The Spectrum of Economic Radiation

Visible light is electromagnetic radiation that we, as humans, can detect with our naked eyes. When we observe the heavens on a clear night – either with or without the aid of a telescope – we are detecting radiation in “the visible spectrum” – that portion of electromagnetic radiation emitted from celestial objects that happens to fall within the range our eyes can detect. We are not observing everything that is there; only those things emitting a certain type of radiation. This visible light covers only a small percentage of the existing electromagnetic radiation – I’ve seen estimates as small as .0035% and as high as 2.5% – so we’re only “seeing” a small portion of what exists and what it is doing.

Since the existence of radiation outside of the visible spectrum was discovered in 1800, scientists have developed tools for detecting and measuring the radiation in many other ranges of the electromagnetic spectrum. Aided by these tools, humans can now “see” and measure things that are invisible to the naked eye; from low frequency, low energy radio waves to high frequency, high energy gamma rays.

This ability to see that which was once invisible has been a prime mover behind the exponential growth in our understanding of the universe as well as practical inventions humankind has found quite useful – like radio, television, microwaves, lasers, night vision goggles and x-rays.

Financial accounting is the decision maker’s visible light. Through the eye of financial accounting, a decision maker can detect and measure only the economic radiation that happens to fall within financial accounting’s “visible range.” Financial accounting does not detect and measure all of the economic radiation lurking in the universe, only the radiation within its limited range. When decision makers limit themselves to economic information as defined and measured by financial accounting, their level of effectiveness is comparable to that of a 21st Century astronomer who limits himself/herself to information that can be detected through visual celestial observations.

Predictive, causality-based operating and economic cost models, like those promoted in the Profitability Analytics Framework, provide visibility along a much wider range of the economic radiation that permeates the universe. Those models not only provide cost information at a much greater level of granularity, their cost measurements are not constrained by the rules of GAAP or IFRS, they link costs with the activities that cause them, and they effectively measure the cost impact of decisions under consideration.

Cost information is not just required to value inventory and measure cost of goods sold. Other measures will be required depending on the decision or action being contemplated by management. Different information will be needed to measure the impact of an operating improvement, determine product and customer profitability, estimate the cost of a product or service for use in a pricing decision, determine the return on a possible capital investment, evaluate the advisability of outsourcing a process, select the lowest cost (vs. lowest price) vendor, or any other use. As John Maurice Clark pointed out a century ago is his classical work Studies in the Economics of Overhead Costs, “…if cost accounting set out, determined to discover what the cost of everything is and convinced in advance that there is one figure which can be found and which will furnish exactly the information which is desired for every possible purpose, it will necessarily fail, because there is no such figure.” The effective management accountant understands that there are “different costs for different purposes” and has the ability to view economic radiation at whatever point along its spectrum is appropriate for the use at hand.

The confusing “clutter” of concepts circulating in the management accounting community (Financial Accounting, ABC/M, Lean Accounting, RCA, GPK, etc.) is a direct result of individuals viewing business from differing points along the spectrum of economic radiation and believing theirs to be the only valid point of reference. Each concept makes perfect sense when the portion of the spectrum being used is believed to be one-and-only “economic truth.” The fact is that the “economic truth” can change as decision situations change. Only by understanding the entire spectrum of economic radiation – not just one small section of that spectrum – can management accountants provide the decision support needed for an organization to be financially successful in the 21st Century. Continued reliance on economic information that is emitted from only a miniscule portion of the vast spectrum of economic radiation – regardless of which portion that is – is a road that leads to underachievement for those who are lucky and failure for those who are not.

The Profitability Analytics Framework provides for the incorporation of causality-based revenue, operating, cost, and investment models that enable decision makers to view the entire spectrum of economic radiation when making critical business decisions.