Featured Malpractice
Or, how to screw up your business and impede its development
Links to best practice articles and training below
This page contains a practice, (which is changed regularly), from our library of over 100 business malpractices, to illustrate the very worst practices we have encountered, and which we seek to eradicate by showing you and your executive responsible for this practice how they are damaging your business. We are currently featuring a Finance practice of which we thoroughly disapprove:
Malpractice M007
The Fortunes of Innocence:
"The Cost of the Costing System"
(Or why you do not understand your product costs, however sophisticated your costing system is, without firstly simplifying the process.)
The purpose of this article is to explain one of the finance department's, contributions to operational inefficiency in trying to understand costs by incorporating spurious accuracy & unnecessary sophistication into management accounts.
In this article we explain why this is a hopeless task anyway.
Hidden Costs
Our hero "Innocence", a fresh out of university, young (and innocent, to the extent that some might say naive) new PA to the Managing Director, was trying to persuade an operator one day in his plant to keep a record of faulty work to reveal the scale of a suspected quality problem. The operator's response was "I will need to discuss this with my accountant", which left Innocence incredulous. "What do you mean?", he innocently replied. The operator indignantly retorted, "It is now a standing joke out here in the shop. The accounts department contains as many people as there are operators in the shop. They rule every detailed activity and measure everything that moves." This struck Innocence as a ludicrous and very frivolous comment which he ignored!
Innocence compromised. "OK don't report the numbers. Instead of just reworking the faulty work, can you please set it aside for one week." Before the week was out the operations manager burst into Innocence's office demanding to know why he was causing chaos in the shop. Innocence nonplussed, accompanied the operations manager to investigate. There was a mountain of faulty work! (Virtually every job needed rework and there was almost no output.) Of course this actually achieved Innocence's objective to reveal the size of the hidden rework problem without adding to the administration by using simple visual methods! (But he had made an enemy of the Operations Manager!)
Also Innocence asked, "what is the root cause of this problem". The operator replied, "well when these raw materials were bought from our original supplier we did not have a problem, but I think the Buying office decided to buy from our current supplier because they are "cheaper". Shouldn't the supplier pay for this", he asked?" (See Malpractice M003: Buying Cheap)
On another occasion when Innocence investigated high scrap rates, he revealed that the biggest quality problem they had, was the operator, cutting corners to make more output (to hit the numbers)! Despite threats of disciplinary proceedings and mounting scrap the operators had convinced themselves that this method was better. It was certainly quicker the first time they made it wrong, but making it twice almost certainly cancelled this benefit and roughly doubled the cost!
If there is a black market for your product, Innocence's next adventure is for you.
Promoted, Innocence flushed with his success, (but avoiding the operations manager) as a production planner, noticed the constant shortage of a particular casting & became concerned. He suspected that castings were going missing, but could not prove it in the chaotic, stalled, mountain of work known as "work in progress". (His initial observation was that most of this work was in fact parked and most certainly not "in progress"!) The castings in question were gearbox housings, about a metre cube in size and needed a crane to lift them! Having spent several days trying to understand the numbers, he attention was diverted from the task by a boat travelling along the canal adjacent to his window. The people on board were in a panic and shouting for help. Their boat was sinking! He ran to the rescue and saved the unfortunate occupants before the boat disappeared below the water. Later, in order to retrieve the boat, the canal was drained & revealed that the boat had in fact been holed below the water line by one of the many missing (scrap) castings strewn at the bottom of the canal! There was an inquest and the night shift was blamed, for which the Operations Manager fired the night shift team leader. (Innocence concluded that is in no one's interest to report scrap if the result is that you get fired, but failed to understand why the night shift team leader had hidden the problem, (but that is a different story which we tell in the article "M004 Creating the wrong culture"). However Innocence had revealed another huge hidden cost as well as a navigation hazard!). But the relationship with the Operations Manager deteriorated further!
