Understanding Operations Management Resource Flows

True or False?  Business information is fundamentally about the application and flow of financial resources (i.e. dollars) within an organization to generate revenue and profit.  My answer is—only if you are an accountant and your head is in the sand. The rest of us manage people, equipment, material, buildings, and the like which we shape into processes. The application of monetary units is an abstraction. It simplifies some analyses, but it can grossly distort information about resources and processes.

Successful managers apply resources to achieve objectives. Resources cost money, but resources are much more complex than money.  The most distorting characteristic of money is its divisibility. It can be applied in dollars, cents, and fractions of a cent. Physical resources are much “lumpier.” Certainly, a person’s time can be divided into very small units, but eliminating the cost of human resources must normally be done at the unit of a full time person. Similarly, any costing approach that seeks to be useful to operational managers must begin by tracing the application and flow of resources. Money can adapt and reflect the resource relationships, but if physical resources aren’t reflected, the monetary measure ceases to provide actionable insights.

Resource flows

Tracing resource flows can appear very complex when faced with many individual resources. How can it be done to achieve better insights into your operations and their costs? First, resources are logically arranged into pools that produce an output or limited number of outputs. They are probably already arranged this way for organizational purposes, but refinements may be needed to separate resource pools with widely different capabilities. For example, old and new machines may produce at significantly different rates and quality levels.

Second, you need to determine how the resources in the resource pool respond to the pool’s output. This doesn’t mean final product, it means the direct output of the resource pool. The response in question is whether the use of the resource varies with the volume of output.

There are two types of relationships between the resources and the resource pool’s output: fixed or proportional. Examples of fixed relationships for a maintenance group are supervisor hours and the use of shop floor space. Proportional relationships would be technician hours and supplies.

The third step is to map the relationships among resource pools, to show how outputs are consumed by resource pools and, eventually, products. Notice that these three steps require no dollar amounts. They model the organization’s use or consumption of resources and, equally important, identify the unused capacity in each resource pool.

Once this model is complete, money is applied. It is relatively easy to figure out how much a resource cost or is paid. Money, which is infinitely divisible, can then flow with the resource consumption, and the result is an accurate picture of cost in your organization. You have probably had arguments about what is the “true cost” of a product or a process. Next time, ask for a definition of truth and listen to the sputtering.

Millennia ago, Aristotle created the “correspondence definition” of truth. It simply states: Truth must correspond to facts. In a factory, the facts are the resources on the production floor. A true cost must demonstrate the cause and effect relationships of your resources. It is the only way cost information can have meaning for operations managers.

This approach to costing is not common because it focuses on supporting operations managers rather than on financial reporting. Resource consumption accounting and GPK are costing approaches that use this type of operational and cost modeling. 

Larry White, CMA, CPA, CGFM, [email protected], is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org) —an organization seeking to advance management accountants’ ability to contribute to improving business performance.