In this particular case, financial accounting is like the building plan of your house: in theory and on paper it looks fine. But when making short & long term decisions, FA cannot deliver the intelligence required to making the right decisions from a profitability point of view.
Mumbo jumbo in the basement
Management accounting focuses on getting the right information to the right people at the right time. Managers and CEOs make decisions based on a number of factors, parameters and hypotheses. Having the right data in terms of profitability, overhead costs, cost breakdown are essential for good decision making. The question whether you want to (dis)continue a certain product or service requires an understanding of the contribution management fundamentals.
Contribution management is the mumbo jumbo that managers do when making short-term decisions. They look at hedging the overhead costs of the organization with incremental orders. Thus they can consume unused capacity at a marginal cost: the variable cost.In order to reach your full capacity potential, you might want to hire some black-belt ninjas that deal with bottlenecks inside your organization. This "Theory of Constraints" was introduced in the Seventies by Goldratt and focuses on optimizing your production capacity. Obstacles along the road (overbooked people, jams in the througput, means,...) are skillfully removed in order to maximize your capacity.
This mumbo jumbo can go on until you have reached your full capacity.... producing more will become counter-productive. You need to make considerable investments to grow your capacity but your overhead costs now grow exponentially... Time for another approach I'd say.
No ABC without technology
Now, if you want to optimize and sustain long-term profitability, you're talking about Activity Based Costing. The principle behind ABC thinking is simple: allocate a ratio or percentage to each of your activities. The grand total of all activities can be expressed in hours or man days and that's the total (operational) cost. Now each activity will account for a given percentage of the overal cost et voilĂ : We have a cost per activity. That's OK if the process is straight-forward and you don't have Murphy wondering around the work floor.
Complex organizations rather opt for a time-driven ABC approach where you can include multiple parameters into the cost equation. These parameters are called drivers and they... euhm drive the overall cost per process, product or service up or down. This approach allows to identify new (structural) bottlenecks or efficiency accelerators. The problem I see with ABC is that it takes more than two to tango: you need ERPs, CRMs, BIs, BSCs and CIOs; If the going gets tough, the technology has to keep on going; There is a critical dependency on several core IT systems to make it all work - and still has to be easy on maintenance. Not easy of you are dealing with legacy systems or a lack in web service capability.
But then again, if you want to know: who is your most profitable customer, which products or services yield high margins or what is driving corporate overhead costs, organizations need Aayooh - technology.
I think that I have a grip on it: there's full costing but that's not the same as pricing, you have variable costs that can be fixed and fixed overhead costs that become variable. And in the long run, you end up with a whale in your showroom: Aha, so that's what management accounting is all about - if we can't convince them, we'll confuse them.
Will the real Jean Jacques Cousteau stand up!
