How cost management runs, step by step

Cost management runs as a loop. Cost structures are set up, the drivers behind cost are identified and measured, costs are gathered and allocated, critical activities and asset use are reviewed, and the results feed budgets, pricing and reporting. Each step depends on clean output from the one before.

The steps in order

1. Set up and maintain the cost structure. The cost accounting team owns this, working with whoever administers the finance system. They create and update cost centers, projects, cost pools and cost objects, and they set spend limits where budget holders need them. The handoff is an approved, loaded structure in the ledger that every later step codes against.

1. Determine the key cost drivers. Management accountants sit down with operations managers to agree what actually causes cost to move. Typical drivers include headcount, floor space, machine hours, transactions processed or cases handled. The handoff is a written driver list. Each driver has a definition, an owner and a named data source.

1. Measure the cost drivers. The data owners do this work, not finance. HR supplies headcount, facilities supplies space, IT supplies system usage, and operations supplies volumes. Finance checks the figures against the prior period and challenges anything odd. The handoff is a set of driver volumes for the period that the owners have confirmed.

1. Accumulate direct and indirect costs. General ledger and payables staff make sure costs land in the right cost center or pool during the period close. Miscoded invoices and payroll entries get corrected here. The handoff is a set of closed ledger balances, coded to the structure from step one.

1. Allocate costs. The cost accountant applies the measured drivers to move indirect costs from pools to cost objects, projects and responsibility segments. The allocation basis used each time is captured and kept. The handoff is a full view of cost by cost object, which anyone can trace back to the ledger.

1. Determine critical activities. Finance business partners and process owners review the allocated results together. They pick out the activities that carry the heaviest cost or matter most to service and margin. The handoff is a short, agreed list of activities to watch and improve.

1. Manage asset deployment and utilization. Asset managers and operations leads, supported by the fixed asset accountant, compare how equipment, space and systems are used against what they cost. Idle or overloaded assets get flagged. The handoff is a set of decisions to redeploy, retire, share or invest, along with any changes to cost centers that follow from them.

1. Report on cost. The management accounting lead produces cost reports by cost object and by cost center. Budget holders get their own view. The handoff goes several ways at once. Budget formulation receives cost history for the next plan. The billing team receives cost information for rates and invoices. Financial reporting receives figures for the statement of net cost.

1. Close out and feed back. When projects end or cost objects stop being useful, cost accounting and the project managers close them out. Lessons from the review, such as a driver that no longer fits, go back to step one. The loop starts again with a cleaner structure.

Where the handoffs tend to break

The weakest point is usually between steps two and three. Finance agrees a driver, then nobody owns the data. The number arrives late, gets estimated, and the estimate quietly becomes permanent.

Another common break sits between steps one and four. A new cost center exists in the plan but was never loaded in the ledger, so costs pile up in a suspense or default code.

Allocation keys also drift. A key set years ago can survive long after the business changed shape. When results look wrong to operations, they stop trusting the reports and keep their own spreadsheets. At that point the process still runs, but nobody uses what it produces.

Finally, the outbound handoffs in step eight are often informal. Billing or budgeting may pull cost figures from an old file, not the current report.

Questions to ask the people who run it

What staff actually do often differs from the documented process. These questions tend to surface the gaps.

• Who creates a new cost center in practice, and who approves it? Is that the same person the policy names?
• For each driver, where does the number really come from? Is it measured, estimated or copied from last period?
• Which allocation keys have not changed in a long time, and does anyone remember why they were chosen?
• What manual adjustments are made after the allocation runs, and who asks for them?
• Where are costs coded to a default or catch-all center, and who clears them?
• Which reports do budget holders actually open? Which ones do they ignore?
• Where do the billing and budgeting teams get their cost figures? Is it the current report or a saved file?
• How are asset utilization problems raised today, and who has authority to act on them?
• When a project ends, does anyone close it out, or do old codes stay open?
• If a step were skipped for one period, who would notice first?

The answers usually show which step carries hidden workarounds. That step is often the right place to start a change.

APQC's Process Classification Framework® (PCF) is an open standard developed by APQC, a nonprofit that promotes benchmarking and best practices worldwide. To download the full PCF or to view definitions and measures, please visit www.apqc.org/pcf.