Product costing. A lost art?
Through numerous discussions with manufacturers, we’ve found that it’s become more difficult for companies to accurately calculate how much it costs to produce a product. A big part of the problem is that companies have become too reliant on ERP technology solutions. What continues to surprise us, though, is how many manufacturers aren’t even aware just how off-the-mark their product-costing has become — and, more important, just how much it’s costing them.
About two decades ago, ERPs began featuring automated product-costing solutions, and this was embraced enthusiastically — and for good reason. The technology streamlined what had traditionally been a complicated, time-consuming task: capturing the actual cost of producing a product. It promised to measure more quickly and accurately the costs of thousands of items with multi-level bills of material — and across numerous plants and other work spaces.
But, something happened along the way. As companies’ supply chains and manufacturing operations grew more complex, so, too, did ERP costing calculations. Now, many companies rely too heavily on ERPs’ automated costing solutions, which don’t always accommodate increasingly complicated and digitized operations (e.g., tracking only one costing methodology, or unable to track some costing data). Companies also struggle to track important operations performance and maintenance data, increasingly available via digitalized or automated machines and devices. In many cases, inaccurate product costing has masked operational and supply-chain inefficiencies and has even affected bottom lines.
The case for an ‘operational finance’ reboot
Over the years, diminishing product-costing expertise prompted many companies to enlist technologists and system implementers to make key decisions on the design and delivery of product-costing solutions. Some companies have assigned specialists with little product-costing expertise to carry out and oversee product costing. As a result, more and more companies — particularly in the manufacturing sector — are finding it difficult to provide reliable and accurate product costing. Such companies need to build a product costing group from the ground up. Improving matters means triangulating finance, operations and technology solutions to achieve a robust operational finance function. Ultimately, this could unlock data that can support growth strategies — and even improve top and bottom lines.
Bridging finance and operations
As a company changes and grows, so, too, should the collaboration between operations and finance departments. For many manufacturers, both finance and operations specialists lack the knowledge required to calculate the various costing values attached to producing an item. This can lead to inaccurate costing data that hinders operations personnel to make production improvements supported by solid costing data. Meanwhile, finance personnel are challenged in accurately measuring performance and variances which can lead to approximated financial statements.
Additionally, balancing operational and financial insights could help in building business cases for change and to validate investments and operational improvements (e.g., a new machine, a new plant, or an additional shift or production line). The soundest investments achieve two things: they yield the expected improvement to operations and demonstrate the value they create in financial statements. To meet these twin aims, companies need a strong and collaborative operational finance/products costing group.
Ambitious people-change management needed for improved costing
Ever-increasing complexity in cost calculation, together with high turnover in finance, accounting and supporting IT groups, has led to a shortfall of product-costing experts. To fill this talent gap, many companies have turned to IT resources; however, information technologists rarely have the know-how to use costing information to support business strategies. Some companies enlist system implementers (SIs) for product costing, but they typically lack expertise (e.g., the ability to build product-costing values into ERPs or the experience to work with manufacturing floors to track all costs).
That means companies need to look inside (and even outside) the organization to build a strong costing group well-grounded in direct costs and the impacts those costing impacts have across the organization. A rebuilt product-costing group will also be able to identify root causes of costing variances.
Three keys to rebuilding the lost art of product costing to accommodate new complexities:
1. Define consistent global costing data elements.
First, rebuild the foundational partnership between management, operations and finance. Collaboratively assess whether your company is tracking the right cost elements. Indeed, each company’s costing function is unique and needs to evolve to support diverse business needs (e.g., controlling or improving specific types of expenses, efficiencies, quantity, customer service, etc.). Enlist operations and the finance functions (as well as technologists) to validate these cost elements. These first steps are critical to building a balanced and interacting product-costing group.
2. Align costing data inputs and outputs between finance and operations.
Gain a granular visibility into what data is currently being provided by both operations and finance. For operations, this includes the data required for rate calculation, variance creation and understanding of what data is recorded to the ERP system. In addition, map inputs from finance to drive these key costing metrics and to document the process in training documentation. Finally, develop tools and processes to enable rapid access to financial information so operations personnel can track operational performance and improvements.
3. Build out an operational finance team.
This includes training finance functions in day-to-day operations responsibilities, tracking operations data in financial accounts and generating information required for operations to understand the financial numbers and trends. Focus on measuring for variances in a standard costing environment. Break the variances down into actionable pieces and train both operations and operational finance on the components involved in variance creation. If needed, create training materials and playbooks that can be used to enlist additional product costing specialists. In all training, focus on product-costing causes, effects and countermeasures to correct variances on costs that can occur across the organization.