Innocence also pondered on what the accounts department had assumed about the cost of these products, since it was obvious to him that scrap & rework (yield) rates are a function of the tolerance allowed for individual products individual characteristics and the capability of the process (& people) to deliver that consistently (See Six Steps to Near-Perfect Quality.) Rework of these specific items is extra work for which costs are hidden, and the cost of "lost" materials are hidden and unattributable. (The "annual stocktaking" will be the subject of a future article involving Innocence.)
Unknown methods
For his heroism, Innocence (keen to employ his newly, hard won, engineering skills), was promoted to production engineer. On his first day on the job he was asked to design a method of manufacture for a new product, which he enthusiastically accomplished in record time and reported back to the manager with the finished article. He asked, "would you like to check it?" The manager had a quick look and replied in a tired, worldly-wise way, "no just get the new equipment on order." Taken back by this trust that had been bestowed on his undoubtedly brilliant, but virgin, skills, he asked, "why are you trusting me like this?" "Son", the manager added in his paternally, laconic style, "you have had 5 years training now in this discipline. You believe you have defined the best method." Innocence proudly concurred. The manger's worldly-wise response was, "I can assure you that those guys in the plant know better and will find a better method as soon as this job hits the floor for the first time. Get the equipment on order! Innocence concluded that the real problem is getting the feedback from the shop floor as to what these experts have changed so he can incorporate that in future methods!" He also concluded that no-one really knew the method which was actually being used except the guys doing the job, & therefore the costs are unknown!
Alternative methods
One day the there was a unprecedented telephone call from some animated person in the accounts department. (It was the assumption that they pretty much kept themselves to themselves and were rarely observed straying beyond the confines of the smoked glass windows of their office except when the coffee machine broke down.) (It was discovered later that the person making the call was new and did not understand this convention.) To continue, this caller had observed something they called "excessive labour variances" in the machine shop and insisted that this was not acceptable and required investigation. The caller added that this seemed to be related to the shop not using the "standard method". Innocence had previously noticed that it was common to specify the fastest method as what the manager called the "standard method". When another method was technically approved, but slower, this was called an "alternative method". (E.g. the "super machine" verses the "Heath Robinson" method.) It seemed obvious to him that the cheapest method would surely be the fastest! Therefore this rule of specifying the fastest method as the "standard method" was obviously good guidance to the shop as to which method is preferred.
He became concerned however when, on investigating several weeks of computer analysis, he discovered that the "alternative method" was often employed, so sought to understand why. He challenged the team leader! "We used to do that", responded the team leader. But we found that the "super machine" had a backlog of work, some of which was causing customer complaints, whilst the "Heath Robinson" method had nothing to do! It is common for a very high proportion of work to go through the "Heath Robinson" method for other reasons such as insufficient capacity on the super machine or perhaps; smaller batch work, or better quality". (This is a bigger subject which we discuss in "Capacity Management".)
Later the same complaint arose in the treatment department where a small mixing pot was never used (because it was "expensive" to run). Unfortunately the large pot (which by this time had been defined as the "standard method") had a backlog of work and customers were being asked to take larger than required orders in order to fill the pot! (This is a bigger subject we discuss in a separate article M005 "Economic Batch Quantity EBQ / EOQ: The worst way to set batch sizes".)
Innocence's reputation grew and he was then seconded to a special assignment at HQ! After signing a secrecy agreement, it was revealed that this assignment was to decide which of two plants to shut down because there was over-capacity. (Briefly, the characteristics of the two plants were that one was heavily capital intensive and full of super machines, (and a large computer department) and the second was fairly "Heath Robinson".) Intuitively this was a "no brainer", he thought. The super machines are cheaper! (This costing argument however, is based on the assumption that because the super machine is quicker it must be cheaper & therefore must be highly utilised.)
He visited the "super plant" (which he viewed as wondrous thing to behold with lots of AGV's running round, flashing lights and beeping sounds, the cavernous, automated, raw materials store (which unfortunately was not working when he visited) and robots doing most of the little work available) and spoke to the engineering manager in charge of the large department who managed the equipment. This engineer resented anyone questioning the "goodness" of this obviously superior way of doing things and was contemptuous of the "Heath Robinson" plant which he had recently visited and viewed jointly as "something out of the stone age" and "Luddite"!
