Forum Posts

Larry White
Jan 07, 2022
In General Discussions
When it comes to improving profitability, the management and optimization of resources and processes (work/activities) is only secondary to design of strategy. However, management accounting courses, texts, and methodologies provide a confusing array of choices and create confusion. Let’s simplify the situation. Product or service costing and profitability is part of the issue, but about the entire organization- all resources engaged in any process impacts profitability. Let’s discuss Resources first. Anything or anyone a company hires, buys, leases, etc. is a resource. Resources are the source of costs. Of course, they also generate all revenue. There are fundamentally two ways to manage resources: 1. Pay less for them, which includes eliminating them. 2. Make them more productive – produce more output or more revenue. To be comprehensive, RCA uses the CAM-I Capacity Model which uses Theoretical Capacity. This means resources you own are available 24 hrs/day and resources you lease or hire are available for the full period of the agreement. Resources are used for 3 fundamental activities: 1. Productive – doing the activity you hired them to do 2. Non-Productive – doing a necessary, essential activity – such as, maintenance, repair, training, rework, vacation, sick leave, etc. – but not specifically what you acquired or hired the resource to do. 3. Idle - when there is no productive work for the resource to do. Idle time is often disguised as non-productive work, and hidden from management for fear of losing resources or inviting negative scrutiny. But isn’t an employee, supervisor, or manager's job to become more efficient and create idle capacity? It's a leading indicator of process improvement and should be celebrated and rewarded. Activities or Work are what resources do. This leads to a chicken and egg question – which comes first? the resource or the activities? Clearly resources are acquired in anticipation of work and activity. But, once an operation is going, only reducing (or avoiding the acquisition) of resources saves money; changes in the quantity, type, and quality of work can lead to the reduction of resources. Improving profitability requires you understand how the resources throughout your business contribute to the creation of profit. RCA calls this the operational model. It answers the questions about how resource quantities flow (or are consumed) throughout the organization. Resource capacities must be modeled. Some level of activity or work also needs to be understood and sometimes modeled. This may range from a basic – productive, non-productive, idle/excess – to a detailed process analysis useful if you are focusing on process improvement of a business process or area of the business. Typically, the most positive approach to management and profitability is to focus on making existing resources more productive – How can sales and marketing personnel and their supporting systems and contracted support bring in more sales with the same resources? How can the existing production and support resources – people, equipment, buildings, etc. create more output – services or products? RCA can provide the insights to grow productivity - first with existing resources, then with new resources. Productive time should be maximized by minimizing non-productive time, but also by expanding the capabilities of the resource – process improvement, knowledge, better systems, etc. You may be thinking that all of these require more resources and investment of resource time and money - and you are right. But process improvement and development is productive time. Excess and idle time should never be subject to negative consequences unless of course the resource has work that is not being done. As a leading indicator of improvement, the creation of idle time should be rewarded, then reinvested to grow the organization’s profit potential. RCA provides comprehensive information on resource use and can incorporate various levels of activity or work modeling as required by a business’s strategic situation.
Resources vs. Activities – Is There a Problem? content media
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Larry White
Nov 22, 2021
In General Discussions
Real time financial information is entirely possible, but we need to be very clear about what we mean. Accountants often think in terms of financial vs. non-financial information, but that completely misses some very important points. It is more useful and less confusing to think about monetary information. I differentiate between 2 major categories of monetary information: (1) monetary information which complies with generally accepted accounting principles and external/regulatory financial reporting standards (I suspect this is what is most often meant by “financial”), and (2) monetary information which reflects operations based on causal resource and process relationships. RCA focuses only on the second category. RCA creates a causal model of operations that shows the flows of resources within the organization, if no operational model exists. If an organization has a real time operational model, such as a manufacturing enterprise solution, enterprise resource planning solution, or logistics model, RCA uses those models to the extent possible. The RCA approach is to collect monetary information that reflects the use of resources and processes throughout the organization (not just production or service delivery) as accurately and quickly as is necessary to support the economic decisions managers and employees need to make. My financial reporting-oriented colleagues will argue that this must involve estimates, and they are correct. But using a correct model with reasonably accurate data will get you a much more accurate (and much timelier) answer than using a wrong, slow with perfect data. RCA monetary models create a plan, a target, and an actual. The planned monetary result is what you expect will happen in the future. The target monetary result is what should happen for the actual level of resource use and output generated based on the monetary model. The actual monetary result, which often isn’t known until somewhat later, is what really happened. Overtime, with experience, the monetary model is refined, particularly for the target results, based on feedback from actual monetary results. Does this mean the first category of monetary information is ignored by RCA? No, it can be reconciled at the input and output level to ensure organizational confidence. But each model has its own uses, perspective, and requirements. Neither is better or superior, they are different applications of monetary modeling – one based on financial reporting standards, and one based on the causal relationships among resources used, processes, and customer requirements. The ability to provide real time monetary information for decisions is increasingly becoming a necessary characteristic in today’s economy. RCA makes possible a real-time monetary model that reflects resource, process, operating, and customer causal relationships.
