Entities focus on cost accounting data rather than the factors that influence the data. Vast sums are spent to allocate costs that have nothing to do with cash. Instead, start with value, determine price, then justify costs that can incur profits.
Since you can calculate different costs using the same data it’s obvious that costs do not represent cash. Cost accounting confuses metrics with measurements.
There are three primary reasons cost accounting is a bad practice:
- You have to create and force math and relationships that do not exist.
- By doing this, you lose touch with your operations.
- You create meaningless numbers that people consider as gospel, when in reality they are nothing but opinions.
The lesson is that a company needs to start with value, then determine price, which finally justifies the costs that can be profitably incurred to produce a good or service desired by customers. It seems so obvious to constrain your company with a final price before you begin to incur any costs, yet this practice is not widely followed, despite its proven successes. Costs are, no doubt, important to consider, but the crucial distinction is when they are considered, and what measures are to be used.
- Identify why modeling cash flow and capacity is superior to cost accounting.
- Recognize the Adaptive Capacity Model.
- Determine the difference between metrics and measurements.
- Recognize Segall’s Law: A person with one watch knows what time it is; a person with two watches is never quite sure.
Level of Difficulty:
- Modeling cash flow and capacity
- Adaptive Capacity Model
- Segall's Law
Accounting and financial professionals.