8. Some Accountants are the Blind Leading the Blind
I recently met a management consultant specializing in management accounting and FP&A whose intentions were sincere. However his advice was surprising, but not totally surprising, to me.
He mentioned to me that a company had inquired to him whether they should consider using activity-based costing (ABC). His next step was initially encouraging. He contacted the accounting departments of the inquiring company’s major competitors. He asked them if they are using ABC. The answer from them was that none of them are.
A missed opportunity for good advice
I was hoping the next thing he would tell me is this. I was hoping he would inform the inquiring company that they had an opportunity to gain a competitive edge.
I presumed he would say to them, “I have good news for you. Your instincts are correct. You have realized that the amount of your indirect and shared expenses has grown large relative to your direct expenses. You may understand that this expansion is a result that your products and services have expanded with much diversity and variations. And the result is that complexity has caused this increase to manage the complexity. By your using a highly aggregated indirect cost pool with a single allocation factor that has no cause-and-effect relationship with those indirect expenses, the consequence is that you are simultaneously over- and-under-costing your products. Their costs exactly reconcile in total but not in with parts. This is because cost allocations are a zero-sum error condition. Your competitors do not realize this, but you do. Go for it. Implement ABC. Your company will much better understand their profit margin layers and where it makes and loses money – and why.”
Sadly, he advised the inquiring company that since its competitors do not use ABC then that is evidence that ABC is of little benefit.
How long can this ignorance continue?
My ranting and raving
Those readers who follow my blogs and articles about this topic recognize that I have been relentless in criticizing the ‘homo accounticus’ accountants who remain in the stone age. They are exposing their organizations to a risk that the enterprise risk management (ERM) community rarely references – invalid and flawed cost information that leads to misleading profit margin information.
I remain in awe. The advanced and mature organizations that have adopted ABC would never go back to traditional standard costing (unless a new mindless CFO or CEO shows up and rejects ABC as too complicated and abandons it).
The longer these types of primitive accountants delay applying ABC, the greater the risks. The issue here is not mainly about product and standard service-line costing. The issue is about the emerging need to report and analyze channel and customer profitability. This includes the broader scope of marketing, distribution, selling, and customer service expenses that are below the product gross profit margin line.
Open your eyes. It is apparent that today customers view almost all suppliers’ products as commodities. They want to be specially treated and serviced. This means that suppliers must provide differentiated services to increasingly differentiated micro-segments of customers. These are cost-to-serve costs, not product and standard service-line costs.
An increasing pressure comes when suppliers recognize that they have high maintenance customers, in contrast to low maintenance ones, whose extra costs erode profits. The objective of sales and marketing is no longer about growing market share and sales, but rather it is about growing profitable sales. Accountants must accurately measure the ‘middle line’ to subtract from the ‘top line’ because the ‘bottom line’ – profits – is a derivative from both of them. And to use large aggregated cost pools with a non-causal allocation factor (e.g., sales amounts, number of labor/machine input hours) to allocate costs is irresponsible. The results are distorted.
When the consultant advised his inquiring company that their competitors are not using ABC, then it is a case of the blind leading the blind. And, remember, that in the land of the blind the one-eyed man is king.
This article was previously published on www.epmchannel.com
7. The CFO’s Expanding Role – Reality or Delusion?
Am I alone in wondering if the many references and articles concerning the CFO’s emerging role as a “trusted advisor” is more hype than reality?
Increasingly, I read articles and research studies alleging this emerging CFO role to be actually happening. In an article written by Gianni Giacomelli, senior vice-president at Genpact, titled “Can a CFO Innovate?” he states:
“Modern financial executives are moving toward a more central and expanded role as stewards of the company's longevity, using the finance function to enable growth, especially in new markets and in response to market changes. For those who are ready for change, the new finance is an exciting and rewarding way to help shape a more intelligent enterprise that is better connected to the market and its customers.”
Really? Just to be a devil’s advocate for a moment, what proof do we have that Gianni’s observation is true? When we cut to the chase, what are CFOs more concerned about – regulatory compliance or organizational performance improvement? Certainly, many CFOs monitor and report on performance using scorecards and dashboards. But do they actively participate in assisting line managers to move those dials. As examples:
- Do they assist sales and marketing managers with identifying which types of customers to retain, grow, win back, and acquire?
