Hello, everybody:

It's finally springtime in Atlanta (...almost, anyway). The pollen will cover everything like snow in no time. Lately I've been working on a new project, and I wanted to share it. It's a series of dialogues from people within a fictional company. Each installment in the series addresses a different quality/management issue and features 3 people from this company talking about the issue from their own perspectives. I thought it would be an entertaining way to illustrate a point.

Please take a look at the attached file, which addresses the need to understand your true costs. Let me know what you think.

Talk to you soon,
Craig

Craig, this is a very good illustration of how a faulty cost accounting model can almost be worse than no cost accounting model at all. Its a chance to do a smoke and mirrors job on the true state of a company's affairs. Or, it can be a dangerous tool in the hands of those who do not know the process. I won't get into what it can be in the hands of those who intend to do wrong.

The process rules.

That's a good one. I would like permission to use it in the next City University course I teach. I got roped into teaching "Financial Management" next quarter as the regular instructor was not available. I have usually held up my clove of garlic, silver bullet, and cross at any mention of Finance, so this is turning out to be interesting. The textbook is really pretty good and is updated through Enron finance manipulations. It is very interesting getting an "insiders look" at the world of Finance. Lots of interesting twists to the operational definitions in the Finance world.

Craig,

Thanks so much. A little bit of knowledge can go a long way, and that way might be full of fire and guys wearing red suits, holding pitchforks. One of the plants my old company acquired a few years ago had no clue what it costed to make their products. Random costing, basically. Needless to say, no amount of process improvement could help them. It took about a year before the company finally closed the plant (...and it was 6 months too late). How's everything in Sandersville?

Steve,

Thanks a lot for your feedback. You poor rascal--They should give you special hazard pay for teaching finance. I know you'll knock 'em out, but of course you'd rather be teaching your regular slate. By all means, please use this for the class if you think it would be helpful. I would be very gratified. I'll be interested to hear how your quarter goes.

Craig

Craig

Sandersville's great, but the weather has been a little strange, as I imagine it has been in ATL as well.

Having a degree in accounting, I would like to stress that there are many areas of cost accounting that can snag the unwary manager. Beware the calculation and application of overhead to your budget. Often those costs will be calculated with numbers over which you have little or no control. An example:

A person I know well was a manager who had several people out in the field that reported to him. He and one person who reported to him were located at the plant/office site. When office supplies were budgeted at the beginning of the fiscal year, he would estimate what the two of them (he and his assistant) would need. But, there were several other departments located in this office, and there were 20 - 30 people in these other departments. Because the office supply costs were divided equally between the departments, this guy was routinely over budget in that area.

Hey Craig, long time no see :bigwave:Please take a look at the attached file, which addresses the need to understand your true costs. Let me know what you think. I like it. I would just like to point out that I have seen a similar situation... with my first employer:

When I came there, they were in the process to start phasing an old product out. I was told that it was a pain to produce and gave a very slim return. Just a couple of days later one accountant came (literally) flying into the office shouting that we should leave said product alone. He had done a bit of number crunching and found out that it was the product keeping us alive! Further examnation proved him right.

Phew.... :mg: I never forgot that lesson: It is always a good idea to complicate matters by using fact...

/Claes

Interesting to read, and pretty realistic. I've definitely seen this scenario play out before. :eek:

Just one opportunity to improve:

Well, what we charge for custom molded parts averages around 50% of what it costs to make them. That includes labor, materials, and overhead. Doesn’t sound bad, does it? It’s a 50% profit margin.

If we charge only 50% of what it costs to make, that's a loss, not a profit...

Craig,

One of the things that I like about the traditional MBA is that it forces people to understand a bit of cost accounting and finance. I would never have studied these unless I had been forced! You're right: applied overhead is often a trap. The application is often misguided or flat wrong. It's all in the voodoo...

Claes,

Howdy! Yes, I've been away. In fact, I was incarcerated for a short time, but I was completely exonerated. I got some cool jailhouse tattoos, though! Your example shows how critical and tenuous these costing issues are. One second we've got to phase a product out because it's eating our lunch, and the next second this is the product that's keeping us alive. You wonder how people's calculations can vary so much, but it seems to happen all the time. Is it getting warm yet in lovel Sweden?

Howste,

Thanks for pointing out this glitch, my friend. No wonder this company doing so poorly, they're selling products at 50% of what it costs to make them! What a pack or idiots. They have even worse problems, I'm afraid.

Talk to you soon,
Craig

I would like to see photos of your "jailhouse ink"
Best I ever saw were on some Yakusa done in Japan - next best were designed by a "tagger" (graffiti artist) and executed by a 70+ year old inmate doing life. (The perks of volunteering to help halfway house folks assimilate into straight society)

I was completely exonerated. I got some cool jailhouse tattoos, though!.Good Grief :mg: . Well, its good to have you around again, with or without tattoos. :agree:

You wonder how people's calculations can vary so much, but it seems to happen all the time.I suppose it depends on what you enter into said calculations. We have an expression about that here: SISU. A somewhat moderated translation would be Junk In-> Junk Out (A more accurate translation would get stuck in the foul language filter used here ;) ).

Is it getting warm yet in lovel Sweden?Not exactly warm... but warmer: see the weather thread (http://elsmar.com/Forums/showthread.php?t=14453).

/Claes

I suppose it depends on what yo enter into said calculations. We have an expression about that here: SISU. A somewhat moderated translation would be Junk In-> Junk Out (A more accurate translation would get stuck in the foul language filter used here ;) ).

OK, I can't resist, so here is one more SI, and one of my favorites.

When budgeting, certain assumptions are made. One of these is the number of units that will be produced. This "guess" is very important because it becomes the denominator in many calculations (overhead per unit, for example).

