COST MANAGEMENT BASICS Cost Controlling Agenda Cost Controlling

COST MANAGEMENT BASICS Cost Controlling

Agenda • • • Cost Controlling Explanation Decision Support Data Required Data Analysis Requirements Process Efficiency Tools for Prioritization Process Improvement Dashboards Control Budgeting 2

Cost Controlling Explanation 3

Cost Management Leadership Driven Management Cost Planning – Operational managers set cost targets and efficiency goals – Plan cost based on outputs produced Cost Accounting Cost Planning Cost Management After Action Review – Commanders Lead: 1. How did you perform relative to your expectation? 2. What are you doing to improve? OM Full Cost Measurement – Accurate, timely and relevant data – Connecting operational output/performance data to financial data – Allocate Overhead, Unfunded Costs, Indirect Support FM Cost Management Process Cost Controlling Cost Analysis – Variances – Trends and forecasting Cost Analysis – Product, service or activity cost by expense (labor, material, contracts, etc…) – Understanding full costs of organizations, operations, products and services FM = Financial Management OM = Operational Management 4

Cost Controlling • Cost Controlling means taking the “Best Value” and/or “Best Practice” actions to realign an organization to achieve the defined objectives • • • Act based on Analysis Adjust Targets Update Resources Enhance Efficiency Execution of Trade-off Decisions Cost Accounting Cost Planning Cost Management Process Cost Analysis Cost Controlling 5

Cost Controlling • It is where the benefits of Cost Management are realized • The step where leaders and decision-makers use the results of their cost analysis as decision support, implement the changes and enhancements that ultimately move us to a more efficient Army 6

Looking to the Future As the Cost Module of GFEBS matures, Army leaders and decision-makers will have the information which will best facilitate the optimal use of scarce resources. S S E N E V I T C E F F E 7

Decision Support 8

Decision Support: What is it? • Enables decision makers to make informed decisions that wisely and better utilize resources, and improve program and operational effectiveness. • Objective and systematic way of collecting, examining, analyzing and reporting information to support decision-making • Conceptual way of thinking • Applies to all aspects of managing programs, finances, and operations 9

What It Means To YOU! Today there are challenges in all areas of the Department of the Army. BUT! There also opportunities for those who are prepared. 10

What’s Different Today? The New Resource Environment Focus on achieving and measuring results! Organizations must demonstrate that they are getting results when preparing budgets and reporting performance results Congress is more interested in seeing results from public expenditures and meeting their expectations Greater scrutiny is being applied to Do. D programs as the defense budget continues to shrink 11

Focus Of Decision Making Ask the Important Questions: • What should/needs to be done? • For whom? • Why is it important – what is the desired / expected impact? • How should it be done? • By whom? • When? • At what cost? 12

Leading to Performance Management Decisions Execute Goal/Objective Programs § Outcomes – Results § Customers § Outputs – Products/Services § Activities § Inputs – Resources § Budget § Key questions: § Is the resource being used having intended results/impact? § Is the investment worth the results? § How good is the management process? 13

How Is The Analysis Done? A decision-maker should always know how an analysis is done in order to: • Know how solid it is (i. e. Analytical Rigor and Completeness) • Be comfortable with and be able to defend any decision made based on the analysis 14

Utilizing Decision Support To be effective, analysts must: • Understand an organization’s business • Understand how analytic “need” relates to the business • Apply sound, thorough analytical methods specifically tied to the “need” • Provide useful information to support decision -making 15

Basic Guidelines For Decision Support Ask questions; be willing to wonder Define the problem/concern/question/need Examine the evidence (i. e. data) Analyze assumptions and biases Be objective; avoid emotional reasoning Don’t use either/or thinking; don’t overgeneralize • Consider other interpretations • Accept that there will be uncertainty/questions • • • 16

Define Questions • Critical starting point • Questions will drive the entire analysis • Analysis must focus in on users’ needs. Some critical questions are: • The user’s business and their role in it • What the user needs/wants to know and why • How the results will be used for decision-making • Thoroughness requires asking 6 key questions = what, where, when, who, why, and how 17

Example: What Are The Real Questions? • How effective is the property accountability contract. . . • Do resources used provide adequate accountability? • Are millions of dollars in lost property going down? • . . . at reducing FLIPL reports? • Is the dollar value associated with the FLIPL reports decreasing? • Are there fewer incidents for FLIPL reports to be filed? • Is there less property missing? FLIPL: Financial Liability Investigation of Property Loss 18

