Would your life be easier if the financial information provided by your accountants exactly reflected your operations and supported your decision needs?
Of course it would! Have you struggled with your finance and accounting department to get the budget and funding for critical operations or significant improvements?
The language of money is a common denominator for communicating with your organization. Why is it that your operations don’t seem capable of speaking that language? And why can’t accountants speak your language? Managers like you and your employee teams are already becoming more efficient and effective, but you struggle to communicate that success with traditional financial terms.
There is a way to bridge this communications gap. It’s through the use of managerial costing: costing that reflects your operations very clearly with financial information. It brings everyone to the same page with the same language. What is that page? Well, it isn’t traditional cost accounting, which is designed to value inventory for external financial reporting to regulatory agencies and the investor communities.
Managerial costing is costing for internal decision support. It is done purely for an organization’s internal use to ensure information for decision-making reflects the characteristics of the organization’s resources and operations. It differs from managerial accounting, which is a profession involving partnering in management decision making. It also differs from cost accounting, which is about measuring and reporting costs for external financial reporting or regulatory purposes.
Managerial costing is costing designed to reflect the operations, processes and resources in your organization (not like a fun house mirror…but clearly) in a manner that all managers and employees can relate to. It is foundational to have costing information that meets organizational needs such as operational cost control, financial planning and analysis (FP&A), pricing decisions, variance analysis, capacity management, cost simulations, and so on.
Managerial costing is based on the development of effective cost models, which must be based on basic managerial cost modeling principles and concepts. These are principles and concepts that best represent the behavior of resources and operations, and how those resources are consumed by an organization’s outputs. (For more on these see the Conceptual Framework for Managerial Costing.)
A key principle in the design, implementation and use of a managerial costing model is causality. Causality deals with capturing, understanding and quantifying operational cause-and-effect relationships and their monetary impact across the enterprise. (It is important to distinguish between causality and correlation. Two variables may behave similarly, i.e., they are correlated, but they do not have a causal relationship.)
Optimizing decision-making requires managerial costing that supports planning, simulation, measurement, and analysis through cause-and-effect insights. For example, a costing model built around cause-and-effect relationships should be used to support decisions involving an organization’s existing strategic plan. A model with appropriate structure and detail better facilitates managers in their forward-looking decisions involving the strategic plan.
In developing a costing model, it is critical to start with the resources used for performing operations. Most managers in an organization make decisions about resources and processes (such as whether to outsource a product) that subsequently affect costs. Hence, costs for internal decision making must be collected and framed in a manner that describes accurately the effect of resources and processes on costs.
Resources often exist in a chain of cause-and-effect relationships. Resources provide outputs in achieving intermediate managerial objectives, or they may provide ultimate business outputs that directly drive revenue. To achieve effective managerial costing, it is important to understand and clearly model this chain of inputs, intermediate outputs and ultimate outputs. The resulting model captures the organization’s cause-and-effect relationships and can serve as the basis for assigning resource uses and costs through the costing system.
How well does your organization’s current costing model supports decision-making needs? Probably not well. Most accounting and finance departments are very traditional: they only do costing focused on meeting external financial reporting requirements. Ask yourself the following questions about the costing information you receive:
- Does it reflect the complexity of our organization’s operations?
- Is it actively used for decision making throughout the organization by nonfinance managers?
- Does it support forwarding-looking activities such as scenario analysis, planning and simulation?
- What specific decision-making support benefits does it provide, particularly with respect to the organization’s strategy?
- Is it creating dysfunctional behaviors among operating managers?
If the answers to these questions are negative, it’s time for your company to improve its costing information using more accurate managerial costing models!