The financial manager is not one of the most enviable persons within an organization. He must continuously deal with a professional dilemma in order to achieve the goal of his job; i.e. support management to establish a process of ongoing improvement. The dilemma resulting from this objective is that on one hand he must provide information to management appropriate for exercise of sound budgetary control. In order to be able to do this he must recommend actions based on well-established cost world measurements. On the other hand he must allow managers to guide their decisions based on experience and intuition. In order to allow this he must recommend/endorse/support actions not based on well-established cost world measurements. This dilemma can also be shown as follows:
This dilemma shows that there is a conflict within the financial manager’s domain. The underlying assumptions with regards to the pre-requisite that financial managers must recommend actions based on well-established cost world measures are:
– well-established cost world measures are reliable
– reducing standard product cost will ultimately improve the bottom-line
– products should be sold at full-cost and with a positive contribution margin
– the accounting system takes into account all relevant items
– budgetary control means reducing operating expenses
On the other hand, the underlying assumptions with regards to the fact that the financial manager must recommend/endorse/support actions which are not based on well-established cost worl measures are:
– the accounting system only report ex-post data
– the accounting system does not report information
– the data/information provided by the accounting system is generally too aggregated for operational decision making
– not all aspects of the organization have been properly defined and given appropriate (accounting) measures
– the accounting system is not appropriate for planning & control
– the accounting measures do not reconcile with the manager’s intuition
– the product cost data is perceived to be incorrect
The fact that the financial manager must deal with this dilemma continuously means that:
1) the accounting system does not measure all facets of the organization
2) the cost world measures are not consistent with the experience and intuition of operational management
3) the cost world measures do not guide management correctly
4) the cost behaviour implicit in the cost world measures is not realistic
It is well known that accounting systems usually do not capture all aspects of the organization. Although ABC Methods have been introduced as a way to enable this, the reality in most companies is that it is perceived as too complex and therefore too expensive. Even the much better and easier to implement and to maintain method of TDABC is not widely implemented. Often, companies compromise between system complexity and user complexity. And since the IT Department is usually the budget holder and must maintain its deadlines, the user complexity is compromised resulting in lesser acceptance by the users.
Another result of the fact that the accounting system is not trusted and often is overridden is the overwhelming implementation of Balanced Score Cards. With the BSC’s financial managers are trying to compensate for the failures or missing aspects of the accounting system. However, most of the BSC’s are too complex and have too many Critical Success Factors and are not based on proper cause-effect relationships. Various Critical Success Factors conflict directly with each other, especially when related to interdependent business processes and functional areas. In order to reduce the tensions between the functional areas within the organization many Critical Success Factors will be compromised. ( See my blog on BSC for more detailed explanation ).
Another result of the fact that the management accounting system is not trusted and often overridden is the huge number of BI Projects and Implementations. With BI organizations are trying to tie together the various aspects of the company. However, most BI Projects and Implementations are done without much intelligence. Most often, they are just fancy reporting tools used to report in a nicer way than the ERP Systems can.
The dilemma of the financial manager is therefore not enviable. However, the financial manager usually accepts this dilemma due to the fact that he does not see a solution to his situation.
He knows very well that the accounting system does not provide the proper information for proper decision making at the strategic/tactical/operational level. There is a very well known fable going around with regards to this topic, which goes a bit as follows ( Performance Management, page 117, Gary Cokins ):
“Several centuries ago there was a navigator who was serving on a wooden sailing ship that regularly sailed through dangerous waters. In order to be able to safely navigate the ship through these waters, the navigator had some very important and sophisticated instruments. Without the effective functioning of these systems, he could not properly execute his function and direct the ship safely through these waters. One day, however, he realized that one of his most imporant instuments was calibrated incorrectly. As a result, he was providing the captain with inaccurate data with regards to the safest way through these dangerous waters. The navigator decided not to tell the captain, because he was afraid that he would be blamed for not detecting the problem sooner and that he would be requested to find a way to report more accurately which would require a lot of work. As a result, the navigator made sure that he slept near a lifeboat to prevent him from going down with the ship in case the wrong information lead to a disaster. One day, the ship hit a reef and the ship was lost as well as its cargo and many sailors lives. However, the navigator survived and became a navigator on another ship.
Now, imagine a management accounting many centuries later, who worked for a company in which a greate deal of money was invested. It was his job to provide information on how the company had performed, its current financial situation, and the likely consequences of decisions being considered by the company’s management. In the performance of his duties he relied on modern and sophisticated management accounting system that was believed to represent the economics of the company. Without the effective functioning of the costing practices reported from this system, it would be impossible for him to provide management with the accurate and relevant cost information they needed to make economically sound decisions. One day, however, the management accounting realized that the calculations and practices on which the cost system was based were incorrect. It did not reflect the economic realities of the company. The input data was in most cases correct, but the reported output data and information was incorrect. As a result, the current and forward-looking information he provided to management was incorrect. No one but the management accountant knew about this problem and he decided not to tell anybody, because he was afraid to be blamed for not detecting the problem sooner and that he would be required to go through the agonizing effort of developing and implementing a new, more accurate and relevant cost system. That would require a lot of work. Instead, he decided to keep his network intact and up to date in case he had to find another position. After a while, the company went bankrupt based on poorly informed pricing, investment and other decisions. The company went out of business, the owners lost their investments, creditors incurred financial loses, and many hardworking employees lost their job. However, the management accountant easily found a new job at another company“.