Data Required 19

Identify Data Required • Key question = What data do you need to answer the question? • Data collected from: • Primary sources = you collect • Secondary sources = others collected • Sources and quantity of data gathered depend on: • The questions needed to be answered • The availability of data • The time allowed for the analysis • If data does not exist, revisit your questions 20

The Data Quality Axiom All decisions are data driven. The quality of the decision can be no better than the quality of the data supporting the decision! 21

Collect the Data • Key questions in deciding how to collect data: • Where and how are you going to get the data? • Will it enable you to answer the questions? • Common data sources: • Records = cost reports, analyses • People = within and outside the organization • Time available key to source and amount • Verification important 22

Data Analysis 23

Analyze The Data • Analytic method = steps taken to understand, display, or interpret data • Methodology dependent on question(s) • Methods numerous and varied • Important to know purpose and function of each and when to use them • Review results of analysis: • Did it address question(s)? • How sensitive is it to internal and external influences? 24

Analysis Axiom The rigor of the analysis must reflect the risk and significance of the potential impact of the decision! 25

Determining The Type Of Analysis • Primary Data Analysis • Collect, assemble, and analyze data • Secondary Data Analysis • Use data gathered and in some cases analyzed prior to your own analysis • Evaluation Synthesis • Use the combined results from two or more previous analysis 26

Report Analytic Results • Important phase of process • Impact decision-making; bring about change • Reporting methods (written vs. oral vs. video) have different advantages • Goal = convince audience that the work done and the results reported are reasonable, appropriate, and actionable. • Answering analytic objective, i. e. question, is the most critical goal • Remember what drove the analysis – customer’s need / interest / role, and planned use of results 27

Revalidating Questions • Regularly re-check and validate questions. • Questions may need to be modified, dropped, redefined or added. Analysis Feedback Loop Define Questions Identify Data Sources Collect Data Conduct Analysis Report Results 28

Requirements 29

Determining Requirements Problem/ Opportunity Statement Critical Customer Requirements & Efficiencies Prioritize Requirements S. M. A. R. T. Objective S. M. A. R. T. = Specific, Measurable, Achievable, Realistic, Time-bound 30

Key Elements of a Problem/Opportunity Statement Problem/ Opportunity Who? Customer/ End Users Expectations What/Extent? Output(s) Products/Service Performance How, Where, and When? Process • There is an inherent relationship between problem/opportunity and customer, output, and processes. • The objective is to meet customer expectations consistently 31

Determining Requirements Problem/ Opportunity Statement Critical Customer Requirements & Efficiencies Prioritize Requirements S. M. A. R. T. Objective S. M. A. R. T. = Specific, Measurable, Achievable, Realistic, Time-bound 32

Defining “Who” is the Customer • A primary customer is anyone who receives or uses the outputs (product/service) from our work activities (process)- the end user – They define Critical Customer Requirement (CCR) and measure characteristics (Quality, Speed, Cost) • Internal customers are referred to as business partners or “process partners/owners” – They define the Voice of the Business (VOB) requirements to meet CCRs 33

Sample Categories of Customer Performance Metrics Quality Reliability, Availability, Effectiveness, Completeness, Freedom from Rework or Defects Cost Resources, Repair Costs, Purchase Price, Sustainment Cost, Training Cost, Doctrine Cost, Material Cost, Facility Cost, Depreciation, Productivity Speed Lead Times, Delivery Times, Turnaround Times, Setup Times, Cycle Times, Delays, Throughput Service and Safety After-Purchase Reliability, Parts Availability, Service, Warranties, Maintainability, Product/Service Safety Stewardship Business Risk Management, Regulatory and Legal Compliance, Ethical Business Conduct 34

Process Efficiency 35

Purpose of Process Efficiency • To identify inefficient steps and activities across business processes • To identify measures of efficiencies and cost drivers across an enterprise • To define types of inefficiencies/process waste (cost drivers) • Refine problem/opportunity statement 36

Definition of Efficient Process Steps • • • An activity in a process that is essential to deliver a service/product to the customer – Must be performed to meet customer needs – Adds form or feature to the services/product Those tasks which the customer would be willing to pay for if he/she knew what we’re doing Tasks should be optimized 37

Determining Requirements Problem/ Opportunity Statement Critical Customer Requirements & Efficiencies Prioritize Requirements S. M. A. R. T. Objective S. M. A. R. T. = Specific, Measurable, Achievable, Realistic, Time-bound 38

