Down With Silos
Integrated systems help management improve the bottom line
Businesses today have multiple management systems, including financial, quality and environmental. Unfortunately, these management systems usually do not talk to one another. They behave like independent silos, which results in less-than-optimal operations, excessive costs and unhappy customers and investors.
Quality and environmental managers need to understand the language of finance and the effect of operations on the bottom line, while financial managers need to know how quality and environmental managers can help improve results.
The long-term advantages will be cost savings, continual improvement of processes and products, and a greater understanding of each other's work and responsibilities.
Quality management systems
ISO 9001 promotes a process approach to develop, implement and improve an organization's effectiveness. This broadly consists of the application of a system of processes, together with the identification and interaction of these processes and their management and improvement over time.
ISO 9001 describes the basic structure of a good quality management system (QMS) in clauses 4 through 8:
- Clause 4 (QMS) defines the process approach and documentation requirements, which include the quality manual and procedures for control of documents and records.
- Clause 5 (management responsibility) requires evidence of management commitment, customer focus, a quality policy, planning, definition of responsibilities, authorities and internal communication, and management review. As part of planning, the organization must define measurable objectives that are consistent with the quality policy.
- Clause 6 (resource management) requires providing resources to implement the management system, continually improve its effectiveness and enhance customer satisfaction. It also requires procedures to assure competence of personnel and management of the organization's infrastructure and work environment.
- Clause 7 (product realization) requires planning the realization process, and determining and reviewing customer requirements and procedures for customer communication. Subclauses define the design and development process, purchasing procedures, production and service provision, and the control of monitoring and measuring devices.
- Clause 8 (measurement, analysis and improvement) contains subclauses for planning, monitoring and measuring customer satisfaction, processes and products. There are requirements for documented procedures covering internal audits, control of nonconforming products and services, and corrective and preventive action. Finally, there are subclauses requiring analysis of data and continual improvement of the management system. The continual improvement process links back to management review in clause 5, which restarts the improvement cycle.
Environmental management systems (EMS) are based on ISO 14001, which is a document paired with ISO 9001. The structures are very similar. EMSs protect against failure to satisfy governmental requirements. The following elements are part of a compliant EMS:
- Environmental policy.
- Planning environmental aspects, legal and other requirements, objectives, targets and programs.
- Implementation and operation, including resources, roles, responsibility and authority, competence, training and awareness, communication, document control, operational control, and emergency preparedness and response.
- Checking, including monitoring and measurement, evaluation of compliance, internal audit, nonconformity, corrective and preventative action, and control of records.
- Management reviews.
Financial management systems
A typical financial management system (FMS) consists of investment management, statement of cash flow, profit and loss (P&L) statement, balance sheet, general ledger and internal control system. Other management systems can provide inputs and supports for financial management.
Investment management: The bases of the investment management process are the tools used to make good decisions about the costs and benefits of projects. Decision tools can include payback time, net present value, economic value added, review of the variances associated with current budgets and statistical forecasting. The break-even point occurs when total revenue equals total costs.
QMS/EMS support of investment management focuses on strategic planning and management. Support examples include supply chain management, new product introduction, inventory management, marketing strategy, R&D and customer communication.
Statement of cash flow: The statement of cash flow describes the day-to-day business operations. It reflects the flow of activity in the profit and loss statement and the balance sheet. There are three types of cash flow: from operations, from investments and from financing.
Tables 1 and 2 provide examples of typical elements found in a statement of cash flows and support provided by the QMS/EMS organizations.
P&L statement: This measures the income and expenses of the business at a given time. A major input from quality and environmental management is cost of goods sold, which consists of the costs associated with raw materials, purchased components, direct labor, operation and repair of manufacturing equipment, and other manufacturing expenses.
Quality and environment management also provides information on operating expenses. This includes sales, marketing, finance, HR, administration, supply chain (for example, transportation, distribution and warehousing), customer service and R&D.
The following are how QMS/EMS improvements contribute to the financials and impact the P&L statement:
- Operating and production cost reduction.
- Transaction cost reduction.
- Head count reduction.
- Cycle time reduction.
- Sales or revenue increases.
- Supply cost reduction.
- Effective logistics control.
- Cost-effective inventory management.
Lean Six Sigma is a tool for reducing cost and improving quality. Lean increases efficiency, simplifies workflows and eliminates waste. Six Sigma reduces variation, eliminates defects and provides effective project management. These have positive effects on the P&L.
Balance sheet: The balance sheet measures the financial health and liquidity of the business over time and covers current and long-term assets and liabilities. Equity equals total assets minus total liabilities.
Examples of how the QMS/EMS improvements contribute to financials include:
- Shorter lead time and faster time to market.
- Risk management.
