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Activity based management and performance measurement systems.

Advanced capabilities associated With modern enterprise financial systems now provide a vehicle by which governments can realize the goals of measuring performance and capturing costs of core business activities. The author describes the impact of such systems on public-sector decision-making capabilities.

More than ever before, governments are using technology to enhance organizational efficiency by either automation or cost reduction. Technology and business process reengineering are at the center of efficiency initiatives. As government technology utilization continues to evolve, effectiveness is becoming the dominant factor surrounding the organization. Taxpayers are looking for government organizations to leverage technology as a way to formulate and execute better business strategies. Efficiency is about "doing things right" and effectiveness is about "doing the right things." From a financial management perspective, the demands of efficiency and effectiveness are quite different. Whereas efficiency demands doing things more inexpensively, effectiveness demands accomplishing what is intended and providing services with fewer resources.

Traditional Accounting Systems

The traditional government accounting system was developed in a world where program costs and revenues were tracked easily. As the nature of business changed and direct costs became harder to tie directly to programs, management dissatisfaction developed. Rather than supplying managers with information necessary for forward-looking action, with an emphasis mostly on financial control, traditional systems chronicled past data for citizens, regulators, and other parties. As shrinking resources and increased productivity demands placed greater pressures on accountability, managers needed to know which activities delivered the greatest benefit. Without this detailed information, managers could only guess at the program's real efficiency in performing service. Choosing which programs to fund, which services to alter, even which processes to provide at all was driven by instinct rather than information. For reporting overall budget information, traditional accounting systems served their purpose. But for delivering the information necessary to better manage an organization, traditional accounting systems have deficiencies. To gain a better understanding of the contribution of the next generation of financial systems, some of the other deficiencies of traditional accounting systems are described below.

Limited Capability. The traditional approach to cost accounting was adequate when processes were not complicated. However, technology investments and the expenses associated with increased overhead, increased services, complex processes, and changing roles of government have significantly complicated the cost profile of governmental organizations. As a result, costs that traditionally had been considered overhead now represent activities critical to the delivery of government services and account for a majority of expenses. It is increasingly difficult to associate these costs directly to individual programs or customers for results analysis purposes.

Increasing Complexity. Organizations that produce a limited number of services or conduct business with a limited number of customers find it relatively easy to accurately report costs using standard cost accounting. However, when the volume of products and customers increases so does the overall complexity of the operation. For instance, costs from one activity may be incurred at different rates depending on the customer. Traditional cost accounting has had difficulty tracking cost variances associated with different customers.

Data Retrieval Limitations. Traditional cost accounting systems can easily convey information about overall costs. But because traditional cost accounting systems were developed to catalog costs, they cannot provide the level of detail needed for the effective management of today's complex organizations. As a result, rather than performing ad hoc inquiries as the need arises, decision makers must conduct special queries to extract more meaningful information than is provided in summarized data.

Information Aggregation. Because they lack the capacity to handle more complex costs, traditional cost accounting processes may obscure critical information. For instance, in a department of public works, the cost of machine downtime, special work set ups, or special customer requests cannot be adequately tracked, resulting in misleading and unrealistic cost allocation. By separating the costs by location rather than activity, traditional cost accounting actually disassociates costs from the activities that drive them.

The next section describes how many of these limitations are being overcome with advances in information technology.

The Next Generation of Systems

Robert S. Kaplan in Relevance Lost (1987) stated: "Today's management accounting information, driven by the procedures and cycle of the organization's financial reporting system, is too late, too aggregated, and too distorted to be relevant for managers' planning and control decisions."

Activity based Costing Systems

In the 1980s, leading business experts started to search for alternatives to traditional cost accounting systems. They recognized the need to develop a system that more accurately captured costs and related costs to the activities that drove them. In the late 1980s, the concept of activity based costing (ABC) was developed and quickly received widespread acceptance. ABC is a system of financial analysis based on activities rather than materials. It has helped establish a vision for the future of integrated financial management systems. There are four stages for cost accounting in financial management systems.

1) Stage one states that the traditional cost accounting model is broken and incapable of tracking real costs.

2) Stage two shows some improvement by transferring costs to a single database, typically a general ledger.

3) Stage three is when the organization maintains two systems tracking separate information running in parallel. The first system, the traditional accounting system, catalogs daily transactions and control and provides the day-to-day information that managers need to make immediate operational decisions. The second system, based on ABC, captures the real costs associated with activities and provides a long-range organizational view, providing information to better measure where resources are most profitably allocated over the long term.