The 2003 Survey of Best Accounting Practices ( E&Y ) clearly shows that this fable is not just a fable but sadly enough reality. According to the survey more than 98% of the financial executives believed that the cost information they supplied management to support their decisions was inaccurate. More surprisingly and disturbing was the fact that the survey also showed that more than 80% of those financial executives did not plan to do anything about it. This shows clearly that the financial executive’s resistance to change is not a matter of ignorance. What could be the reasons for this irresponsible behaviour? Apparently, financial executives believe that:
– the error is not that big
– the extra administrative effort does not offset the potential perceived benefits
– (product) costs do not matter
Although many financial managers realize that the error exist, they do also do not think that it is big. However, numerous examples of ABC Projects have clearly shown that the error may be big, especially in organizations with a product mix with relatively high differences in volumes and complexity. The error may be a big as ranging between -60% and 180% from the current standard product cost. This is a significant error and since most companies have the policy to sell only at full cost margin the impact on pricing and the competitive position could only be imagined.
Financial managers have seen many improvement project fail and may not see the benefits outweigh the efforts for improving the management accounting system. Especially not when the error is perceived being not big. This is no wonder, because studies have shown that the failure rate of improvement projects is enourmous:
– TQM > 65%
– Six Sigma > 60%
– Lean > 50%
– Balanced Score Card > 70%
– Business Process Re-engineering > 55%
– Organizational Transformation > 70%
– Outsourcing Initiatives > 60%
– MRP/ERP > 50%
Another reason why financial manager may not plan to do anything about it, is the fact that they may think that (product) costs do not matter. This is especially the case in situations where the focus is on growth.
So, the financial managers clearly knows that the management accounting system is failing, which is also shown by the overwhelming failure of the budgeting process and as a result in a failure in the growth curve of the organization.
The failure of the management accounting system and its corresponding decision making and motivational aspects result in a failure of the budgeting process. The result is that managers usually do not put too much expectations in their coming year budget, and compensate this in the budgets for the years after that. However, this is a yearly ritual resulting in the so called ‘hockey stick budget curve’, which is shown below:
Since the financial manager is fully aware of these shortcomings within the management accounting system, he will often stray away from the management accounting system and even override it. This is due to the fact that he must be able to recommend actions based on experience and intuition. He knows that he must do this in order for the company to grow. This is part of another dilemma he is dealing with; the ‘growth/stability dilemma’ which is shown in the next picture:
Each organization and therefore also or even especially the financial manager is facing the above shown dilemma. In order to progress it must grow, while at the other hand it must survive. This dilemma enforces the financial manager’s own dilemma, because in order to grow, the company must make changes. Howewer, in order to survive it is perceived that the company should not make changes. The usual result of this dilemma is that the organization and the financial manager:
– do not make changes ( to prevent decay or wasting resources )
– make many small changes ( to maintain stability )
– make a few very large changes ( to achieve growth )
The result is that companies and financial managers will only make a large change, in case the situation of the company is such that a big change is required. Otherwise, no or only small changes will take place.
This dilemma enforces the ‘efficiency-effectivity dilemma’, which causes the organizational structure to be changed once in a while. This is shown below:
Companies feel the pressure to be efficient ( stability/survival ) in order to be successful, but when this period lasts too long, they will get more pressure to be more effective ( growth ). The result is a continuous cycle of centralization and decentralization. Many companies are known to change their organizational structure every ten years or so.
All these dilemma’s reinforce the natural dilemma which exist within all people and organizations:
The objective of most people is to be happy. In order to be happy, however, the majority of the people wants to feel secure. In order to be secure, these people do not want to make changes. On the other hand, there is a minority of people ( approx 30% ) who needs to have satisfaction in order to be happy. For these people, satisfaction can only come from (continuous) changes.
As one can clearly see, there is a ( perceived ) natural dilemma or better conflict between security and satisfaction. I quote perceived, because in my opinion there is no conflict. The problem of the conflict is embedded within the underlying assumptions behind this conflict. These underlying assumptions are the following:
Each relationship within this dilemma schema is build upon underlying assumptions.
The solution to the conflict is embedded in the assumptions regarding impact of change upon the level of security. If people and organizations can predict relatively safe the outcome of a change than the proposed change will be accepted and may even be endorsed by the people within the organization. In order to overcome the resistance one must carefully follow a change process which will enable the elimination of all levels of resistance. Resistance of change is caused by nine levels of resistance, which are:
– Get agreement upon the fact that there is a problem
– Get agreement on the real problems
– Get agreement upon the fact that the problem is within management control
– Get agreement on the criteria for a good solution
– Get agreement on the proposed solutions
– Discuss all objections and modify proposed solution if necessary
– Get agreement on the negative effects of the proposed solutions
– Get agreement on the implementation tasks
– Get agreement on the implementation plan
In the overwhelming majority of all improvement and change management projects, these natural layers of resistance have been ignored, resulting in predictable failure. The other and perhabs even more important reason is that managers do not really see a reason for change. Why fix when it is not even broken? The result is continuation of managing and reporting ‘old stuff’.
Because of all these dilemma’s and conflicts within the organization and within the managers own mind set, the financial manager and therefore the organization is absolutely not in control. The result of these dilemma’s are:
– lack of trusted management accounting information
– management decisions often based on experience and intuition
– lack of real sustaining performance improvements
– relatively low level of revenues
– relatively high level of inventories
– relatively high level of operating expenses ( correlated with revenues )
The conclusion can not be anything else than that the only way to be (back) in control is to break the internal dilemma’s and conflicts.