Last week I was sitting at my desk trying to think of a blog topic, and the ideas were coming slowly. Since our team has started blogging, my usual well of ideas has dried up because everyone’s saving their best ideas for their own articles. Then out of nowhere, our newest application specialist, Bhavin, decided to pop in to tell me about an interesting book he’d just finished by Lianabel Oliver called Designing Strategic Cost Systems: How to Unleash the Power of Cost Information. After I read the section he shared on dysfunctional cost systems, I knew I had some valuable information that could help manufacturing companies understand the problems inside their costing process.
The book talks about the eight internal warning signs that indicate your costing system is dysfunctional. In part one of this blog, I’ll discuss the first four signs and what companies need to consider when designing their costing processes.
#1 – Financial reports are inaccurate or don’t reflect business operations
Call it a sixth sense, intuition or ESP, but business leaders know how their businesses operate. Plant managers know how swapping raw material inputs or changing to a different production line will impact costs of a product. And when they see reports that don’t line up with those expectations, they tend to distrust the results and ultimately stop relying on the data. To gain acceptance, cost accountants need to take an in-depth look at both their operations and accounting processes to develop a system that is true to their manufacturing process and accounting methodologies.
#2 – Managers are unable to explain financial results
The best way to verify if you know something is to teach it to someone else. Accountants who cannot give a simple explanation to their financial results from a business perspective have no idea what the results mean. It’s easy to hide behind explaining the logic and never tying it back to the actual business. But for managers to clearly relate the results to the business, an alignment between the cost system and the business process it represents is fundamental.
#3 – Managers don’t use financial reports
Oliver discusses four reasons that managers don’t use reports: (1) the reports are too late; (2) the information is stale; (3) the reported costs don’t reflect the true costs of the operation, and (4) they are too difficult to understand. For costing to become an essential component of decision-making for any organization, the costing system must make up-to-date costing information available from a straightforward interface. They need the ability to build reports that capture the information important to the organization in a format that is both digestible and actionable.
#4 – Managers develop their own cost models
If the operations team doesn’t buy in to the costing methodology, they will build their own offline costing models to support their decision-making process. Ultimately, having multiple costing processes existing inside one company can only lead to confusion and negatively affect the company’s profitability. Gaining agreement from the users and customers of cost data within the organization on the costing methodology is a critical step in implementing any costing system.
Fortunately for you (and me!), my next blog is already underway. Stay tuned for part two where I’ll cover the second four signs that could mean your cost system is dysfunctional.
Update: Read Part 2 of this blog series to read about the final four warning signs.
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