Every large organization in the world today, from Apple to P&G and from Ford to...
Can Accountants Grow the Beans Too?
Managers are increasingly shifting from reacting to after-the-fact reported outcomes to anticipating the future with predictive analysis and proactively making adjustments with better decisions. Despite some advances in the application of new costing techniques such as activity-based costing, are management accountants and FP&A professionals adequately satisfying the needs of managers and employee teams for decision-based cost information? Or is the gap widening? That is, are the accountants still just counting the beans, or are they helping to grow the beans?
There is a difference between what management accountants report and what executives, managers and employee teams want. This does not mean that information produced by accountants is of little value. In the last few decades, accountants have made significant strides in improving the utility and accuracy of the costs they calculate and report.
The gap is being caused by a shift in managers’ needs – from needing to know what things cost (such as a product or standard service-line cost) and what happened – to a need for more purposeful information about what their future costs might be and why – what can happen?
What is the purpose of management accounting?
Contrary to beliefs that the only purpose of management accounting is to collect, validate, transform and report data, its primary purpose is first and foremost to influence behavior at all levels – from the desk of the CEO down to each employee – and it should do so by supporting decisions.
A secondary purpose is to stimulate investigation and discovery by signaling relevant information (and consequently bringing focus) and generating needed questions that may not be asked without management accounting.
The widening gap between what accountants and FP&A professionals report and what decision makers need involves the shift from analyzing descriptive historical information to analyzing predictive information, such as budgets, cost estimates and what-if scenarios. Obviously, all decisions can only affect the future, because the past is already history. However, there is much that can be learned and gained from historical information.
Although accountants and FP&A professionals are gradually improving the quality of reported history, decision makers are shifting their view toward better understanding the future and the financial impact of decisions.
This shift is a response to a more overarching shift in executive management styles to an anticipatory, proactive style where organizational changes and adjustments, such as staffing levels, can be made before things happen and before minor problems become big ones.
An accounting framework and taxonomy
The large domain of accounting has three components: tax accounting, financial accounting, and management accounting. There are two types of data sources. One source is from financial transactions and bookkeeping, such as purchases and payroll. The other source is non-financial measures such as payroll hours worked, retail items sold, or gallons of liquid produced.
The financial accounting component is intended for external statutory reporting, such as for regulatory agencies, banks, stockholders and the investment community. Financial accounting follows compliance rules aimed at economic valuation, and as such is typically not adequate or sufficient for internal decision making within an organization. (The tax accounting component is its own world of legislated rules.)
Our area of concern – the management accounting component – can be broken into three categories: cost accounting, cost reporting and analysis, and decision support with cost planning.
To oversimplify a distinction between financial and management accounting, financial accounting is about valuation whereas in contrast management accounting is about value creation ultimately for shareholders and owners through good decision making.
The three management accounting categories are all recipients of inputs from the “cost measurement” procedure of transforming incurred expenses (or their obligations) into calculated costs. They are these:
- Cost Accounting represents the assignment of expenses into outputs, such as the cost of goods sold and the value of inventories. It primarily provides external reporting to comply with regulatory agencies.
- Cost Reporting and Analysis represents the insights, inferences and analysis of what has already taken place in the business in order to track performance.
- Decision Support with Cost Planning involves decision making. It also represents using the historical cost reporting information in combination with other economic information, including forecasts and planned changes (e.g., processes, products, services, channels, and customers) in order to make the types of decisions that lead to financial improvement and success.
The last two categories offer diagnostic support to interpret and draw inferences from what has already taken place and what can happen in the future, respectively. Cost reporting and analysis is about explanation. Decision support with cost planning is about possibilities.
What? So what? Then what?
The message here is that the value and usefulness of accounting information increase, arguably at an exponential rate, from the cost accounting to decision making. Cost reporting displays the reality of what has happened, and provides answers to “What?” That is, what did things cost last period?
However, an obvious follow-up question should be “So what?” That is, based on any questionable or bothersome observations from the management accounting information, is there merit to making changes and interventions? How relevant to improving performance is the outcome we are seeing?
But this leads to the more critical need to propose actions – to make and take decisions – surfaced from cost planning. This is the “Then what?” question. For example, what change can be made or action taken (such as a distributor altering its distribution routes), and what is the ultimate financial impact? Should we internally make a product or deliver a service, or should we purchase it or outsource it?
Business analytics and cost modeling
Of course, any proposed changes will lead to multiple effects on customer service levels, quality and delivery times, but the economic effect on profits and costs should also be considered. This gets to the heart of the widening gap between accountants and decision makers who use accounting data.
To close the gap, accountants and FP&A professionals must change their mindset from management accounting to managerial economics which we might describe as “decision-based costing.” They must classify the capacity behavior of their individual resources, employees and assets, as sunk, fixed, step-fixed, or variable. And this classification depends on
- the planning horizon because capacity in the short-term cannot be easily adjusted but it can be as the planning horizon extends (e.g., replacing full-time employees with temporary ones or leasing assets rather than purchasing them), and
- the type of decision being made.
This is where business analytics, especially predictive and prescriptive analytics, comes into play. The ultimate way that managers can test the outcome of decisions is to deploy robust methods of forecasting combined with valid cost-estimating techniques based on reliably measured past-period “calibrated” per-unit-level cost consumption rates, such as from an activity-based costing system. (It is industrial engineering 101 – The forecasted volume and mix times the per-unit-level consumption rate equals the capacity required: the needed headcount and spending with suppliers.) With this information managers will be more confident that what they want to change will have the effect that they expect and desire.