Need Real Time Financial Information? Try RCA content media
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Larry White
Oct 14, 2021
In General Discussions
Cost of all sorts have an essential “nature”. The “nature” is a consumption relationship between a resource and its direct output; the nature of a cost must reflect the the operational quantities that a resource provides to create an output. For example, 0.5 labor hours are required for each output unit. (Simple and obvious, but wait…) In RCA, this is often extended to resource groups that create a homogeneous output. Typically, the “nature” or relationship is defined by a fixed component and a proportional (or variable) component. In most cases, the relationship is linear; but inverse, exponential, and other relationships can certainly exist. Over broader ranges of output, steps in fixed costs can occur when you need to add larger quantities of resources. Like most things in life, the “nature” of cost gets much more complex. Consider the 0.5 hour of labor which initially appears completely proportional. Is it? Labor is supported by a payroll infrastructure; a set of benefits – insurance, vacation, retirement, profit sharing, etc; a work group supervisor; and perhaps more. This support often adds a fixed cost component to what appears to be a purely proportional cost. Furthermore, the same direct labor hour may be regular time, overtime, or a holiday rate. Additionally, the “nature” of a cost can change. The 0.5 labor hour and its fixed and proportional components may produce an output unit such as a required periodic maintenance procedure on a refrigeration unit. The cost of the refrigeration unit becomes a fixed cost of the product that is produced in the refrigerated facility. Such changes are always from proportional to fixed, never fixed to proportional. This seems awfully detailed and complicated: Why is the “nature” of cost so important? A costing approach and supporting system that creates such information is the key to continuously knowing and using marginal and incremental cost information to maximize profit. Additionally, operational systems in manufacturing, logistics, retail, and high-volume services are becoming real time and “SMART” at a very granular level; a level of performance traditional financial accounting and cost systems cannot begin to support. Resource Consumption Accounting is the only cost modeling approach that recognizes and supports tracking the nature of cost and a cost’s potential to change its nature as it is consumed by an organization and its processes. If you want to step up your game as a business partner, it’s time to create financial information that keeps pace with operations and their supporting systems.
The “Nature of Costs” is Essential Information: Do you know what I’m talking about? content media
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Larry White
Aug 20, 2021
In General Discussions
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.
Cost Information Confusing?  Fix it...Now! content media
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Larry White
May 27, 2021
In General Discussions
When talking about cost and internal decision support information, you often hear this question asked? Why? Most costing efforts begin in finance. They begin by dissecting the general ledger to create more operationally meaningful information. Which means they need to reconnect financial accounting information with operational information (that was meticulously stripped away in the traditional accounting processes and systems). Doing this is complicated - its hard work, information must be re-aquired, shortcuts are often used to make connections (often designed on the fly and poorly documented), and even when its done credibility is often low. The real problem is the financial accounting model was never meant to be a model for internal decision support; it was designed to provide “general” information for external creditors and investors. The times are changing, for the better. Good internal decision support always required a different model. It required an operational model with costs designed to reflect the resources and processes of the organization. The biggest change is Industry 4.0. As industries adopt “smart” technologies, they create a model of their value creating operations, many support functions, and inbound and outbound logistics. The operational model is mostly there. You just need to figure out how to design a cost system to reflect it. This is where RCA excels and has long experience. RCA has only focused on modeling for internal decision support to improve performance, managerial innovation, and profitability. RCA focuses on accurately modeling cause and effect relationships, modeling fixed and proportional costs (and how they change) through processes, modeling capacity and capacity cost. RCA information creates readily available incremental and marginal cost information that is critical to many profitability decisions. Product and services costs are not distorted with arbitrary overhead allocations, they don’t change with production or sales volume and mix, and costs can be multi-dimensional for sales channels, customer costing, etc. Why would you not want this view? Especially when the technology you are investing in and applying to your company’s operations minimizes the “climb”.