Common Tools to Prioritize • • Once you have defined CCRs, TIMWOOD, and customer issues, then various graphical tools can be used to prioritize the selection criteria and solve problems and take advantage of opportunity, as follows: – Kano Model: Are the issues related with performance/quality requirements? – Pay-off Matrix: What is the impact of CCR/TIMWOOD issues on the organization’s requirements? – Run Charts: Is the CCR/TIMWOOD issue showing significant step changes over time or a steady performance? – Pareto’s Law: Are 80% of the customer issues described by 20% of the CCR/TIMWOOD? – Histograms: Are customer issues showing significant variation? – SIPOC Process Map: What is the extent of the problem? These tools help characterize and quantify the extent of the problem/opportunity in terms of magnitude (quantity) or trends (changes in magnitude) 39

Pareto Chart Defects • A simple graphical display of problems (or other data), in columns in descending order to show the relative size of each category • Used when you need to improve communication by presenting data which is difficult to express in words or as raw data. • Highlights and prioritizes multiple problems in a process. • Identifies and quantifies the few vital priorities. 5 100. 0 4 80. 0 3 60. 0 2 40. 0 1 20. 0 0 Step 6 Defects 4 Cumulative % 22. 2 Step 7 4 44. 4 Step 5 3 61. 1 Step 2 2 72. 2 Step 3 2 83. 3 Step 4 2 94. 4 Step 1 1 100. 0 Step 8 0 100. 0 40

S. M. A. R. T. Objectives Problem/ Opportunity Statement Critical Customer Requirements & Efficiencies Prioritize Requirements S. M. A. R. T. Objective S. M. A. R. T. = Specific, Measurable, Achievable, Realistic, Time-bound 41

Define S. M. A. R. T. Objective The objective of the effort is to improve, reduce, or increase some aspect of a process, procedure, or program. • S. M. A. R. T. objectives ensure that there are measureable outcomes • The objective should be evaluated to ensure that it aligns with the mission and strategic goals of the organization • When defining initiative goals, they need to be verifiable through formal measurement 42

Process Improvement 43

Process-What is it? • A series of steps or actions that lead to a desired result or output • A set of common tasks that creates a product or service for a customer • Processes are largely affected by one or more of the following factors: a) people operating the process b) materials used as inputs (Ex: information) c) machines/equipment used d) methods (Ex: documentation) e) work environment It is vital to understand how these factors interact and affect processes Step 1 Step 2 Step 3 44

Process Improvement • A systematic approach to help organization’s optimize their underlying processes through the closing of process or system performance gap • Streamlining and cycle time reduction • Identification and elimination of causes below specifications quality, process variation, and non -value-adding activities. 45

Mathematical Foundation of Lean: Little’s Law The Avg Lead Time The Number of “Things” in Process = of Any Process The Avg Completion Rate Example: • The Procurement Department Processes (12) Orders per Hour • There is a Backlog of (89) unprocessed orders Order • A 90 th order is put into the queue • How long must the 90 th order wait to be processed? 90 Orders in Process 7. 5 Hours = 12 Orders per hour Lean is a set of tools to reduce the number of “Things” in process without reducing the completion rate 46

Everything We Do Follows a Process • Everything that is involved with getting a product or service to our customer is part of the overall process or “value stream” • Looking at the value stream, we determine what portions of what we do “add value” for the customer and what portions are non-value-added • We need to look at the performance of the whole system when getting services or products to the customer, instead of focusing too much on optimizing portions of the overall process • Every process has some level of variation – Variation is evil! 47

How Processes Work The output (Y) is the direct result of the inputs (x 1, x 2, …) and how they are processed By improving process and inputs, the end product will be improved 48

LSS Starts With the Voice of the Customer • Who are the customers? • What are their needs? • Do our services or products: – Answer the Voice of the Customer? – At a price he/she is willing to fund? • And how do we know? ! It is common for organizations to ASSUME they know what their customers want based on either “they always wanted it that way” or “it’s the way I would want it. ” 49

SIPOC Computer Acquisition Process Suppliers Inputs Process Outputs Customers 3 1 2 4 Input Metrics Process Metrics Output Metrics Quality Speed Cost 50

