Accounting and Logistics Costs – an Impediment to Supply Chain Effectiveness
Supply chain management (SCM) is one of the key drivers in today’s business world with offshore sourcing, foreign competition and global markets.
The responsiveness required to keep the inbound supply chain flowing with materials and products and to keep store shelves filled is demanding. SCM requires reducing costs, increasing inventory velocity and compressing cycle time; and these three may not be compatible or consistent.
Doing all this-and doing it well-takes creativity and management skill. However there is a factor that limits the design, development and implementation of such supply chains. That factor is accounting and how it recognizes and treats logistics costs. Accounting is an impediment for logistics whether for supply chain management, both international and domestic, for lean and for outsourcing.
Generally accepted accounting principles create the foundation so that every company reports its financial data the same way. This financial snapshot is consistent then from firm to firm. This makes analysis of the data and comparisons possible.
These accounting standards have a long history. They date back to Henry Ford and the Model A. Companies then may have been vertically integrated with a primary focus on domestic sales, sourcing and production. That business model has become nearly extinct, especially for large companies. As a result, accounting rules have not kept up with present business operations and practices.
Some differences with supply chain management and accounting are:
- Process versus Transactions. SCM flows across the organization. As a process, it flows across many of the company departments and boundaries. Accounting is transactions-oriented with its focus on identifying and summarizing vertical sales and make-or-buy activities.
- Organization Direction. Supply chain management is horizontal and crosses departments and organization boundaries. Transactions are vertical and are consistent with organization silos.
- Scope. SCM extends into suppliers and logistics service providers to gain inventory velocity and to reduce cycle time. Accounting stays within the company facilities and boundaries and looks inward.
- Outward or Inward. Supply chain management looks both company-inward and outward to deal with suppliers, transport firms, warehouses and other logistics service providers. Collaboration is important to managing the complex, global supply chain. Accounting is traditional and focuses within the corporate boundaries.
- Continuous versus Discrete. SCM is ongoing. Product is always flowing. Accounting looks at different summaries which create supply chain disconnects. Logistics costs are individually recognized, not recognized at all or recognized in different places. For example, freight and warehouses show on the income statement and are recapped monthly. Inventory appears on the balance sheet and is presented annually. So three key logistics elements are dissected and shown in different financial reports. And nowhere does “time”, a vital business driver and the action that creates inventory and service, appear on any financial statement. To some extent this view of logistics costs makes accounting obsolete for supply chain management.
- Dynamic versus Static. Supply chain management is constantly changing–as suppliers, customers, plants and warehouses, shipment sizes and order mix and as store locations change. This contrasts with accounting which has the historical perspective of what has already happening. As a result, accounting does not understand changes in transportation costs, for example, because of changes in the distance inbound and outbound shipments must travel, or in the shipment size or in the mix of commodities being shipped.
These differences make it difficult to develop meaningful performance metrics for supply chain management that are recognized in the board room and that are aligned with the company strategic plan. Financial metrics, while commonly used, have limited application to supply chain management performance improvement.
For example, inventory velocity, inventory turns and inventory yield maximization are important to achieving the best returns on inventory and on the capital that it represents. Cycle time, from purchase order to sale or time within the total supply chain, are measure of company performance with strong bottom line implications. Yet none of these are part of traditional accounting measures which are rooted in the past.
Today’s business world is focused on the customer. The perfect customer order is a key performance metric for gaining and maintaining customers and for achieving deeper customer penetration. But again, these are not standard financial measure.
Similarly developing unique supply chain programs that differentiate by A vs B vs C inventory, or by customer or by product family segment or other delineator are not supported by accounting. Financial standards do not readily recognize such stratifications. Sourcing right decisions are also restricted by accounting which has blinders as to the potential impact of the outsourcing decision on the company and transforming its processes, operations and results.
These limitations also impact the success of lean program development and lean success. Waste, non-value added, actions do not conform to traditional accounting. As a result, time and inventory waste identification and removal run counter to how accounting sees these manufacturing and supply chain processes and sub-processes. Incremental and continuous improvement with its flow and pull are part of adapting to the new business model of faster and better and less expensive. Unfortunately cost accounting practices are enablers of the old ways, not the new ways of business and business models.
Accounting professionals have recognized the limitations of accounting in today’s business. Activity based costing is one way they try to adjust to the new world. But ABC is not incorporated into income statements and balance sheets, which still reflect an antiquated way of summarizing business financials and performance.
At some point Accounting must step up and stop band-aiding a bad system and redefine and reinvent itself to be part of the global business world. Until that happens, companies will continue not to properly measure and improve their performance, operations and results.
LTD provides logistics consulting for strategic and tactical needs. The scope of capabilities is broad–supply chain management, outsourcing, transportation, warehousing, inventory management, and more for both domestic and international needs. Clients include retailers, wholesalers/distributors, manufacturers, logistics service providers and 3PLs.