Budgeting is a farce
Budgeting, in cost accounting, is a farce, leading to decisions based more on the affect on the appearance of the balance sheet, than on operational effectiveness. If it looks like a duck, and walks like a duck it must be an aardvark! What we need is a second set of principles that allows us to model what is really going on in the flow of time, operational accounting principles that leads us to ask the right questions!
Hold your Horses, I am Not Alone!
For the last 20 years the shortcomings of cost accounting have been a hot button issue in the most prestigious international accounting organizations around the world. In fact, as early as 1985 Eli Goldratt, the creator of Throughput Accouting, spoke at the annual conference of the Institute of Management Accountants on the topic, “Cost Accounting–Public Enemy Number One of Productivity.”
I am not making this stuff up. Garbage in garbage out! Cost accounting is choking your business.
Wrapping it Up
Cost accounting, the primary feedback mechanism for business, invented back when labor was paid for by the piece, is a failed 19th century solution shoe horned into modern businesses.
It provides an inaccurate picture of what really is taking place in companies today, and covers over the true dynamic of how money is made. Even in honest hands it is used to pervert the facts in the interest of creating a false picture of “shareholder value. By focusing on costs, it turns the focus of a company upside down.
For counting value for investors, with discipline and integrity perhaps; for helping people run better businesses: NOT.
In the real world, not the world of green bar paper, breakthrough profit is made by how many times a dollar invested can be turned into sales before it has to be replenished. Cost accounting provides no effective way to see this. I call it the Repeater, or Wealth Builder effect.
Two of the most damaging aspects of cost accounting are the way it which it can encourage the creation of both in-process inventory and final goods inventory, and the way it treats capital expenditures. Inventory is a necessary evil that needs to be managed with skill, including your capital goods investments. Anything more than what you need for sales, to keep the flow of value adding output meeting the demands of the market, freezes money and dampens the repeater effect, losing you money.
So if you shouldn’t use Cost Accounting, what should you use?