Swim Lane Client Mgr Client HR Green (CVA); Amber (NVA-R); Red (NVA) Notify HR of employee exit date Places information into HR database Sends exit date to IT, telecom & facilities Avg. Delay 2 days Form require approval? no Re-verifies with manager on employee’s exit status Yes Client IT Contact ITS NT Admin Secure approval (s) Sends Email to NT Admin Create ticket if request coming directly from client Admin Avg. Delay 1 day Email Vendor Delete account Utilize e-mail vendor’s web tool to submit delete request to vendor Avg. Delay 1 day Avg. Delay 4 days Avg. Delay 2 days Sends Email to Admin closes ticket and manager notified Generates IT ticket & forwards to NT Admin Mark request as completed on admin web site 115

Trend Chart – Simple display of trends with observations over specified periods of time – To monitor a process to see whether the long range average is changing – To focus attention on truly vital changes in the process – To identify meaningful trends or shifts in the average 52

Control Chart – Statistical technique for analyzing the variation of a process – To determine whether process is in control – To know when to adjust a process – To know the difference between assignable and chance variation Control limits are determined by the data 119

Process Capability – Compares process performance against requirements – Ability to measure how well the output from the process meets requirements Specification limits are decided by the customer 54

Cause & Effect Diagram Materials 3 Too much reliance on Pallet jacks Manual labor moving around numerous boxes Lack of parallel processing Lack of multiple lanes Limited scanners Delays in processing Methods 1 Utilization of experience Lack of Knowledge (Competing for Same Space) Location Lack of Controls for FIFO / LIFO Segregation of pallets Mother Nature Unforeseen Circumstances Wrong Location Lack of Computers Number of printer stations “Dedicated” to Task 2 Lack of single flow Facilities & Equipment Manpower Manual movement of parts Lack of heat or Air Conditioning 4 Multiple Processing tables (Y) Effect: CWT = 3 days (too long) Unplanned Deliveries Multiple deliveries showing up same time Measurements Lack of single flow measurement Too Long (Time) Time Based upon completing entire pallet 55

Productivity = Units produced Input used ▶ Measure of process improvement ▶ Represents output relative to input ▶ Only through productivity increases can our standard of living improve 56

Productivity Calculations Labor Productivity Units produced Productivity = Labor-hours used = 1, 000 250 = 4 units/labor-hour One resource input single-factor productivity 57

Multi-Factor Productivity = • • Output Labor + Material + Energy + Capital + Miscellaneous Also known as total factor productivity Output and inputs are often expressed in dollars Multiple resource inputs multi-factor productivity 58

The Measurement Problem • Organizations by nature have many – Elements and functions – Diverse activities – Varied resources • There a variety of opportunities for – – Inefficiency Ineffectiveness Redundancy (overlaps) Gaps in operations 59

Dashboards 60

Dashboards Definition • “Dashboards” are a compilation of standardized performance measures. These measurements are designed to: – Facilitate achieving objectives – Provide feedback – Enable learning • Dashboard measurements should accomplish each of the above at all levels of the organization • Dashboards should be clearly defined, simple to produce, and easily understood by users • Dashboards are the tactical tool used by lean implementations to measure and track project performance 61

Dashboard – Example Owner: J. Stubbs 137

Dashboards Support Corporate Goals • Minimal and balanced • The objective in a dashboard is to use the smallest number of metrics that still provides a balanced picture of process, site and/or organizational performance. • For example: just measuring and driving towards lower WIP may starve the process and destroy productivity • Objective – Metrics chosen for dashboards should be objective, rather than subjective • An objective metric is one that is well defined and yields the same value regardless of who is conducting the measurement. • For example: mission effectiveness can be subjective unless a clearly defined, quantifiable approach is used to measure it 63

Budgeting Controls 64

Budgeting for Control • • • Budgets are often used to assign responsibilities by allocating resources to managers Budgeted amounts can be used as goals to motivate Budgeted amounts can be used as targets by which performance is evaluated and rewarded 65

Participative Budgeting • • • Participative Budgeting is a concensus process With Participative Budgeting the person ultimately being held responsible for meeting the target makes the initial budget forecast Motivation to achieve the target is higher 66

How Budgeting Helps Resolve Organizational Problems Links knowledge with responsibility to make planning decisions Measures and rewards performance for control Budgeting Systems An administrative device to resolve organizational problems Distributes Responsibilities 67

Short-Term vs. Long-Term Budgets Strategic Planning Long-term Budgets (more than one year) Forecasts of large asset acquisitions 1. Selecting overall objectives Financing plans 2. Choosing Research markets and development plans 3. Selecting products to produce Short-term Budgets 4. Determining price/quality mix (1 year or less) 5. Choosing technologies Quantities to produce Quantities to sell Supplies acquisitions 68

