Which is more Important? Operational or Financial Metrics

Your first reaction may be that this is an “invalid” question because both are important, but please bear with me for a moment because I think there is something to be learned by pondering this question.

Particularly in manufacturing, traditional approaches to inventory valuation/product costing have been creating distorted information from a decision support point of view. A accountants like to claim the information helps “control” operations while operations personnel have been ignoring this information, to the extent they could get away with, for decades maybe a century. Yet during this time, the efficiency, quality, and performance of manufacturing has exponentially increased! This was though a rigorous focus on resource operating efficiency, quality, and implementing new technology that supported optimization. Yes, these improvements improved financial results, but they were not driven by financial information. Operating metrics guided the improvements to optimize resource use which has the logical outcome of reducing cost and greater output and quality has the positive outcome of improving revenue.

I’ve been writing a column for a manufacturing magazine for about 12 years, and often speak to manufacturing groups. When I ask whether they find information from accounting/finance useful or consider accounting/finance their business partner, the most positive response I have ever gotten is 20%. The descriptive terms I get for accounting/finance are typically: hurdle, roadblock, irrelevant…..

The PACE model approach seeks to remedy this situation by always ensuring that a cause and effect operational model is the basis for monetary modeling. Furthermore, it doesn’t just look at inventory valuation/product cost the way financial reporting does. The PACE model seeks to improve decision making by applying causality and broadening the view of cost. Product cost is one dimension, but it should incorporate all organizational expenses with a clear causal relationship to product cost. If a sales person gets a commission on the sale of product, isn’t that causally related to the cost of the product? Another important dimension is customer cost: many organizational resources are tied causally to customers – credit, some sales & marketing, receivables and collection, sometimes order processing, sometimes warehouse order picking and outbound logistics, etc. Sometimes costing needs to be done for the selling or distribution channel: brick and mortar vs. online, direct sales vs. distributors and resellers. Much depends on the nature of the business, its products or services, other costing dimensions may need to be explored to support effective decision making.

PACE focuses on supporting decision making for long term survival and success based on clear causal relationships. These nearly always flow from resources, operations, processes, and customer non-financial metrics. Cause and effect based decision support information is a vital and a necessary complement to financial accounting and reporting information.

What’s your view of the important metrics – operational or financial?