4) Stage four is when the organization integrates the transactional and ABC systems created in the third stage into an effective, single enterprise-wide system.

The next-generation financial management systems are being built on the understanding that resources, both labor and materials, are consumed during the execution of activities. Answering a support call consumes the resources of the phone system, labor of a technical support operator, space in the building to house the operator, and furnishings to provide a workspace for the operator. The consumption of these resources incurs costs for the organization. This association between costs and activities enables organizations to allocate overhead costs directly to activities.

Using traditional cost accounting, an organization might determine their total cost of service and allocate a percentage to each agency. This approach cannot accurately portray how the function may differ between government services and how those differences impact the cost of a given service. Using performance measurement, costs are grouped by the activity and then by cost object (program, customer, channel, etc). Rather than calculate the total cost of service, one would calculate the cost for each of the individual activities involved in the process and use that as the basis for determining the cost to budget and allocate. One of the programs may require a more involved cycle with a greater number of staff or materials. The added expense of the service may negate the value that might be realized from the customer. With this understanding, one can shift resources to the most effective programs and services. Also, one can evaluate non-value-added service to determine whether a shift in the process or activity might be appropriate, or whether the government should simply discontinue or outsource the service.

Activity based Management

It is important to note that performance, even when measured in financial terms, is impacted by more variables than just cost. Examples of non-financial or operational measures include achieving program goals and improving customer satisfaction. The new financial management technology solutions must integrate these operational measures and ABC into a complete costing model referred to as activity based management (ABM). ABM, with its mix of financial and operational performance measures, forms the application engine for performance measurement. Unlike previous ABC systems, performance measurement systems will offer two critical advantages over other ABM-based applications - 1) shared transactional data, and 2) robust calculations.

Shared Transactional Data. Transaction-based accounting systems and ABC systems address costs in very different ways. Transaction systems use materials and program labor costs while ABC systems use activity costs. To overcome this dual-system issue, performance measurement systems use transactional data stored in the accounting systems. The data from the general ledger is then transferred to the performance measurement warehouse where, using certain rules and algorithms, an ABM engine enriches the data. This enriched data then supports end-user reporting and analytic applications through the warehouse. This pass-through approach ensures that transactional and ABC systems are continually reconciled to provide end users with up-to-date information for decision making.

Robust Calculations. The calculations used to convert transactional data and extract meaningful performance measures from ABM applications are extremely complex, requiring enormous amounts of calculating power. Earlier systems could not support these complex and challenging calculations. As a result, early ABM systems were dumbed down, making them interesting exercises but impractical tools. The architecture of contemporary performance measurement tools makes it possible to transform transactional data into accurate ABC data. Additionally, the architecture is able to deliver the power needed to execute complex calculations that turn activity costs into performance measures for programs, departments or any of the dozens of balanced measures critical to evaluating an organization's performance. See Exhibits 1 and 2.

Performance Measurement Systems

Business activities are at the core of what the organization does: that is, everyone performs an activity. Performance measurement provides the insight to evaluate these activities and how they affect the outcomes of the government organization. By better understanding the true costs of an activity, ABC enables organizations to create a performance measurement system that supports decisions about budgeting, performance goals, employee mix, customer service, and process reengineering. One can analyze costs at multiple levels including program, region, or department. One also can improve operational control by targeting the activities, departments, or processes that are most inefficient. After this evaluation, one can better determine where changes such as shared services can be made to deliver increased productivity and citizen value. This overview provides a picture of how the organization is currently performing and how changes might affect this position. As a result, the government is better able to allocate resources to the most strategic aspects of the business and implement changes to boost the lagging productivity of other areas.

Multi-dimensional Analysis and Reporting. The government organization's success has many dimensions including programs, services, and customers. Performance measurement enables one to better understand how each dimension affects the overall goals of other dimensions and, ultimately, the organization as a whole. Actual information is integrated directly into the architecture so that an end user can perform budget analysis with the most up-to-date data. With all information stored in a single repository, this critical information can be shared throughout the organization. Using a modern reporting and analysis tools, a front-line manager can determine the cost of providing a special service to one customer and how that additional cost affects the overall organization. Using this information, the manager may determine that the cost is justified because of the results to the customer. Or the manager may discover that the service is actually costing the organization more money than the value the program generates.

Balanced Performance Measures. No single measure can provide a clear or accurate indication of performance or the critical areas for overall organization success. However, by tracking both financial and operational measures, performance measurement solutions should provide a more balanced measure of real performance. Like a panoramic picture, a wider snapshot of the organization provides a better vision of where the government organization actually stands in four key areas.

