Mitch Max completes his series on developing cost consciousness within organizations with five factors to consider in looking at how the information is presented and used.
In episode 29
Coming up on Performance Management Edge… Mitch Max wraps up his series on creating a Cost Conscious organization.
Thanks for coming back to our final segment in this series on Raising your Cost Consciousness. If you missed the earlier segments, be sure to watch them right here on Performance Management Edge.
Our first segment introduced the notion that an organization can only become Cost Conscious when it has a strong set of cost analytics to guide its culture in making effective decisions. In segments 2 and 3 we reviewed different types of cost analysis techniques and reports to help the organization identify ways to improve its cost structure.
In this segment, I want to explore how this information gets used in a company’s culture. It is an axiom that information is only valuable when used for decision-making. Organizations have two types of reports that can be used – regular reporting and ad-hoc analytics. Ad-hoc reports are used for specialized reporting to support specific point needs for information. For example, while branch profitability reporting is used for regular performance monitoring, a branch-close decision requires special analysis that isolates variable costs that will truly “go away” from fixed costs that will be reabsorbed within the organization.
I want to focus more on regular reporting as a vehicle for improving Cost Consciousness. There are 5 factors to consider in looking at how the information is presented and used:
- QUALITY – Is the information provided clear, transparent and understandable?
Information based on activity analysis is different than the type of financial information that managers are used to looking at. It’s important that it is presented clearly, and that users can drill down to understand how it was developed. It needs to reconcile to the financial information they otherwise receive, and it needs to be presented consistently within the organization and over time. The tools provided to support the analysis must be robust, intuitive and easy to navigate. Where appropriate, graphical capabilities should be provided to support visualization of trends and underlying data anomalies.
- INTEGRATION – Is the information integrated as a part of the total financial reporting package, or is it seen as additional information?
When information is presented outside of the regular reporting cycle, its perceived value is diminished. We have seen some organizations even delay their reporting by a day if needed in order to incorporate cost analysis. When presented at the same time as other financial information, the ability to use it as part of the monthly review cycle is enhanced, and it then can be further leveraged to support ongoing forecasting.
- ALIGNMENT – Does the information align with accountabilities?
Nothing frustrates managers more than seeing costs that they cannot manage included in their performance reports. It’s critical that overhead costs allocated to businesses be separated out from those that are directly controllable. If costs are allocated, such as HR admin or payroll, the cost rates used should be held fixed during a planning year so as to eliminate rate variances.
Similarly, new information won’t be used when decisions conflict with other more established or incentivized information. For example, if branch managers are measured and compensated on sales volume, reporting on profitability will be a wasted exercise. Or, if performance is based on Line of Business reports that use other allocation methods, people won’t trust or use the new costing information. Often, conflicting information is more damaging than new information.
- TRAINING – Are the users trained and supported in the use of the cost information
Training is more than just helping people understand the reports. To be truly effective, training needs to help people see how to use the information to support decisions. Building case studies for training in the business context helps people internalize new decision styles, and become more comfortable in using the information effectively.
- TRUST – Are managers trusted to make decisions?
This last item is perhaps the most difficult to implement. Our nature is often to centrally control decision-making. To truly give managers the ability to manage their costs in a “cost-conscious” way, they need to have the freedom to act, and to make tradeoffs in how they are spending the company’s funds. Great organizations ensure that their mangers understand corporate strategy, give them the information and tools to make decisions, and reward them based on the decisions that they take.
I hope you have found this series interesting as you work to raise your own organization’s Cost Consciousness. I welcome any feedback or questions as you explore this in your own environment.
Thank you Mitch. This is Alan Stratton your host. Until next time on Performance Management Edge.
Pierre Guillaume completes his series on critical principles governing cost systems.
In episode 28
Coming up on Performance Management Edge… Pierre Guillaume continues his series on the principles that should govern a cost system.