Innocence pondered, "so what does it cost then?" It was then he discovered something called "depreciation". All these super machines, engineering departments and computers had to be paid for by the products they were making, not just now, but way out into the future, and there is a charge made against these products to reflect these costs. Whilst there is a great deal of money involved, if this plant is highly utilised it can be cheaper, but in a period of low demand he recalled a conversation with the accountant on the project who called this a "burden". Innocence, on reflection, could see what this meant now!. He became more confused about costs, but the salutary lesson of this project was that "fast" does not equal "cheap".
PS: The "Heath Robinson" plant survived and Innocence together with the engineering manager was made redundant as a part of a cost cutting exercise!
Changes of Method (& Barriers to change)
Innocence reviewed his career prospects at this point and decided (with a degree of cynicism) to be a "big fish in a small pond" rather than a "small cog in a large machine". In his new job as a Production Engineering Manager, in a small aerospace manufacturing business, he was responsible for defining methods and the maintenance of an individual piecework incentive scheme.
His first task was to try to improve the output of a bottleneck process, which he simply speeded up. The output immediately doubled! He obviously needed to document the changes so re-wrote the method. It was then he discovered that he did not have the authority to make the change because all method changes resulted in "cost changes" which needed the MD's approval. He complained to the MD, "don't you trust me" (ironic based on his previous experience). "Yes", replied the MD, "but we have to conform to these new rules devised by Sarbanes Oxley", (apparently some American rules bought about by the Enron scandal.). "As soon as you document a new method we have to go through this paraphernalia!"
However he did ask the accountant, "what difference does this make to the cost of the item. Does it halve?" "Not at all said the accountant, we use "standard costing" so individual costs only change once a year. In fact it is a problem to us now because we will only recover half of the cost, which will result in a stock loss." Pressure of time curtailed the conversation, but Innocence vowed to never waste time improving processes, unless ordered and never to document future improvements!
(It was discovered much later that speeding up the machine actually reduced output, because the machine kept breaking down. But the "bragging rights" had already been won by that time.) (This dilemma of "defining the best method" is something we will discuss in a future article.)
His final task (before he was fired), was to time an operator who was rectifying faulty castings to remove "flash" lines (excess material left over from a worn mould in the moulding process). The operator seemed extremely proficient and they agreed that the appropriate rate was 1 per minute (60 per hour) and this made them worth 5 pence each to the operator who could then earn £3 per hour. However Innocence's naivety was showing at this point. The operator, he discovered later, had found a better method and was capable of 240 per hour which meant they went home with £12 per hour (at that time nearly as much as the accountant was earning). PS: This job remained the best paid job on the shop floor for years, since once set, this time could not be challenged, even though Innocence knew he had been conned. In fact the operators did not report all of the production at one time because they would reveal the con. (But that is another story for a future article.) However the operators did complain that there were other jobs where it was impossible to meet the time and the output rate was very low! These were the real "pigs". (See Pig Analysis)
Innocence recalled the words of his old manager as he collected his personal belongings from his desk, "those guys in the plant know better" and vowed to be extremely tight in future! But he did wonder:
- Why the worn mould had not been replaced years ago!?
- Why improving methods (particularly on bottleneck processes) had no immediate cost benefit!?
- The value of personal incentive schemes based on a narrow and short term set of criteria (e.g. banking bonuses)? (Also see Focused Improvement Systems : Note F: Rewards & Punishment)
- What Sarbanes Oxley has to do with a small engineering business in the UK and why these new rules did not stop the US and UK banks going bust?
But then he thought life was too short and left the building for the last time.
