Establishing a Cost Model: Let’s Start at the Beginning

Oct 03, 2013

I received a phone call from a client a few weeks ago asking if our firm had any experience with installing a specific type of software. This company is a very successful manufacturing facility and surprisingly to date have been able to manage their operations and financials using a mix of limited capability software, manual procedures, and Excel.

They have already purchased the new software and want us to help them implement the costing component. Unfortunately, it appears there really is no “costing component, but that is another entire discussion.

The Company is going through some significant changes including expansion, planning for new customers and products, new technologies and employees that all need to be managed as part of this process. If not managed effectively, this could spell out a recipe for disaster. The most important issue for this client is: where do you start when you want to build a cost model? AND you want to implement the software to encompass these new cost rules? When I say build, I mean from the very beginning. In this particular case, with so much change, we need to start at square one, which is to identify exactly what the manufacturing process entails, and yes, in pretty specific detail.

I refer to this process as mapping for operations. Any time you are going to implement a new software/ERP system, or build a cost model, it is imperative that you have a complete understanding of every different type of transaction that can occur on the production floor. You need to walk through the facility in its entirety. You need to look at all of the work areas on the production floor. Are they grouped by machine? Are they grouped by function? Are there multiple pathways a product can take through the various machines? How are raw materials issued? Do we self-construct any parts or tooling? Is it “mass production”, job shop, or a combination?

The point of these questions is the foundation of your cost model and provides the appropriate information in determining what features you will need to include as part of your software selection. It will help you to identify if you need to direct costs based on resources consumed by machine or work area or product group or any other possible driver. This initial assessment is crucial and will have a significant impact on how product will ultimately absorb costs. In addition, it is not possible to know if a software will provide the options you need if you don’t know up front exactly what any possible task might be.

This does not even scratch the surface of questions that need to be addressed when setting up a cost model as part of a software selection process, but it is the beginning of the journey. The items to identify are also very company, plant and industry specific. As always, the beginning should start with the end in mind…make sure the solution will solve the problem. In order to do that, you must first define the details of the problem.

Categories: Cost Accounting