- Do they assist operations managers to determine which productivity actions and projects will realize gains in efficiency, effectiveness, quality, and cost reduction?
Or do they simply serve as gatekeepers and keep score?
Bean counter or bean grower?
In an article by Myles Corson, a consultant with the Financial Accounting Advisory Services of Ernst & Young LLP, titled “The Evolving Role of Today’s CFO”, he writes:
“In addition to overseeing the company's financial health, CFOs are increasingly involved in setting operational and commercial strategy, navigating their companies safely through tighter credit markets, more complex regulation and unstable trading conditions. … As organizations continue to adjust to market volatility and economic uncertainty, CFOs must increasingly provide expert advice to support boardroom decisions. In fact, many CFOs feel that they are in an exceptional position to offer this level of strategic counsel because of their ability to gather information from disparate parts of the company.”
But is this evolving role one of just better reporting or one creating a greater impact on analysis and decisions?
In a survey conducted by Mary Driscoll of the America Productivity and Quality Center, titled, “A New CFO Priority,” she writes:
“Surprisingly, only five percent of survey respondents believe that finance is currently delivering game-changing value to their enterprises. Is this cause for concern? … Finance organizations that are seen as a partner to the business generate thoughtful, clear, and authoritative analyses. However, the biggest barrier preventing business partnership is the lack of time to perform this same work.”
My intent is not to be a naysayer and deny there is truly an evolving and expanding role of the CFO. In fact, my intent is just the opposite. I am a believer that, particularly given the opportunity provided by the connections of technological forces ( advanced analytics, cloud, in-memory computing, mobile and social computing) the CFO’s finance and accounting function is uniquely positioned at this moment in time to accelerate the adoption rate of enterprise and corporate performance management (EPM/CPM) methods along with emerging business analytics to gain crucial insights that were previously inaccessible and truly facilitate business innovation in new and novel ways. Finance and accounting professionals have developed a strong quantitative aptitude – which technology will only further fuel.
Delusion or reality?
But do we know or just think we know? Which is it - delusion or reality? I bemoan the slow progress in performance improvement methods such as the adoption of activity-based costing (ABC) principles. If ABC is done at all it is typically only taken as far as product and service-line gross product profit margin line reporting and does not look beneath that line to report and analyze channel and costs-to-serve for arguably more critical customer profitability reporting and analysis. And what about marginal / incremental expense analysis for that matter? This involves classifying available / used resources as sunk, fixed, step-fixed, semi-variable, or variable. This involves an understanding managerial economics, not just managerial accounting. How many finance organizations have built core competencies in these functions? My suspicion is that many finance organizations are for the most part dealing with more fundamental problems and have yet to build core competencies in many of the practices espoused by analysts, consultants and business pundits.
For now though, my opinion is the CFO function is about to enter a golden age of business analytics and managerial accounting. But we need more evidence. Are CFOs taxiing on the runway, or have they begun lift-off?
This article was previously published on https://www.information-management.com
6. How Many Types of Key Performance Indicators (KPIs) are There?
It seems the Holy Grail for scorecards and dashboards seem to be organizations seeking to answer, “What should our key performance indicators (KPIs) be?” At the heart of selecting KPIs should be their linkage to the executive team’s strategy. However, there are different stakeholders in an organization, such as internal managers and investor governance boards. Each stakeholder has different needs. Hence there should be different types of KPIs for different purposes.
Performance measures reported in scorecards and dashboards is one of the core components of integrated enterprise and corporate performance management (EPM/CPM) rivaling in importance other improvement methods such as customer relationship management and managerial accounting. Regardless of the type of KPI, analytics (such as segmentation, correlation, regression, forecasting, and clustering) should ideally be imbedded in each method, and they are critical for employees to achieve and exceed KPI targets.
Author Brett Knowles, founder of the consulting firm PM2 (https://www.hirebook.com) and a veteran of the balanced scorecard thought leader community, has given much thought to the topic of different KPIs for different purposes. In Volume 4, Number 6 of his firm’s Performance Measurement &Management newsletter Brett describes different types of KPIs in an article titled “Five Distinct Views of Scorecards – and Their Implications.” With Mr. Knowles permission, here they are abbreviated with my minor edits:
- Financial Valuation – A scorecard view is needed to describe what the organization does in a way that the financial world can understand: monetary currency (e.g., dollars, Euros). All activities need to be financially valued, including tangible assets (e.g., buildings and inventories) and intangible assets (e.g., brand equity, employee retention, and customer loyalty). Several methodologies exist that grapple with this need, including economic value added (EVA) and activity-based costing (ABC).