Line-Side Materials Losses
In his next job, as inventory controller responsible for the management of both direct materials and consumables, Innocence found himself a hate target for constantly running out of materials. He immediately set to work on tightening up controls over work movements. He recalled the canal incident! "Where is this stuff going", he asked. One day he had to move from his department where he topped up "line-side" stock on the shop floor, to a department where they kitted assemblies prior to issuing them to the shop. After one day he came back and exclaimed to his manager, "this kitting is far better than line-side, because I am not rushing around replacing stuff they have lost!" His manager explained that the line-side method had superseded kitting as part of a "lean manufacturing" initiative. "Seems daft to me", he murmured. "Can I have a permanent move to this new area?"
Consumables vs. Direct Materials
In his new "kitting" area Innocence as a part of his responsibilities was also in charge of the supply of consumables including oils and greases to the shop floor. He noticed that whilst he was expected to count out low cost items including screws and shims to make up kits, he was not expected to kit very expensive oils and greases for individual products. In fact they did not appear on the kit list at all. Someone had decided that this would be treated separately as a "consumable", unattributable to individual products. His enthusiasm had not waned during his chequered career, whilst his determination to be tight had been strengthened by his bitter piecework experience and his conviction that kitting was better, he resolved to kit oils and greases. He retrieved specifications and made a list of how much oil and grease was required for each individual product. Whilst this was very time consuming for each kit, he then pumped out a measured portion of oils and greases and issued this with the kit. (He had to buy special containers for this but it was clearly a better way!) He resolved that phase 2 of this project would be to cover all of the other consumables, drills, gloves, aprons, and what about the electricity they used, etc.
However on the first kit issued the operators complained that they were short of grease to complete the job. On the second they had some oil left over, which Innocence then decanted back into the original barrel.. This went on until Innocence had the great idea of issuing a whole barrel each time and then measuring how much was left in the barrel at the end of the job. By subtracting this from the amount issued he could calculate how much oil they actually used per job and take them to task if they did not use the correct amount! But unfortunately he found that even this varied from the theoretical value and from batch to batch of the same job. Then he noticed that a similar problem had existed all the time with shims and screws, where the operators had constantly needed to chase up shortages when they lost one. Of course they never complained if they had too many!
Other Direct vs. Indirect costs
After much deliberation he found that trying to assess electricity per job (although expensive) on the basis of the oils and greases fiasco was a definite no-no. The only way he could do it would be to put an electricity meter at the end of each area and meter their individual usage whilst the work was being done. But then he decided that life was too short and he could not win anyway! But he did wonder about how accurate the product cost was?
Innocence's thoughts then turned to the IT department. The people were well paid, held in high esteem and the Government have now decided that this is a core curriculum subject. Maybe engineering is a thing of the past! He took a short break on a Caribbean cruise to consider his future. In conversation with the purser he enquired about the cost of running the ship. "About £5m pa",. the purser replied. "Very expensive", he thought. Innocence took a short course in Microsoft and wangled a transfer to his first junior position in a help desk call centre in the (large) computer department. (Embittered by his "big fish in a small pond" experience.)
His first observation was that they did not seem to worry about costs! He had been counting shims to save pennies, but they were not counting at all! They even had biscuits and take out sandwiches in meetings that went on for hours. (See Meetings Management.) He enquired about the cost of the department. "About £5m pa", the manager replied. He nearly choked and responded, but then thought better of it and muttered under his breath. "There are about 1,000 people employed in this business. That is about £5,000 each! We ship about 10,000 items pa. That is £500 pounds each! I could run a ocean-going ship for a year for that! Couldn't they all have their own little IT system instead, all this stuff ends up on local spreadsheets anyway?" (Centralization vs. Decentralization is a topic we discuss in Previous Technique of the Week T005: Centralisation vs. Decentralisation Analysis.)
"Or, surely accountability would be improved if we asked the guys in the shop if they needed the IT system to make their products. If they agreed (which they probably would not) then try to attribute the large bill to individual products that actually needed those things in some sensible way (however difficult) and have an educated guess about the cost effect of the shims. Didn't that guy Pareto solve this problem centuries ago? Is it as simple as that?!"
