Performance Management Shared Interest Group

As you read this comment, please think about your solutions, ideas, or additional problems.  SIG members would love to hear other perspectives!!!

Financial information is necessary to run an organization. Financial statements are required by law for public investors and creditors in capital markets, and private equity and financing generally impose similar demands. There are many useful, and even vital routine financial tasks to operate a business – for example:  maintaining cash levels, paying vendors and employees, collecting from customers, and so on.

But how useful is that general financial information to improving processes and outcomes? Frequently, it is not that useful, and sometimes it can even be dangerous. Financial reporting conventions and rules can distort business performance insights with illogical cost assignments, product costs, depreciation, and other "standardized" metrics that don't reflect the reality of operations.

The critical factor for financial information to be useful for internal decision making is that it must accurately reflect the causal relationships seen and experienced by process owners and operators. To achieve this, financial information must possess three key qualities: transparency, defensibility and timeliness.

Transparent financial information means the financial and cost figures clearly show the cause-and-effect relationships within operations. Without this transparency, most managers will be inclined to ignore cost information. The relevance and reliability of a costing system's information must directly connect to operating resources, processes and decisions. Managers will tend to second-guess opaque financial and cost information, and the resulting discussions or arguments might undercut efforts to improve decision-making, profitability and processes within organizations. Transparent causal cost information will satisfy financial and operating managers who demand evidence that relates directly to production-type resources and operations.

Defensibility means that financial and cost information can help both financial and operating personnel to build and evaluate business cases, explain results, support and explain decisions, and advocate ideas. Transparency of operational causal relationships makes cost information defensible to challenges from either finance or operations about its accuracy and applicability.  Defensibility becomes truly useful when managers and employees outside finance can readily apply cost information to investigate operational problems or evaluate operational solutions without worrying that finance will find fault with cost figures used in the analysis. At that point, managerial costing becomes an enabling tool for making better decisions about the employment of resources or investments that will improve the organization's performance. The key to making financial information defensible throughout the organization is to apply the principle of causality and its supporting concepts from the Institute of Management Accountants' Statement on Management Accounting, The Conceptual Framework for Managerial Costing, when designing the processes and systems to create the information.

Timeliness means cost information is recent and consistently available. Depending on the situation, "recent" may be defined by seconds, minutes, hours or days to reflect current and ongoing operations. Real time information should be the goal. Consistently available financial cost information requires an effective internal decision support oriented system to generate information on demand for managers and employees. Periodic cost studies-no matter how effectively done, no matter how quickly completed, no matter how well-guided with policy and procedures-are never as useful as having information available for day-in, day-out measurement and evaluation. Only through continuous observation and evaluation can financial and cost information be understood to a degree that gives managers confidence that the model reflects the cause-and-effect relationships of the resources, processes, and operations they manage.

It is also important to recognize when financial and cos information is NOT designed to be useful for internal decisions. Further, no matter how "useful" it is for other purposes or how well audited it is, it should not be used for decisions it wasn't designed to support.