WHY USE MANUFACTURING VALUE ADDED—MfVA?
Performance measures are used to deliver information to support corporate management decisions and to deliver information to assess divisional and unit level performance. Currently, there are not any measurements that accurately provide manufacturing performance using value-added data. Pure accounting profit is often distorted, and other manufacturing measurements do not include any sort of value measurement. No one knows whether manufacturing is adding value to the company and, if so, where and why. The key to understanding whether manufacturing value is increasing or decreasing is to know what the operating cash flow of different production units are in comparison to the operating costs necessary to support the operation's investment.
Traditional management accounting causes management to waste valuable time controlling and evaluating nonstrategic investment, which is more or less a result of past strategic investment decisions. To spend time on nonstrategic investment decisions also distorts management's business understanding, since the returns on nonstrategic investments are often very different from the overall return on the strategic investment (which is the return that matters to investors). Focusing on non-strategic investments also distorts management's perception of the underlying pace of the business, since the frequency of strategic investment decisions is normally significantly less than nonstrategic decisions. Management should instead focus on the strategic investments and the resulting long-term investment pattern of nonstrategic investments that the strategic investments will create.
The primary difference using MfVA is the unique treatment of equipment or strategic investments. Manufacturing value, using MfVA, is the comparison strategic investment using the life of the investment and the cost of capital to the amount of money earned by the investment. One of the primary differences between this approach and the more standard techniques is the classification of strategic investment. Value is based on strategic investment—all other investments for the purpose of maintaining the original investment value are considered "costs." Figure 1 describes the different types of strategic investments. The initial strategic investments will generate a cash flow over their economic life, corresponding to A. The lines B1 to B5 indicate non-strategic investments with the purpose of preventing the expected cash flows to drop according to Cl and C2 (nonstrategic investments made to defend the initial value of the strategic investment). These investments are not meant to create new value. Using normal accounting principles, these investments would be capitalized. Using MfVA, they
are treated as "costs." The dotted line D changes the fundamental value of the initial strategic investment by extending its economic life combined with a capacity increase.
Knowing these values can greatly improve management's ability to understand the most profitable investment strategy. Is it to extend the economic life of their existing plants and machinery through strategic marginal investments or is the most profitable strategy to avoid strategic marginal investments and instead run existing assets down in order to make new major strategic investments in completely new machinery thereafter?
To Be Continued