COST ACCOUNTING

One of the myriad of appalling consequences that result from fitting an engineer-to-order (ETO) environment with a repetitive-oriented ERP system, which does not have, in the very least, a product configurator facility with generic items (encapsulating options, variants, and constraints), generic bill of materials (BOM), generic routings, or pricing functionality, is that the sales order capturing clerk has to contact the engineering department for a product code or for the price or cost of a product, sometimes waiting days for a response. Needless to say the standard master data becomes bloated because each product variant has to have a separate stock item code, BOM, and routing as if it was a standard stock item and not a once-off made customized product (for example, a special color or gauge thickness). As a result, the ill-fated user company would have to literally close down operations so that the entire place can participate in a dreaded stock-taking exercise with an item master printout as thick as encyclopedia and with less than 10 percent of listed items expected to be really stocked. This is without considering the likelihood of identical products having a number of different item codes as different people created new codes unbeknownst to each other.

As for the production planning aspect, the differences do not come only from days- or weeks-long lead times for repetitive items versus months- or years-long lead times for an individual project. Further, as mentioned earlier, a simple count and addition of the purchasing and manufacturing lead times will not determine the overall lead-time or time-to-deliver a project, since projects often have numerous product definition activities and commissioning and installation to arrange before and after manufacturing respectively. Also, it is not a mere scope of the planning that differs in repetitive and project manufacturing, since there are other major differences in the way that these environments approach planning.

First, project manufacturers tend not think in elapsed time, given they calculate effort. For example, if a project is estimated to have one hundred hours worth of installation, it could mean one person deployed for one hundred hours, or that it could be deployed much quicker with a larger crew. Establishing and managing a critical path is the "motherhood and apple pie" of project management. Critical path is that set of activities that defines the duration of a project, and these activities have very little float or slack, usually zero, and thus a delay in any critical path activity will delay an entire project. Still, losses in one area may be made up in another. For example, if design is budgeted to take a team of five people, and one falls ill and cannot be replaced, the design time overrun will be inevitable. However a project organization may decide to make up the time by increasing the applied effort in downstream manufacturing /or installation activities in order to hit the overall deadline.

Secondly, project manufacturers know that they cannot always be in control of the lead-time even if this project is nearly a repetition of the previous one. All sorts of issues can impact the plan to deliver even a simple project. Customer late with the design approval? Subcontractor late with the delivery due to a strike in its plant? Cannot get access to the site on the day we need it? Wide load needs a police escort? Welding can't be inspected on time? All of these have an impact on delivering the plan. Although some may not be controlled, all must be accounted for since they can profoundly affect the overall plan.

Thirdly, traditional MRP based systems work without priorities, but rather with time-phased, back-loaded scheduling and with the "oldest order first" principle. Advanced planning and scheduling (APS) and some other job dispatching techniques may use more advanced algorithms (e.g., critical ratio), but they do not really recognize a "rush job" logic (see Advanced Planning and Scheduling: A Critical Part of Customer Fulfillment). In other words, it is often difficult to see why any one job on the factory floor is needed or where it is going to go. Since their business is often more cyclic, project manufacturers want clarity and simplicity to be able to juggle priorities within the network of remaining activities. They demand that everyone knows what the critical path is within the plan today.

This is not to imply that in repetitive manufacturing planning and re-planning are simple activities, given one has to take the maximum or optimal utilization of plant, equipment and absorption of overheads into account. It is to say that project manufacturers have just as complex albeit an entirely different planning problem. As such they need a system that thinks in terms of applied effort, can plan for items and activities outside the bounds of the company, is clear to understand, and is flexible enough to cope with rapidly changing priorities and circumstances.

This is Part Three of a three-part tutorial.

Part One defined the terms and provided background information.

Part Two discussed ETO versus Repetitive Differences.

Project Cost Accounting

When it comes to accounting, project-based manufacturers are more concerned with the profitability and cash flow of the project than of the departmental or organizational accounts. These organizations are looking for systems to support the project manager, who is responsible for sharing and tracking the revenue, expense, and profitability of a project. Yet, most enterprise-wide business systems sold by software vendors are general purpose in design and, without significant tweaking, they do not address many of the unique requirements of businesses engaged primarily in providing products and services under project-specific contracts and engagements.

The key difference here is project cost accounting versus standard cost accounting. According to APICS Dictionary, project costing is "an accounting method of assigning valuations that is generally used in industries where services are performed on a project basis. Each assignment is unique and priced without regard to other assignments. Examples are shipbuilding, construction projects, and public accounting firms. Project costing is opposed to process costing, where products to be valued are homogeneous." Conversely, standard cost accounting" is a cost accounting system that uses cost units determined before production for estimating the cost of an order or product. For management control purposes, the standards are compared to actual costs, and variances are computed."