Is the View worth the Climb? content media
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Larry White
Apr 21, 2021
In General Discussions
Most cost information accountants generate and present is based on financial reporting standards and generally accepted accounting practices (GAAP). It is “truthful” to those standards. But is it “truthful” for other uses? RCA follows the IMA’s Conceptual Framework for Managerial Costing to create information that is “truthful” for internal decision making. How can both be truthful and different? This is truly a question the accounting profession needs to do a much better job of addressing. Many accountants are hesitant to leave the well-defined safety of their accounting standards and rules. Truth has five major theories, according to Wikipedia: Correspondence Theory – Truth corresponds to facts. Coherence Theory – Proper fit of elements within a whole system. Constructivist Theory – Constructed by social processes Consensus Theory – Whatever is agreed upon Pragmatic Theory – Putting concepts into practice Only the Correspondence Theory is relevant to science and the scientific method. All the other contain social/human compromises. What type of “truth” do you want to use for decision making? Unless, you are only looking at a quarterly bonus tied to financial statement results, you want to use the Correspondence theory to make long term value creating decisions. And that “truth” is what the IMA’s Conceptual Framework for Managerial Costing and RCA use for modeling operations and cost for internal decision support. The Correspondence Theory of truth is what your operational systems use to help you optimize operations. (Not many operational systems are beholden to a group of people like the five accountants in Norwalk, CT to define standards for its “truth”, i.e. Financial Accounting Standards Board for the US.) Cost and operational information for internal decision making needs to reflect the “Laws of Nature”, or factual reality. Accounting standards for financial reporting are clearly “Laws of Men”, resulting from a social consensus process. Fortunately, this is not an “either/or” choice. You can, and should, have both operating in your organization.
Are You Ready for a New Definition of Truth for Your Cost Information? content media
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Larry White
Mar 10, 2021
In General Discussions
Financial information often confuses operating managers. Typical accounting information from company financial systems is geared toward financial reporting standards and audit, not supporting operating decisions. Often it is so generalized and convoluted that it simply isn’t fit for any other purpose. Operating managers in the age of Industry 4.0 are increasingly digitalizing processes and systems and pursuing process improvements based on the metrics they design, typically to optimize resource use. This has been very successful, even in the absence of relevant and corresponding monetary information. But how much better would things be if monetary information was available? A platinum mine had invested in digitalization and advanced operating systems. It had developed a dashboard of metrics to control a complex ore conversion process. The core of the innovations was to create a stretch goal for the operating metrics based on optimal process capabilities. Supervisors were challenged to meet the stretch goal during their shifts. The stretch goal was extremely difficult, and supervisors developed a number of different strategies to get as close as possible. A problem arose because there was no way to assess which of the various strategies was most successful. Several were equally effective at closing in on the stretch goal, but the strategies differed significantly. The company needed to know which strategy was most cost effective. The solution was to use Resource Consumption Accounting to create a causal monetary model of the operations, one that reflected the resources and processes the supervisors and employees knew at the same level of granularity they managed the work. The monetary information also had to be simultaneously with the operational information, every 15 minutes. The result: Operating managers now have all the operating metrics to pursue the operating stretch goal, AND they have an Opportunity Cost metric which shows how much they operating above the operating stretch goal cost. They can compare their various operating strategies using the Opportunity Cost metric to see which strategies are most cost efficient. Furthermore, then can experiment within a shift to continuously improve their cost performance.