Line-Item Budgets • Budgets that authorize the manager to spend only up to the specified amount on each line item • Managers cannot spend savings from one line-item on another line-item • The manager does not have the responsibility to substitute resources among line items as circumstances change • Impose more control on Managers • Prevalent in government organizations 69

Static versus Flexible Budgets Static budgets do not vary with volume and are used when a manager has control over volume or the consequences thereof Flexible budgets are adjusted for changes in volume and are used mainly in manufacturing where the manager does not have control over volume 70

Incremental Budgets • Rolling the Budget from a previous time frame to be the Base of the next Budget (priori Budget or Actuals from Prior Budget time frame as base) • Incremental expenditures are then added to meet a new objective • Inefficient base budgets are not eliminated • Incremental Budgets are most frequently used • Easiest to generate • Best when in a stable environment with little large scale fluctuations in organizational objectives and outputs 71

Zero-Base Budgets • Starting from Zero to develop the Budget each Budget cycle • ZBB motivates managers to maximize firm value by identifying and eliminating those expenditures whose total costs exceed total benefits • Incremental expenditures are deleted when their costs exceed their incremental benefits • Inefficient base budgets are eliminated • ZBB is used infrequently • Most useful when new top-level management come from outside a firm • Costly to conduct 72

Performance-Based Budgets • PBB links the programmatic Budget request to the expected performance results • Improves knowledge of agency operations • Cuts waste and enhances cost savings • Performance Plans required by GPRA 1993 to move Government entities to be more output and outcome focused; better stewards of the taxpayer's dollars • Incorporation of the Planned output/Outcomes drives to the Budget requested • Requires an understanding of the conversion of inputs to outputs (Cost Management) • Difficult to do since more Government entities are not Cost focused 73

Budget Method Comparison Incremental Budgets § Base budget is the previous budget § Only incremental changes from the previous budget are examined in detail Zero-Base Budgets § Each line-item is set at zero each year § Every line-item must be justified and renewed each year Performance - Base Budgets § Each line-item is associated with a Output/Outcome § Every line-item must be justified and renewed each year based on new Performance objective 74

Conclusion 75

CAPSTONE CASE • FORSCOM INC is a four person company finishing its first year of operations. The company started with a good idea and the desire to own the F 150 Platinum edition. • The company has one sales manager and three hourly employees that provides ~10, 000 service actions/year. • Travel is necessary for business development. 76

Plan & Actuals Plan Year 1 Actuals Quantities Cost Sales Manager 1 $ 100, 000 Hourly Personnel 3 $ 300, 000 3 $ 360, 000 Equipment 2 $ 110, 000 1 $ 80, 000 Travel 10 $ 12 $ 21, 000 20, 000 Total $ 530, 000 $ 561, 000 Units 10000 11000 • What are the variances? Are they good, bad, ugly? • What is the unit cost of service? 77

Plan Year 1 Actuals Quantities Cost Manager 1 $ 100, 000 $ - Hourly Personnel 3 $ 300, 000 3 $ 360, 000 $ 60, 000 Equipment 2 $ 110, 000 1 $ 80, 000 $ (30, 000) Travel 10 $ 12 $ 21, 000 $ 31, 000 20, 000 Total $ 530, 000 $ 561, 000 Units 10000 11000 $ $ Cost/unit Variance • Which costs are fixed and variable? • Determine the target budget (should’ve been) and new variances. 78

Plan Year 1 Actuals Qty Cost Qty Manager Hourly Personnel 1 $ 100, 000 $ - 1 $ 100, 000 $ 300, 000 3 $ 360, 000 $ 60, 000 3 $ 330, 000 $ 30, 000 Equipment 2 $ 110, 000 1 $ 80, 000 $(30, 000) 1 $ 110, 000 $ (30, 000) Travel 10 $ 20, 000 12 $ 21, 000 $ 1, 000 12 $ Total $ 530, 000 Units 10000 Cost Flex Budget Variance Qty $ 561, 000 $ 31, 000 11000 Cost Variance - 20, 000 $ $ 560, 000 1, 000 $ 1, 000 11000 • Output is estimated to increase to 13, 500 for next year. • Determine a new plan for the next two years. 79

Performance measures • In order to further grow the business, the company needs to mature its planning processes. • Determine your performance measures and future targets. – Sales price of each unit was $55. – Orders are dependent upon business development trips and sales price. YEAR TRAVEL 1 2 3 4 5 6 7 8 9 10 11 12 1700 1900 2100 2300 2000 1900 1700 1600 1500 1600 1400 1300 80