However, as we all know (except Innocence), life in call centres is hard. In fact it is a great day if no-one swears at you because their computer has been unplugged by the cleaner, or the manager has not threatened you with being fired because "your call rate is too slow" at least twice. Innocence decided to really jump ship and try to understand how to calculate costs. He got a great job as an estimator in an thriving business.
Volume related costs
Innocence's first task was a real challenge. It was to estimate the costs for a product which contained spacers. These were not the penny shims he had laboriously counted in a previous life! His first task was to establish the preferred method. There were a range of 10 spacers in different sizes. He had a conversation with the designer. They had two choices:
- A plastic spacer. He established a source and they turned out to be between 10p and 20p each. "A good price", he congratulated himself. There is an equipment set up charge too of £10,000 for each spacer, but over the product life that will be tiny.
- A "Heath Robinson" fabrication at 50p each with no equipment set up charge.
Innocence paused, "but just before we do let's do the sums: Let's assume a million spacers in total:
- 1 million x say an average of £0.15p per spacer = £150,000 + £100,000 set up charge = £250,000 using the plastic spacer
- 1 million x £0.50p = £500,000 for the fabrication (a no brainer)"
They went for the cheaper, aesthetically pleasing and intellectually more satisfying option.
Variable Materials Usage
He then discovered that the spacer selected for use depended on the size of the gap being filled by the spacer and was not fixed. (They could use any of the 10.) So he asked his manager, "how does that affect the product cost?" His manager responded, "take an average". That sounded reasonable. So Innocence proceeded to produce the estimate. It got to the point where he was ready to take the average. "The average of what", he thought. "Is it really the middle price (as he had originally assumed), or is it the middle sized spacer? The middle price was 15p but the middle sized spacer was 18p. He settled for the middle price (otherwise he would have to go over the method again), and that on average two would be required per product. (He called this a "planning bill of material" but that is a larger subject to be discussed in a future article.)
The order was won! Hurray!
The job was passed to the buying office to buy the spacers. It was at that point that the question of minimum order size emerged. (See Malpractice M005 Economic Batch Quantity EBQ / EOQ: The worst way to set batch sizes) The supplier wanted a minimum order of 100,000 of each washer. "No problem, the technical guys obviously need this", the buyer thought. She repeated the quick calculation done by Innocence earlier and arrived at the same answer, £250,000. The Buyer was comforted by the thought, "if we happen to use more of one type, the minimum order quantity will give me a decent buffer and give me a quite life!"
The order continued for 3 months at which point the engineers decided to changed the colour of the spacer at the customer's request. This was entirely feasible, there were no equipment costs, and the supplier could deliver the new type the following week. The volumes were building up to 2 per week now, so the risk was small. The order appeared in the buying office. Of course the minimum order applied, so a further 10 x 100,000 spacers = £150,000 were bought. When the items arrived, the storekeeper complained that he was swimming in spacers, and could no longer ship other products, but the buyer was dismissive. "He always squeals like a stuffed pig", she commented. (It did cross Innocence's mind that since this was a customer request they should pay any excess costs, but it was not part of the ISO procedure to ask these awkward questions so he let it drop.)
Identifying obsolete stock for the first time
When taking part in the next annual stock take, (nearly a year later), this storage problem was detected by Innocence, who discovered that the customer had cancelled the order in the month following the colour change. On investigation he revealed that only two types of spacer of the 10 supplied had actually been used (the middle sized ones . In total they had used 60 spacers in the 30 products that had actually been shipped! In conversation with the accountant later he was expected to be congratulated for discovering this horror story. The accountant was however distraught! He angrily turned on Innocence and said. "Up to this moment we were making a profit. Now you have revealed this problem I have to declare the loss, which means there will be no annual bonus this year!"