Operations Will Benefit from Causal Monetary Information content media
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Larry White
Jan 21, 2021
In General Discussions
One of the great strengths of RCA is its ability to reflect operational cause and effect relationships when they are monetized. (Keep in mind this is something financial reporting driven cost accounting only does at the most general, entity wide level.) How do you know if your financial decision support information is causal? Your financial model must be based on an operational model that reflects resources, processes and the operational quantity flows. Causality applies equally to both operational and monetary quantities. The flow of operational quantities should show fixed quantities and proportional quantities and should be reflected clearly in the monetary model. Causality applies to both fixed costs and proportional costs. The fixed and proportional quantities and money should start at the product, service, or other equivalent managerial objective. Only quantities and costs with strong causal relationships should be included. No high-level generalized allocations! Business levels such as product/service groups, families, or lines should be used to bring in organizational costs that have strong causal relationships to managerial objectives at that level but lower levels. Examples could include a marketing group at the product family level, a warehouse for a product group, or a business analysis team that works for the product group manager. Idle and excess capacity must not be ignored and should be tracked to the appropriate organizational level responsible for over-acquisition or generating market demand. Keep in mind that production/service providing activities are very seldom responsible for excess capacity, except when they have created it by becoming more efficient…..and for that they should be generously rewarded, not held accountable for excess capacity. One can argue that marketing and sales is responsible for most excess/idle capacity, unless another manager chose to buy more capacity than demand justified….hopefully, for a good reason. If your product or service costs fluctuate with volume and mix, your cost information clearly has a causality deficiency. You must do special analyses or studies to determine the operational cause of monetary effects/results or realistic monetary results of operational changes. Operations and finance argue extensively over the “economic reality” of cost information. I could go on, but hopefully, these eight points give you an idea of the high quality causal internal decision support information that RCA can create. I welcome your questions, observations, comments, and/or challenges.
Causality is the Key to Effective Internal Decision Support Information content media
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Larry White
Oct 30, 2020
In General Discussions
In the 1910's, H.L. Gnatt stated: “When times are good and there is plenty of business, this method of accounting indicates that our costs (per product) are low; but when times become bad and business is slack, it indicates high costs due to the increased proportion of burden each unit has to bear….Our cost systems, as generally operated at present, show us under such conditions our costs are high….far greater than the amount we can get for the goods. In other, words our present systems of cost accounting go to pieces when they are most needed.” Sadly, what was true then, remains true for a shockingly large number of businesses who have not realized the need for managerial cost systems that are designed to provide information for internal decision support. The Institute of Management Accountants has created a Conceptual Framework for Managerial Costing (CFMC) that defines the principles and concepts that must be applied to create cost information for internal decision support. Resource Consumption Accounting is the most comprehensive way to implement those principles and concepts. “Responsiveness” is one of the 10 concepts that support the principle of causality, or cause and effect, which is the fundamental principle for managerial cost modeling. Responsiveness means: The correlation between a particular managerial objective’s output quantity and the input quantities required to produce that output. Practically, this means being aware of the nature of the resources consumed by each step in a process. For example, electricity (when purchased from a power company) is typically a completely proportional resource – it is consumed as it is needed. But if a particular material must be kept refrigerated to a particular temperature, the electricity associated with keeping the material cooled becomes a fixed resource quantity and, of course, cost unless the production using that material is halted and the inventory depleted. Tracing the use and nature of resources is critical to having responsive costs. Traceability vs. Allocation The difference between traceability and allocation is important because, while these terms are often used interchangeably, they are at opposite ends of a scale from a cost modeling perspective. Traceable means the ability to assign costs based on a clear and verifiable quantitative causal relationship. Thus, it becomes a direct cost relative to what can be traceable. In contrast, allocation is an arbitrary or generalized spreading of costs when the link between resource quantities and their dollars have been lost, no traceable causal relationship exists, or a causal relationship is ignored. Under the CFMC, allocations are always viewed as creating distorted information. Pooling and allocating traceable costs using a general metric provides less causal insight than tracing. Allocating costs with weak or non-causal relationships to a managerial objective also distorts the quality of decision-support information. To have responsive cost information, the operational model must drive the cost model. And the cost model must be designed to collect and report information that reflects (like a mirror) the operational quantities used by resources and processes. Financial accounting and reporting information designed to support regulatory requirements don’t have any requirement to incorporate the principle of causality or the concept of responsiveness…..they aren’t even designed for internal decision support, they are designed for external investors and creditors. Get responsive for your internal decision support. Get RCA.
