Whether the company focuses on profitability, earnings per share or market share growth, hitting such goals is becoming ever more challenging.
Real-time Performance Management provides a strategy and a set of solutions to address the real issues confronting today’s manufacturers. Strategic elements include: 1) a focus on Optimum Potential, operationally-focused cost and profitability measures for resource allocation decisions; 2) Dynamic Performance Targets that reflect changing definitions of what is important and what is acceptable performance; 3) real-time monitoring of performance and external factors to keep the corporation focused on the “right things;” and 4) use of continuous improvement as the overall driver for corporate development.
A fundamental problem with traditional accounting methods is that existing accounting and costing systems do not lead to an operational understanding that encourages manufacturers to achieve their optimum potential. In North America, it is quite common for companies to do costing in their general ledgers and then to use that information for the purpose of performance management.
One common performance management methodology is to compare actual costs to a budget based on historical performance. Historical performance is based on rates of downtime, scrap, downgraded goods and other negative measures that have been encountered in the past. These costs are seen as an unavoidable cost of doing business and the goal is usually to reduce these costs rather than eliminate them. In doing this, the cost accounting system may hide tens of millions of dollars of avoidable costs.
A second problem occurs because accounting conventions influence firms to view costs in a way that is incorrect for product-related decision-making. This is particularly true for depreciation schedules. Capital equipment has a lifecycle. However, the Generally Accepted Accounting Practices (GAAP) depreciation schedule used for tax purposes often does not match the lifecycle of the production asset. If the GAAP lifecycle is used as the basis for amortizing cost, the overhead associated with use of capital equipment is likely to be wrong, and thus product costing will be wrong as well.
The final problem with traditional systems is that they are extremely limited in their ability to permit operational personnel to drill down, see the reasons for variances and make appropriate adjustments to systems and processes.
To address traditional cost accounting problems, many companies invest in a range of non-financial reporting systems to measure operational key performance indicators (KPIs). However, these operational KPIs suffer from a major flaw. They do not allow a company to compare apples to apples. Without a model that ties KPI problems to costs or, even better, financial performance, existing solutions cannot answer such crucial questions.
In short, present accounting practices do not calculate the true financial impact of an individual problem or the total impact of all problems affecting the company’s operations.
Financial systems, which provide the basic planning information, are designed to aggregate data over long time periods to satisfy reporting needs, not to run the business on a day-to-day basis. Real-time performance management, however, is an integral part of an overall methodology for driving a business toward optimal performance while adapting to changing market conditions. It incorporates dynamic KPIs that adapt with changing objectives and real-time performance measures that provide insight into how a company is meeting its dynamic targets.
Ideally, real-time performance management should support the natural workflow of people, plants and systems by making common and consistent data visible to everyone who needs it. Adopting a real-time performance management strategy essentially makes every worker a business manager by directly linking his or her actions to the overall business strategy.
Tom Fiske, [email protected], is senior analyst, Enterprise Applications, at ARC Advisory Group.