Of course the £100,000 equipment charge was a write off, but Innocence at this point was given the additional responsibility of heading a committee to establish a profitable way of using or disposing of the obsolete stock. After several long and argumentative meetings spread out over six months and much research and deliberation it was decided. that the 2,000,000 spacers in two colours would make a wonderful children's educational toy when strung out on an abacus. (The set up costs would be small.) The project was duly handed over to the sales department who took over 50 orders for them at £10 each over the next 3 years! In fact it was so successful that ultimately it was decided to donate 1000's of them to a local children's charity. Innocence did a quick sum. "We spent 2 x £150,000 + £100,000 = £400,000 for the 60 spacers that were actually used in the 30 products we actually intended them for and sold. That is not 15p per spacer. That is £6,667 each!" This did however occupy his thoughts only briefly as he had recently discovered the benefits of an IT department This had now extended to his desk top where he could brush up his Microsoft training and he could now browse the Internet to plan his next holiday, whilst he waited for his next assignment.
Shared resources
His next task was to estimate the costs for an Invitation to Tender for a large contract to supply a product similar to existing products. Clearly he needed to define the method of manufacture and estimate the work content, (and this time he thought he should probably include tooling and equipment costs), which he duly accomplished, with no difficulty. "But how does that work content translate to the overall cost?" he asked the manager. Where any required new resources were exclusively used by the new product the answer was clear. It was all of it. He had assumed however that some of the work would be done by existing resources that had already been bought and paid for many years ago? Three questions crossed his mind at this point:
- Although these existing resources can actually do the job, do these existing resources have the capacity to cope with this extra work? If not he would need to estimate the cost of additional resource!
- What is the effect on cost of this additional work on these existing resources? Surely by more heavily utilising existing resources, this would make not only the new product, but also existing products, cheaper? If these resources had been bought and paid for years ago, surely using these resources (except any labour and consumable costs involved) is "free".
- Winning new business has a similar, but opposite effect, of losing business. What effect would that have on existing product costs?
"Well replied the manager, that is not your concern, we have a clever bunch of accountants who now convert this estimate into a cost! If you have finished, pass the project on to them." There was a brief project handover, but the whole thing now passed behind the smoked glass windows of the accounts department, never to be seen again. Innocence could not imagine how they would answer his three questions, or even if they knew that these things might have a bearing on the estimate.
Make vs. Buy
His next task was connected with a project to outsource a high volume product offshore (the argument being that this was almost certainly cheaper, and was such a "no-brainer" that it could be given to anyone with the mathematical prowess of an ant). Innocence was given the task of proving this point, (although he did wonder why the project had been given to him). He thought this was almost certainly his easiest assignment to date. The internal costs were known and the outsourced costs are a given by a supplier. "What could be hard about that! I wonder what I can do after lunch", he mused. He poked his head round the smoked glass door. "I need to know the cost of product abc123", he asked. "What do you want to know for!? We do not give out that information to strangers!", came the rather stern and Innocence thought rather officious reply. "I have been asked to do a project on it by my manager", Innocence timidly replied. The anonymous person in smart casual attire responded after stopping to puff up his collar, "very well here is the "variable cost". It is £5.0275 each." Innocence (staggered by the precision of the costing system, and in awe of these magicians who could calculate these things), thanked profusely the anonymous person behind the smoked glass and made a speedy exit. "Phew, what a monster", he thought. "But anyway that is half of the answer. All I need to do now is get the other half".
Innocence plotted for a moment, "this second part might be an opportunity for foreign travel!" He rang the buying office. "I need to know the cheapest offshore price for buying product abc123", he asked. "Do we have someone in China I can talk to about this?" "Certainly, talk to our purchasing agent Woo Flung on this phone number. He mistakenly electronically transferred the drawing to Wu Fang. While the resulting confusion delayed the project slightly, eventually back came the answer, 25.2345 Yen, or at the current currency conversion rate £4.03245! (A saving of £0.99505, the no-brainer answer!) Innocence reported his findings to his manager, whose immediate response was, "that's what I thought". The product was immediately outsourced to China, and Innocence was congratulated by the Managing Director on the speed of the project.
