Quality Lessons from the Field - The need to understand your true costs

[ccochran]

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 H.]

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.

[Steve Prevette]

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.

[ccochran]

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 H.]

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.

[Claes Gefvenberg]

Hey Craig, long time no see

Originally Posted by ccochran

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

/Claes

[howste]

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

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...

[ccochran]

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