Now, there are fixed costs (rent, for example) and variable costs (raw materials) that are applied to each unit of product. Here's where it gets strange. Usually treated as a variable cost, labor can act as a fixed cost until overtime is incurred. If we produce 20, or 60, units of product instead of the budgeted 40, our overall labor cost is the same, yet the amount applied per unit varies greatly.

Uh oh, I see eyes glazing over already. Wonder if I can hide in this soapbox....

Craig C, an excellent story/example as usual. I can still remember some of the horror stories from when I got my MBA back in 1990. It's amazing but companies are still doing them.
Here's one from my current employer - we import a material at a cost $625/ton, add materials to it and process it and then sell at $800/ton. Production management is proposing that we produce in house at a cost of $600/ton and that we will save $200/ton. To produce in house will eventually require programming changes estimated at $50,000. When I questioned them regarding the savings saying that it was $25 a ton, I was told that I just didn't understand and that it was $200/ton. Pay off time for the required programming changes drastically from $25 to $200 per ton cost savings - @ $200/ton its roughly 1 year.

A couple of additional tidbits of info - numbers have been changed to protect the guilty but are similar in terms of magnitude, the production manager has an MBA from a local college, & we hit year 5 in January, 2006 without having a profit from this plant.

And yes, especially after the response from upper management regarding numbers that do not make sense, I am looking for another position/company :)

I was told that I just didn't understand and that it was $200/ton. Say what? :confused: I guess both of us must have skipped that day in shool...

/Claes

I skipped the day they told the students:

Year 1 $20000 loss
Year 2 $15000 loss
Year 2 $5000 profit

Numbers are always telling the truth.....

Sad to say, the above happened just a few weeks ago...

...I don't have the contract...lucky me...

.....When I came there, they were in the process to start phasing an old product out. I was told that it was a pain to produce and gave a very slim return. Just a couple of days later one accountant came (literally) flying into the office shouting that we should leave said product alone. He had done a bit of number crunching and found out that it was the product keeping us alive! Further examnation proved him right...../Claes

Claes

When I took my MBA I was lucky that finance was taught by an actual living person who had worked in industry and had a working brain in his head.

He made us do case study after case study. No one ever got it right. And there were some very, very smart people in my class.


Budget versus actual
Fixed vs variable costs
Contribution pricing
tax considerations
currency valuation
multinationalFinance is all voodoo math. To make stock prices look good and avoid taxes.

He told us to avoid running a company on any of the financial numbers. He told us that any time it looked like we could make more money by eliminating a product we were probably wrong (the overhead has to go somewhere)

He said run the company like you run your check book. More cash had better come in than you pay out. And thats all there is to it.

I've since seen it call "put and take" accounting (take less out than you put in). But heck, you don't get paid MBA bucks if you talk simple like that....

I had taken 3 years of book keeping at night school several years before my MBA and I learned more from that than all my MBA finance classes. The teacher used to say Goodwill, Inventory, and Receivables may be Assets but only Cash is cash!

Interestingly, the finance professor is still one of the few financial types I have met who actually believed that Cost of Quality was a valid measurement. Most accountants go berserk at the mere mention of it.

It is often said that we in the Quality profession do not speak the language of business. I'm starting to think that may just be "a good thing" as Martha would say. If she had spoken quality instead of business, she may have saved herself a lot of trouble.

FWIW, where I got my undergrad in Accounting, many of the Finance mjors were Accounting majors who couldn't get B or better in Interemediate Accounting. There were Intermediate 1, 2 & 3 (3 quarters). For 1, there were 3 full classrooms, for Intermediate 2, there were 2 fairly good size classes. by the time we got to the deadly Statement of Changes in Financial Position with Outstanding Options and Warrants, there was 1 class with about 25 very tired people. So, the Finance classes did the opposite, with a sizeable number of graduates.

I took a grad school class on "Finance for No-Financial Managers". The instructor said they boiled down a semester course into 2 days. It was pretty easy to understand, but mostly geared to small businesses.
I have seen the accounting trickery used by corporations to increase or decrease profitability of operating units by varying the "Corporate assessments" monthly as needed.

Hello, everybody:

It's finally springtime in Atlanta (...almost, anyway). The pollen will cover everything like snow in no time. Lately I've been working on a new project, and I wanted to share it. It's a series of dialogues from people within a fictional company. Each installment in the series addresses a different quality/management issue and features 3 people from this company talking about the issue from their own perspectives. I thought it would be an entertaining way to illustrate a point.

Please take a look at the attached file, which addresses the need to understand your true costs. Let me know what you think.

Talk to you soon,
Craig

Well done, Craig. :agree1: It's an "Abilene Paradox" sort of situation, with the exception of a lone dissenting voice, albeit one that no one listens to. I was party to a situation once where an idea for a new product was proposed. The S & M (use that abbreviation whichever way you want) people loved it, the CEO loved it and soon everyone loved it. A lot of money was spent on designing and building the top-level product. A mold was built, circuitry and circuit boards were designed and fabricated, etc. The problem was that the proposed product depended on a consumable component which would require its own separate design and engineering, and which everyone should have known was beyond the state of the art at that time. It was possible to make it in prototype form, but mass production was another issue. It turned out that manufacturing in quantity just couldn't be done due to cost issues--information that was readily available before the first nickel was spent on development. The great new product was allowed to die a very quiet death, but only after the development costs--easily in the seven-figure range--had gone out the window.

Good topic - I have been researching the subject of "Costing" - I have always worked the operations side of my industry (service/tranporation) and part of a team visiting our various facilities looking for ways to improve and reduce cost - I realized how inept I was at the financial side of the business. I found an online course through the American Management Association - Self Study courses for areas such as Activity Based Costing, Reading Financial Statements, and tons of others -

Anyone have experience with these courses?