Unfortunately the £: Yen conversion subsequently moved unfavourably and reversed the benefit, but by this time the decision was history and recognising the problem would be embarrassing so Innocence decided not to raise this as an issue. (There were other later side effects too which we will discuss in a future article.) But in the following year there were worrying messages from the management team who had now done the annual recalculation of costs and discovered that everything except abc123 had suddenly massively increased in price, making them uneconomic. This reinforced the "no brainer logic" and led to the call for further outsourcing!? Innocence did ask his manager why outsourcing one product could make another product more expensive but was referred to the magician behind the smoked glass and declined the opportunity!
Life Cycle Costs
This concept is included here for completeness but is dealt with comprehensively in the article "Technique of the Week No. 035 Product Life Cycle Costing"
Spurious accuracy 5 Decimal places; Overhead treatment (Allocation absorption & apportionment)
Innocence's career was in its ascendancy at this point. His reputation of "getting to the meat of a problem" was legendary. He was promoted to department manager. All was going well until the 25th of January when, he received his "monthly operating statement" for the month of November, (his first month in the new job). It was laid out in neat rows by category of expenditure on computer listing paper. All of the figures were to 5 decimal places of a £! But the bottom line was that he had exceeded his budget! (It was also at this point that he discovered that his name had been changed to "cost centre 42"!)
He knew that the budget was a topic much discussed in management circles and next to fraud (which was a capital offence), budget overspends were the accounting equivalent of 2nd degree murder! He also knew that sooner or later he would be called to account for this crime. "Attack is the best form of defence", he thought. "I'll challenge the numbers." He insisted on a meeting the accountant responsible for this damning, but fallacious, report. He was aware of his reputation for investigation and knew that the this would almost certainly have spread behind the smoked glass windows, so was confident that he could deflect any personal criticism. On a quick head-count he concluded that the accounts department did contain approximately the same number of people as were in the shop! Not only that but they all were using an something they called an "ERP" computer system too, to help them organise this information, costs and report them! In the ensuing heated conversation (where he insisted on a breakdown of every single cost line), he discovered the magical world of:
- Miscoding (Other people trying to deflect their expenditure to his department).
- Accruals (Costs attributed to his department which were not current spending and over which he had no control. (An electricity charge for £100,000 per month.)
- Reversals (When the electricity bill actually came in, the difference between the actual bill and what they had assumed the bill to be.) (On recognising this problem Innocence did start to switch his office light off when he left the office!)
- Delays between commitments and invoice processing (Previous (unnecessary) purchasing commitments made by his predecessor for which invoices had now arrived).
- Omissions in month end processing (They had forgotten to include the new coffee machine which had been his first major outlay in the new job. He thought for a moment, "shall I mention this". He decided that he would not and put this down to miscoding. However in the following month it turned up in the figures. (Apparently it was discovered that the invoice had got lost somewhere?!)
- Non controllable expenditure (He had a wry smile when he discovered that his salary was included in the operating statement. He wished he could control it!)
- Charges (HQ and internal cross charging) (The coup-de-grace) Innocence discovered that the three biggest single items on his operating statement were three recharges:
- An HQ recharge for a share of the hospitality suite at Wembley Stadium, (which as a manager he had been told on appointment that he was now entitled to use when clients were not being entertained). (Innocence readily accepted this.)
- A cross charge which (on investigation) represented a share of the cost of the computer department! (He did think this was a bit excessive but still worthwhile since it obviously did help him to plan his holidays.)
- An HQ recharge for a share the cost of the finance department! (Which he thought was totally unjustified since it had merely led to his current state of heightened anxiety.)
To cut a long story short he had discovered something later to become known as "financial instruments" (a major contribution to the "credit crunch"). Innocence, now older and wiser, recalled the words of his old manager, "those guys in the plant know better" and concluded seven things from this experience:
(In fact there were 8 things, but I will leave you to work that final one out for yourself.)
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What you should do instead
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Speed of Beneficial Impact
Typically better decisions start to be made and prudent behaviour starts to emerge as soon as education is complete, although organisation changes take longer.