Project-oriented organizations have many project-specific business and accounting requirements including the need to track costs and profitability on a project-by-project basis; to provide timely project information to managers and customers; and to submit accurate and detailed bills and invoices, often in compliance with complex industry-specific and regulatory requirements. In fact, project managers tend to be obsessed with analyzing actual spend versus achievement. For each separate project, and at any point in time, they need to know exactly what they have committed in terms of purchases, WIP, billable hours, material etc. They want to be proactively alerted as soon as a job goes outside predefined parameters, so that the causes can be identified and the situation rectified. Equally important, they need to know how much work remains and "cost to complete", as well as what is left to spend in order to deliver the project, as an anticipation of profit or loss before the project is complete.

They have to be able to report revenues on the percentage-completed basis, which is more complicated than reporting on a basic completed product. Yet, traditional generic general ledger-oriented (GL) accounting systems have not been designed with project phases, work breakdowns or detailed time capturing in mind, and thus, they merely can report how much it has been spent or collected, but not why certain project is losing or winning money.

In project manufacturing, the received payments may be spread out over the life of the project—including retention for acceptance of the job a long time after its completion. These receipts, also known as "stage payments", may happen at any time in the project, and depending on the contract, may be based on committed purchases or major events in manufacturing. One should note that the effect of stage payments on cash flow may even drive the priorities in the production sequence. So once more, project manufacturers have subtly different needs which can make all the difference in the pursuit of "world class". At least, the ETO amenable ERP system should include project costing, which is kept separate from the ERP system's general ledger.

User Recommendations

But in terms of the scope, those companies who recognize that they are project manufacturers have to seek out ERP systems that will plan and account for activities before and after the "factory" activity. Thus, through the Program Cost Accounting, Project Accounting, Project Definition and Project Resource Planning sub-modules, to name only some, an ETO focused vendor should take a holistic approach to the needs of project-driven manufacturers. This should address the entire process life cycle, beginning with the bid and estimating processes, all the way to installation and service management, and thereby connecting project status tracking with back-office processes. The system should also have a bidirectional interface to CAD design and project management tools such as Microsoft Project. Many customers require weekly progress reports and are comfortable with the MS Project format, but the product on its own cannot give the visibility and scheduling over a great number of concurrent products. That is where products like Encompix, Lilly Software, Jobscope, Made2Manage, Epicor, Visibility and so on come into picture within the lower of the mid-market.

While many of the these functionalities sound ordinary and appear to be "supported" by many vendors responding to requests for information (RFIs), the subsequent product demonstration often reveals the need for some tweaking or even for a major modification in order to satisfy stringent customer requirements. As the old adage goes, "the devil is always in details". For example, Encompix allows users to estimate and quote an overall project using "buckets" of time or dollars, which concept enables enterprises to perform actual rollups. In other words, companies can track orders and projects and compare their progress to the original estimate, as well as to previous iterative changes, all in the "bucket" form, such as total engineering hours or total dollars. Many other systems that are even ETO-oriented can only track the current iteration.

However, while a company's focus allows it to keep pace with trends in technology and customer requirements in its target niche, too narrow a focus comes with its liabilities as well. Namely, in addition to its small size, which may imply negative viability perception these days when many believe "the bigger, the better", limited financial resources; low visibility and brand recognition; and limited global capabilities of a product are the challenges such companies have to overcome. It remains a good practice for manufacturers that are selecting solutions to factor costs, the financial viability of a vendor, local support, and many other criteria, which might not go towards a small company's favor.

On a more general note, companies that are project manufacturers, ETO, build-to-order, jobbing shops or contract manufacturers should think carefully when selecting an ERP system. Given the maturity of the ERP market, its ongoing consolidation, and that competitive advantages are hard enough for manufacturers to find, they should not compromise on their requirements. In particular, small and mid-size enterprises should ask hard questions about the scope of an ERP system, and how it supports project-based idiosyncrasies. After all, a new system should always be about improving the business and not a mere technology initiative.

The vendor that listens to your needs instead of telling you what "cool things" its software can do, and that speaks your language and uses your terminology and vernacular is a good candidate as a vendor that understands your business. Still, as a sort of a litmus test, prod each vendor to tell you what percentage of its sales would belong to your industry. Vertical focus indicates that software contains industry-specific features and that ERP vendors have certain industry expertise. Also, in implementing an industry-specific application, it is important to ensure that the application provider's implementation team includes members with in-depth knowledge and experience in that industry. Vendors geared toward certain industries should have solid integration skills or strong relationships with systems integrators that have industry-related expertise. This should significantly streamline implementation time by eliminating a lengthy vendor or integrator learning curve.

Often, buying a completely integrated solution is not an option when the companies have either an accounting or project-management system in place, which is one that they will not simply "rip-and-replace." Thus, prospects should assess the contesting vendors' flexibility to integrate to legacy and other third-party applications, and to keep up with new versions or upgrades to both solutions. Vendors offering built-in interfaces to commonly used third-party products like Microsoft Project, Microsoft Office, AutoCAD, Crystal Reports, etc., should be questioned during software demonstrations if possible.

SOURCE:http://www.technologyevaluation.com/research/articles/erp-systems-and-the-eto-manufacturing-market-part-three-user-recommendations-17265/