The challenge is that more than 80% of value is created by intangible assets, yet traditional accounting systems do not do a good job of capturing intangibles. The balanced scorecard has proven to be a great tool for making the intangible assets visible and valuable.
Information in this area needs to be:
- Centered on outputs, outcomes or deliverables,
- Closely related to existing valuation mechanisms,
- Standard, repeatable and reliable.
- Navigation – Internal managers need to make informed decisions on a frequent basis that are consistent with the medium- and long-term strategy. Strategy, cascaded downward into the organization through a strategic balanced scorecard and into operational dashboards, dictates both what should be done and how important it is. This view of performance measures creates alignment of employees’ actions and priorities across all functional and regional boundaries and consistency across time. This is where the EPM/CPM methods with imbedded analytics play a critical role.
Information in this area needs to be:
- Very responsive to shifts in the work activities,
- Process based,
- Related to overall effectiveness and efficiency.
- Incentive Compensation – Scorecard frameworks lend themselves to rewarding employees for contributing to the success of the organization. Over-performers should be distinguished from under-performers. A key to this view is for the executive team to assign aggressive yet achievable target measures.
Information in this area needs to be:
- Related to the value that the team can control and create,
- Output and outcome related,
- Accurately measurable and repeatable across locations and time.
- Benchmarking – An effective way to determine whether an organization is making progress is to compare it to other “things” (“comparatives”). There are many comparatives available: competitors, best-in-class, world-class. In the true sense, even target, forecast and revised-forecast are all comparatives too.
The challenge with the benchmark view of scorecards is that the data is sparse and with “dirty” quality. Also, there can be apples-and-oranges inconsistencies (e.g., including or excluding data, measuring different start-and-end times of processes). Comparatives do not typically go into enough detail to provide operational insights into diagnosing any identified issues and root causes, nor do they cover the full breadth of the executive team’s strategy.
Information in this area needs to be:
- Available from other sources,
- Understandable and relatively comparable,
- Strategically related to the organization.
- Evaluation – Periodically, there is the need to get an accurate measurement of how the organization is performing. Periodically the organization needs to undertake such activities as customer surveys, employee surveys, supplier assessments, etc.
These activities are too expensive and time consuming to be conducted often enough to be useful for navigation, but can be used to underpin selection and validation of navigation indicators, support incentive compensation models and be used in reporting performance to outside stakeholders.
Information in this area needs to be:
- Survey based,
- Comprehensive and rigorous,
- Closely related to overall deliverables.
Brett summarizes his five views by stating that most organizations need to consider their organization’s performance in two or more of these views. For example, a shared service IT department may need to prove and measure its contribution to the organization’s overall valuation, provide monthly navigational information for the project managers (and service level agreements [SLAs] for their internal customers), and develop a compensation package for use around the globe. They may also need to compare themselves to industry benchmarks.
The various and numerous stakeholders need to initially develop some confidence that the scorecard model adequately describes their view of the organization. Consider building the various views as a way to speed implementation of a pilot scorecard. A simple way to do this is to create a single enterprise-wide strategy map, but link different indicators to it for each of the views.
My feeling is Brett is on to something important. As I have previously written there is confusion and lack of consensus as to what a balanced scorecard is. There is ambiguity. Further many organizations neglect to first construct a strategy map from which to derive its KPIs. A strategy map is orders of magnitude more important than its companion balanced scorecards and cascaded operational dashboards. They are simply feedback mechanisms.
Understanding that there are multiple scorecard views can bring clarification.
This article was previously published on www.epmchannel.com
5. Does Accounting Undermine Managers' Ability to Make Good Decisions?
By Gary Cokins and his IMA CMCQ task force member colleagues
The Center for Managerial Costing Quality aspires to help management accountants and the broader business community recognize and understand the need, the benefits, and a path forward for improving cost information for internal decision support. Our goal is to establish “managerial costing” as a unique and specific function and discipline within the accounting profession with distinctly different principles and requirements from GAAP and external financial accounting.
This website is not just for accountants. It provides resources for the many diverse stakeholder groups affected by the quality of their organization’s managerial costing practices. We encourage you to use the resources available here learn more about how this issue affects the performance of your organization and what you need to do.