Type of benefits of eliminating the practices and adopting the alternative approach
It all depends how extreme your current financial control matches Innocence's experiences, but we would expect you to be able to:
Ease of Implementation
The benefits are proportionate to the effort, but the effort can start small, whilst the early benefits are potentially huge. (It only takes one better or more prudent decision, or one significant avoidable cost to be eliminated to pay for this effort!)
Prerequisites
None
We hope this will help you to persuade your Operations, Development and Finance Managers to correct this serious malpractice. To do this they will need to persuade their managers to understand the real cost and fallibility of their costing system, by showing them this article.
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Important message
We are currently researching the topic of malpractice and would be interested to hear your experiences (in confidence of course, and if you wish, you do not need to name your organisation)? We are also interested in collaborating in this research project with companies or government departments as fascinated by this topic as we are, and the following question:
There is no shortage of advice on best practice, in fact the opposite. Why therefore is malpractice so easy to find and what are the connections between business environment, practices (good and bad) and performance?
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Follow the links below to training and further reading on this and related topics:
Training Courses and Workshops (All our training courses can be readily tailored to suit your in-house workshop needs.):
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Understanding Finance: OM04 Finance for Team Leaders (Understanding Budgets, Product Costs & Financially Justifying Proposals) M13 Manufacturing Accounting for Beginners (For Junior, unqualified, finance, support staff working in a manufacturing environment, or others wishing to understand the principles and practice underpinning their finance systems)
Improving Quality and Increasing Output: |
Managing stock movement: M06 Stock & Work in Process Tracking SSC06 Warehouse Operations Management
Reorganising Processes: e.g. Centralisation vs. De-centralisation; Make vs. Buy: S02 Business Process Engineering S04 Strategic Capacity Management
Managing Product & Process Configuration & Data: D02 Specification Management (Managing Product, Computer Programme, Documentation, or Process changes) |
To discuss your consulting or training needs with one of our independent consultants or trainers please Contact Us.
Further Reading: The following further best practice articles were mentioned in this paper:
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Permanently Maintained Website Articles: |
Previous articles from our archives: Previous Malpractices of the Week: M003 Buying Cheap (The cheapest is almost never the best) (Buying malpractice) M004 Creating the wrong culture (HR malpractice) M005 Economic Batch Quantity EBQ / EOQ The worst way of setting batch sizes M006 Hitting the Numbers (£'s): The worst way of managing Operations (assisted by Purchasing) (Operations malpractice) Previous Techniques of the Week: T005: Centralisation vs. Decentralisation Analysis T006: Pareto Analysis T031: Pig Analysis T035 Product Life Cycle Costing T036: The Traffic Light (RAG) System (Simple Visible Method of Communicating Problems) Previous Best Practices of the Week: B004 Meetings Management |
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Previous Malpractices of the Week
For a copy of up to two articles from our archives please ring us, or request via e-mail quoting the article number and description. (See "Contact us" for details).
Due to the large demand for these articles we have had to limit the number we can send to a maximum of two.
Previous malpractice articles:
M001 Not paying suppliers on time (Financial malpractice)
M002 BOGOF (Buy One Get One Free) (Marketing malpractice)
M003 Buying Cheap (The cheapest is almost never the best) (Buying malpractice)
M004 Creating the wrong culture (HR malpractice)
M005 Economic Batch Quantity EOQ / EBQ: The worst way of setting batch sizes (Inventory planner malpractice)
M006 Hitting the Numbers (£'s): The worst way of managing Operations (assisted by Purchasing) (Operations malpractice)
M007 The cost of the costing system (Or why you do not understand your product costs however much effort you make without firstly simplifying the process.) (Accounting malpractice)
For a copy of up to two articles from our archives please ring us, or request via e-mail quoting the article number and description. (See "Contact us" for details).
You can also request "Previous Best Practices of the Week", "Previous Readers Questions", and "Previous Techniques of the Week"
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Summary: Best Practice Business Processes |
© SM Thacker & Associates (Consultancy and Training Specialists) April 2010