* Financial measures - How well are taxpayer dollars managed?

* Customer measures - How do customers view the services?

* Internal measures - Where is the organization efficient?

* Innovation and learning measures - Is the organization becoming more productive?

This information helps the organization identify areas for improvement and areas where there is already the greatest return.

Performance measurement supports these critical decision processes with four basic benefit categories: 1) strategic information, 2) accurate information, 3) operational benchmarks, and, 4) cost vs. fee analysis.

Strategic Information. Strategic planning is a forward looking plan of action. Performance measurement provides an accurate picture of overall operations that is comparable between departments, programs, and customers. It provides the framework for future action within an organization and answers the following questions:

* Where should resources be allocated?

* Which customers should be served? and,

* What delivery mechanisms make sense?

By measuring the past performance of programs, channels, customers, and other organizational activities, one is better able to gauge future performance and make decisions that deliver the best impact for the organization. Strategic decisions can include the following.

* Service Offerings - What services are necessary?

* Service rationalization - Will this service add value?

* Taxpayer mix - Which customers require the most services?

* Customer relations - What is the real cost of providing specific services? and,

* Program Goals - Which programs best achieve the overall mission of the agency?

The power of performance measurement makes it possible to distribute this strategic information throughout the organization. With more meaningful information instantly available in all functional departments, managers, and front-line supervisors can make strategic decisions when the opportunities are in the earliest stages.

Accurate Information. One of the short-comings of earlier ABM systems was the need to populate and maintain parallel accounting systems. This two-track approach led to inconsistencies in information. Accurate and consistent information is imperative for meaningful decisions. Insights based on erroneous or outdated data can mislead organizations into pursuing the wrong course of action. To overcome this past challenge, the general ledger should serve as the information clearinghouse for all financial applications. This integration around a central "point of contact" ensures that financial applications only use the most current and correct data available. As a result, all reports and analysis are based on the most accurate and appropriate numbers.

Operational Benchmarking. By using a broad range of financial and operational measures, performance measurement provides a realistic snapshot of the organization's current position. These balanced measures incorporate the critical variables, their relationship with all segments of the organization, and their effects on productivity. and effectiveness. In using performance measurement, one can establish operational benchmarks including:

* Cost behavior - What happens to costs if an activity is changed?

* Customer needs - How are operations affected if a certain service is offered?

* Business process reengineering - What areas offer the best possible cost reduction?

* Change impact - How does a change at one level of an activity affect the entire activity?

Analysis. Performance measurement captures all the costs associated with an activity, regardless of where the activity is performed. As a result, performance measures reflect the real effect on the organization's goal attainment. Each activity can be evaluated for the added value it brings to the organization.


With an increased emphasis on cost-effective government, more and more governmental organizations will look towards activity-based decision making and performance measurement as a framework for successfully managing their processes and operations. The desire to bring such tools to the forefront of government decision making has been with us for decades as the legacy of reform efforts in budgeting demonstrate. But the lack of information integration and limitations of information processing made it difficult to link inputs to outputs and costs to activities. However, the rise of low-cost desktop computing and the utilization of relational databases now provide a vehicle for developing performance measurement systems.

Leading enterprise resource planning (ERP) system companies are developing ways for the public sector to embed performance measurement concepts in system design. System design activities such as the chart of accounts, budgetary structures, and reporting, for example, must anticipate the types of systems discussed here. In summary, as ERP capabilities advance, public-sector managers will need to transform the way they construct and use financial benchmarks, conduct strategic planning, and design financial systems if they want to meet the demands of the "Effectiveness Era."

Exhibit 1

Activity based Cost (ABC) Systems are designed to meet the needs for accurate information about the cost of resource demands by individual products, services, customers, and channels.

Activity based Management (ABM) Systems include the entire set of actions that can be taken, on a better informed basis, with activity based cost information.

Performance Measurement (PM) Systems provide operators and all frontline employees with timely and accurate information, both financial and nonfinancial, on the efficiency, quality, and cycle times of business processes.

JON GEARHART is the Industry Director for the Public Sector at PeopleSoft Corporation. He has more than 25 years of experience in the design, development, and implementation of financial and management systems.
COPYRIGHT 1999 Government Finance Officers Association
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Copyright 1999 Gale, Cengage Learning. All rights reserved.

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Author:Gearhart, Jon
Publication:Government Finance Review
Date:Feb 1, 1999
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