There is a misconception that costs are accurate. Information generated by financial accounting-focused systems is limited to organization-wide measurements and often fails at even basic levels of granularity. As a result, profitability by product, service-line, channel and customer is misstated. Cross-subsidized costs are rampant with misallocations—making profitable business divisions or products look bad while unprofitable business lines look good. Effective business portfolio management is difficult in these circumstances.
Further, the usefulness of information is severely limited. Financial accounting-focused systems fail to measure costs of core aspects of the business. By failing to link costs with causes, the unavoidable results are misleading profit margins, unrealistic budgets and forecasts, as well as ill-informed insourcing, outsourcing, offshoring, capital spending and other critical management decisions.
The persistence of 20th Century management accounting practices and systems into the 21st Century is not due to the absence of better, more relevant accounting models. For several decades, management accounting thought leaders have been developing new, more effective models to meet the needs of organizations competing in a worldwide and highly-competitive marketplace. However, the majority of practicing accountants are unaware of, or are ignoring, these superior methods and concepts. As a result, decision making is weakened.
Management accounting practices need to advance. Accounting systems can and should reflect underlying managerial economics that are essential to guiding an organization to higher levels of success. For too long the accounting profession has fallen behind other business disciplines in its commitment to building and sustaining value. It must now move into catch-up mode to provide managers with accurate and useful information based on cause and effect relationships.
Decision makers should demand better managerial costing from their accountants to manage performance and profitability of products, service-lines, channels, customers and their supporting processes. Simply “adjusting” compliance-focused financial accounting systems and traditional costing practices won’t work. It’s an ineffective solution to the larger problem. Better and more robust information is required to make decisions and take action that builds value in an organization. That information is available, but accountants must be committed to, and managers must demand, 21st Century managerial costing solutions.
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4. A Passionate Appeal for Activity-Based Costing (ABC)
Usually I am fairly rational and do not let my personal emotions interfere with how I interact with others. However, as the readers of my blogs and articles may have detected, my more recent writings increasingly reflect my frustrations with old school accountants. I cannot disguise my irritation and annoyance with accountants who refuse to be progressive.
Several of the titles of my articles these past few years provide hints and clues as to the source of my frustrations. They include “Are Accountants Homo Accounticus?”, “Some Accountants are the Blind Leading the Blind”, “Movie Sequel – Pirate Accounts of the Caribbean”, “Cowboy Accountants – The Lawless Frontier”, and “Do Accountants Lead or Mislead?”
Each time I post an article I’ve written like those I receive several personal e-mails that are supportive of my view. Some are even more vitriolic. Receiving these e-mails, and also the publicly posted website comments to my written pieces, further motivates me to continue broadcasting my message of frustration often shaming accountants. I call it MBE or “management by embarrassment.”
At this point some of you may be asking yourself, OK. What the heck is bugging Gary that he is so frustrated about?” The simple answer is it is the slow adoption rate of applying activity-based costing (ABC) principles as a replacement for the flawed and misleading traditional “cost allocation” methods from standard cost accounting systems. They typically use non-causal cost allocation factors. Examples are the number or amount of direct labor input hours or currency, units produced, sales volume, headcount, or square feet/meters.
Benefits from applying ABC in comparison to traditional cost allocation methods that violate “costing’s causality principle” are too numerous to list here. Key benefits are: (1) extremely more accurate profit and cost reporting of outputs, products, services, channels and customers; (2) transparency and visibility of the “drivers” for work activities and their magnitude; and (3) past period calibrated cost consumption rates that are essential to multiply against future forecasted demand volume and mix that determine resource capacity requirements – workforce headcounts and spending amounts. These rates are needed for what-if scenario analysis, make-versus-buy decisions, and capacity-sensitive driver-based rolling financial forecasts and budgets.
Causality is at the heart of ABC. For example, if the quantity of the activity driver increases 20% then its activity cost should also increase 20%. The work activities are what consume the resource capacity expenses. My opinion is that any CFO/ financial controller or FP&A analyst who are using traditional cost allocation methods and are not using ABC where it is applicable (which is for most organizations) is being irresponsible in their duty to provide valid information to managers and employees. The information they are providing is faulty, distorted and deceiving. Line managers deserve better to support their decisions.
Now read the first letter of the six prior paragraphs as if together they are a two word sentence. My message is blunt: USE ABC !
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