Let’s start with the basics: Profit = Revenue – Cost. It’s simple for an organization. Complexity occurs as you try to understand this equation for individual products or services…or an important but often overlooked dimension - customers.
To maintain a level of simplicity, let’s forget financial accounting rules and standards….and the cost accounting you learned in college. The key to logical, understandable cost information is applying the principle of causality, or simply cause and effect. The primary dimension of causality is the strength of the cause and effect relationship between the inputs to a product, service, customer, or more generically “managerial objective” and the output which you are seeking to understand. The strength of a causal relationship can range from none through weak to very strong. The question I usually ask is: If an input were taken away, how long before the impact on the output would become critical? Very strong causal relationships usually have an immediate impact. The time period usually lengthens as they grow weaker. An exception is items like insurance or regulatory requirements which are often required. They fall under a second question which must often be asked as causal relationships move from strong to weak. The second question is how traceable is the causal relationship and/or how much effort is required? With this question, you often need to consider the effort of changing behavior. Often more administrative areas of the business simply haven’t tracked resource use because it wasn’t necessary for financial reporting cost standards. I strongly recommend that be changed where the causal relationship is strong. At least start a process of improving estimates and presenting the information as a cost contributor to a managerial objective, product, service, or customer.
Simplicity is improved by focusing on a model of operations that shows how resources contribute quantities of effort through processes to managerial objectives. Talking about resources and where effort goes, in terms of real equipment and/or teams of people doing similar work, is much easier and clearer than talking about the flow of money. Modeling monetary flow in a manner that clearly reflects the flow of resources and work retains a level of clarity.
Resource Consumption Accounting is designed to reflect and highlight resources, capacities, and processes and thereby simplify the information used for decision making. It put operations first – operations of all types: administrative, sales/marketing, and production – and makes the costs reflect operations and resources to represent a clear cause and effect reality.