Hi, this is Pierre Guillaume one more time, from Beyond EPS Advisors. This is the last segment of a three part series on the principles that should govern a cost system. Today we will cover principles 5, 6, & 7:
5. Considers Behavioral Consequences
6. Achieves Compliance
7. Delivers Value
The first principle we will cover today is consider behavioral consequences.
The way cost information is used to make decisions has behavioral consequences that should be considered in the design of costing practices. Traditionally, managers address the technical considerations of costing, but fail to adequately consider the behavioral needs around costing. If costing processes fail to consider the behaviors desired, the resulting decisions might inadvertently prevent achievement of management’s objectives and sub-optimize organizational resources.
Costing should support the organization’s efforts to encourage interactions between service providers and consumers (internal and external) to maximize the value of these relationships. There may be occasions when the desired business outcome conflicts with the most technically correct cost-assignment method. Let us look at a couple of examples:
Consumption of legal services may be readily identifiable through examination of the time attorneys spend on each issue. While legal costs could be directly charged out, doing so might result in creating the behavior of not seeking legal advice on a timely basis. This delay can often result in much greater legal risks and higher costs than if legal advice was sought earlier. By keeping legal costs as part of a corporate tax and not allocating them on a use basis, managers are encouraged to utilize the legal expertise available when needed. Use of legal may avoid potential liability for the company, saving the organization’s costs long-term.
Conversely, if the organization chooses to assign legal costs to the lines of business utilizing the legal services, charging directly would be appropriate when the legal costs being incurred are directly related to the applicable lines of business, rather than the result of a random process. Legal expenses incurred when verifying compliance with state regulators for a new service should be reflected in that line of business profitability: the inerrant nature of that business led to the costs being incurred. On the other hand, legal costs related to a sexual harassment law suit are best not directly traced when they are incurred: in most cases, it is best to assume that the incident in any given part of the organization is random and not linked to the nature of that part of the organization.
The second example I will use is that of an Employee Tuition Reimbursement Program. To encourage its employees’ continuing education, one of our clients allocates its employee-tuition reimbursement as an employee benefit across all cost centers. This is in lieu of charging employee-tuition reimbursement costs to the actual units with employees pursuing their education. If tuition reimbursement was charged directly, it could result in managers discouraging employees from using the program to avoid the additional costs.
Let’s move on to our next principle: achieve compliance.
Compliance with all legal and regulatory requirements is vital to any organization’s success. The organization should uphold all requirements outlined by the governing authorities. Your costing information will adequately comply with applicable legal and regulatory requirements and convey its financial standing to stakeholders, analysts, credit agencies, governments and investors. In short, to keep this principle simple, nobody wants to go to jail.
Finally, our last principle: deliver value.
One should keep in mind that the system should be kept as simple and cost effective as possible, or as Einstein said, “Everything should be made as simple as possible, but not one bit simpler”.
The principle of value ensures that time and effort spent gathering and evaluating cost information should result in significant organizational benefits. In developing your cost system, one should focus efforts on areas that offer opportunity for significant returns. The focus should be on material items i.e. elements that, if changed, impact the outcome of a decision. In financial terms, the net present value of the future cash flow derived from better decision making should exceed the cost of providing that information.
For example, a more detailed study of customer-segment profitability could be performed. Before investing in that analysis, management should weigh its costs against the value of any changes it would make as a result, decisions such as changing prices, altering services, or lowering the costs to serve. The analysis costs could be one-time costs for a simple analysis or a major cost to acquire, install and maintain an ongoing costing system. In either case, the costs should be weighed against the expected benefits to determine materiality. If changes could not be made, there might be little need to perform the analysis.
By focusing our efforts on significant decisions and cost benefits, we can thus better optimize our resources. Resources can then be deployed to value-added activities, producing greater value for the entire organization.
This concludes this series on the principles beyond successful costing systems and processes. I hope you found it thought-provoking. As always, do not hesitate to come back to us with questions. We will gladly cover them in our question-and-answer section.
Thank you Pierre. This is Alan Stratton your host. Until next time on Performance Management Edge.
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