- Single-source supplier avoidance.
- Financial reliability increases.
- Reduction of cash tied up in inventory.
- Capital expenditure management.
One major function of quality management is inventory management, consisting of finished goods, work in progress and raw materials. The major functions that quality management is responsible for are:
- Making first-in, first-out or last-in, first-out decisions.
- Reducing inventory losses.
- Estimating value.
- Controlling inventory turns.
General ledger: The general ledger is where all accounting transactions are ultimately recorded. It is the data source for most basic financial statements. The general ledger must always be in balance—total assets must equal total liabilities.
Assets include cash, income, accounts receivable, inventory, depreciation, investments and fixed assets. Liabilities include debt, stockholder equity, accounts payable, payroll and benefits, operating expenses, cost of goods sold and other obligations.
Much of the data in the general ledger is provided by quality and environmental management. This includes results from lean Six Sigma projects.
Internal control system
The purposes of internal control are to aid in achieving the organization's goals and objectives, assist in reliable financial reporting and compliance, lead the organization through its day-to-day operations and provide rules or guidelines for activities that identify and mitigate risks.
Section 404 of the Sarbanes Oxley Act (SOX) defines the requirements for organizations to have an effective system of internal control. The system most often used is the one defined by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. The Securities and Exchange Commission recommends following the COSO guidance for SOX 404 compliance.
A compliant system of internal control assures achievement of the three COSO objectives: operational effectiveness and efficiency, financial reporting reliability, and laws and regulation compliance. The system of internal control also must provide a mechanism for managing risk.
COSO consists of five interrelated components derived from the way management runs a business. The components are: control environment, information and communication, risk assessment, monitoring and control activities. ISO 9001 and ISO 14001 support a compliant system of internal control.1
The SEC suggests testing the following controls:
- Account balance initiation, recording, processing and reconciliation.
- Classes of transactions and disclosure-related assertions.
- Nonroutine transaction processing.
- Accounting policy selection and application.
- Fraud prevention, identification and detection.
- Duty design and separation.
One method of assessing the reliability of the internal control system is to review the extent of documentation of the processes and controls, determine the awareness of the system within the organization, monitor and evaluate the results of the controls, and evaluate the design and operating effectiveness of the system.
Financial management support
Hard and soft savings can result from QMS and EMS support for financial management. Hard savings impacts the P&L statement and is the difference between income and expenses. Quality improvements impact the P&L directly. Lean Six Sigma supports financial management and provides bottom-line improvements.
Soft savings are more difficult to quantify and see, but they affect the balance sheet. Some examples are:
- Reducing cash tied up in inventory or decreasing capital expenditures.
- Avoiding planned capacity enhancement.
- Eliminating budgeted staff increases.
Very soft examples (intangibles) include increased customer satisfaction, employee satisfaction and workplace safety. EMSs provide an understanding of significant aspects and of satisfying legal requirements.
The most effective means of linking management systems is to perform joint audits and use a joint management review process.
Integrating QMSs, EMSs and FMSs will give financial management a better understanding of current operations and result in a much more accurate measure of the status and effectiveness of the organization. QMS/EMS support of FMSs will also lead to greater transparency.
The support of QMS/EMS will help top management and the board of directors identify business risks, control them and prevent major surprises. These management systems provide added resources, especially for internal auditing. They help reduce the cost of compliance and improve corporate governance by connecting management systems.
One immediate benefit of connected management systems is a consistent set of procedures. ISO 9001 requires six documented procedures that can be used by the other management systems: These cover control of documents, control of records, internal auditing, control of nonconforming product, corrective action and preventive action.
- Sandford Liebesman, "Mitigate SOX Risk With ISO 9001 and 14001," Quality Progress, September 2005, pp. 91-93.
Fields, Edward, The Essentials of Finance and Accounting for Nonfinancial Managers, American Management Association, 2002.
Meisel, Robert M., Steven J. Babb, Steven F. Marsh and James P. Schlichting, The Executive Guide to Understanding and Implementing Lean Six Sigma, the Financial Impact, ASQ Quality Press, 2007.
Siciliano, Gene, Finance for the Non-Finance Manager, McGraw-Hill, 2003.
Sandford Liebesman is president of Sandford Quality Consulting LLC, Morristown, NJ, following more than 30 years of experience in quality at Bell Laboratories, Lucent Technologies and Bellcore (Telcordia). He is an author of TL 9000, Release 3.0: A Guide to Measuring Excellence in Telecommunications, second edition, and Using ISO 9000 to Improve Business Processes. Liebesman, a fellow of ASQ, is a member of ISO technical committee 176 and the ANSI Z-1 committee on quality assurance and a RABQSA International certified ISO 9000 and TL 9000 lead auditor.