should American-Made Products be a top priority?

Within this white paper, Shalabh “Shalli” Kumar, founder of AVG Advanced Technologies, stresses the importance of prioritizing American-made products to safeguard the country'...

How to Improve Production Accountability in Manufacturing

David Greenfield, Automation World's Editor-in-Chief, and Shalli Kumar, founder of EZAutomation, discuss the idea of production monitors: a preprogrammed PLC/LED display that ...

HALT/HASS: The Ultimate Test for Reliability

Discover how companies like EZAutomation push the limits of reliability with HALT/HASS testing, originally designed to mimic the extreme conditions of space shuttle launches. ...

Your Next Production Monitor Is Only a Few Clicks Away

Shop for your very own EZ Production Monitor. It's designed for non-technical staff, so there's no programming required! It combines pre-coded firmware, real-time data, and WiFi...