Is your Cost information Responsive to Operational changes? content media
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Larry White
Oct 23, 2020
In General Discussions
Now that I have your attention. The question is largely irrelevant. The real questions about fixed and variable (RCA uses the term proportional) costs should be: 1. Are they avoidable or unavoidable for the decision at hand? 2. What is the nature of my market and my risk tolerance? Question 1: Avoidability is the decision support perspective on resources and associated costs. Depending on the nature of the decision, both fixed and variable costs can be either avoidable or unavoidable. Consider some examples: Example 1: A manufacturing company decides to replace an old extrusion line with modern equipment. This results in a significant reduction in the amount of maintenance required. The maintenance manager realizes that he can reduce his total maintenance capacity by 8,000 hours, the equivalent of a whole crew including the crew's supervisor and workspace. The supervisor’s salary is a fixed cost because his/her activity is not tied to the level of maintenance activity. This fixed cost is avoidable. The technicians’ salaries are a variable cost because their activity is tied to the level of maintenance activity This variable cost is avoidable. The workspace is a fixed cost. It is not avoidable because of this decision, but an additional decision to modify a lease, rent the space, or release a rented storage space and use the workspace may allow some cost avoidance. Example 2: The same company receives an offer from an outside vendor to take over the maintenance & repair of extrusion rollers. The manager knows from his RCA system that the company spends 2,400 hours per year on these activities. A maintenance technician works 1,600 productive hours per year. The technicians’ salaries are a variable cost because their activity is tied to the level of maintenance activity. One technician’s salary is avoidable – 1,600 hours. The second technician’s salary is unavoidable, assuming it is not reasonable to cut hours or hire a part-time technician. If reducing hours is an alternative, then 800 hours could be avoidable. Question 2- What is the nature of my market and my risk tolerance? Fixed resources and costs create leverage. These means that when business is good and the resources that generate the costs are in full use, profits can be very large. When business is bad and fixed resources cannot be trimmed, profits can be meager or nonexistent. Variable resources and costs tend to increase or decrease with business volume. This tends to create a more stable level of profitability if a business can quickly adjust resources to business volume. Few businesses can avoid some level of fixed resources and costs. Conclusion: RCA tracks the nature of resource use and costs as fixed or proportional (the word RCA prefers over variable) as they are consumed in processes. This applies the concept of Responsiveness as established in the IMA Conceptual Framework for Managerial Costing. This means marginal profit, revenue, and cost information is readily available for decisions with RCA. RCA is the only costing approach that provides clear insight into the changing nature of costs in processes. What does this mean? Variable or proportional costs can become fixed based on their use and consumption in processes. RCA shows how that happens. I’ll leave the detailed discussion for another day…..but many management accounting authors have observed that fixed costs have a “snowball” effect and grow rapidly within an organization.
How do you prefer your costs - Fixed or Variable? content media
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Larry White
Oct 15, 2020
In General Discussions
RCA provides actionable information for internal decision support that clearly reflects operational causal relationships and economic reality……That’s a mouthful. What does it really mean? Financial accounting and financial statements create financial information in accordance with financial reporting standards and generally accepted accounting practices. The focus of financial reporting standards is on creating “general” financial statements for investors and creditors. That is required. They do not need to produce information that is useable for internal users; but they do produce some information that is accurate along with some that is quite distorting. It is widely known that financial statement information on its own is not particularly useable in its original form for investment decisions or predicting long term capital market value. Every investment firm or rating firm substantially adjusts financial statement information for their decision-making. Consider EVA, Earned Value Analysis, it adjusts R&D, advertising/promotional expenses, capital investments, and other intangibles to treat them as value creating investments over an appropriate time period. Detailed EVA analytics look at financial statement categories and provide estimates of the impact on the market value of the company from making changes to them. Companies that sell major capital improvements such as digital manufacturing equipment, systems, and software often use EVA to show the return to companies of making these investments. Why to into EVA so deeply? RCA picks up where EVA stops. EVA may show that a company’s SG&A is higher than a comparison group of companies and that investing in reducing it could create a positive return on the capital markets, but EVA cannot identify the resources and work activities included by a company’s SG&A or the causal impact on process, products, and customers the SG&A supports. RCA models provide that detail in both resource quantities and monetary metrics. RCA operates free from financial statement standards and generally accepted accounting principles to create information that reflect the causal relationships of resources and processes on products/services and customers. Information from an RCA model looks like the resources and process in your company. For example, RCA shows capacity information and clearly shows the fixed and proportional amounts of resource use including the monetary implications which means visibility of incremental and marginal cost. Not limited by GAAP, RCA can include any resource with a causal relationship in product/service or customer cost. Items such as sales commissions, collection cost for receivables, or amortization of R&D can be included if they have a logical and actionable causal relationship for an organization. Many companies are seeking a clearer or more economically relevant view of their performance. RCA is part of that solution for consistent value creation with high quality internal decision support information.
Why Use RCA? content media
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Larry White
Sep 18, 2020
In General Discussions
It’s good to have you here. Thanks for being a part of the RCA community. Feel free to start discussions and share what's on your mind. In this forum you can also add photos, videos, hashtags and more to your posts. Enjoy using the forum!
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Larry White
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