Traditional accounting methods measure and manage innovation efforts but too often it is one of its biggest disablers. Conventional metrics can’t predict and measure progress in a meaningful way. Ironically therefore, current accounting tools, metrics and funding processes can work against a company’s goals of future proofing through innovation. The inefficiencies in corporate innovation ecosystems are significant. The current way of financial and managerial accounting in measuring and allocating resources towards teams, projects, portfolios and growth of the exosystem as a whole play an important part in this.
Without historical data, traditional accounting is almost helpless in assisting the business in making decisions for innovation projects. The problem is, that the more innovative a project is, the less historical data it possesses. That is the very problem with investing in innovation projects of course and that is why they often fail. How can the variables constituting Return on Investment (ROI) predictions, for example even be close to true when the product and even the market doesn’t exist? Also, how can we hold teams and managers accountable while at the same time give them enough freedom to come up with breakthrough innovation? Well, that’s the job of Innovation Accounting.
To better understand the need for broadening the current toolset, let’s look at it from a historical perspective.
Once upon a time, there was no…
The double entry system of accounting is at least 650 years old and maybe even more than 1,000 years old according to some reports. Accounting is undeniably a very important part of running a successful business. However, accounting has evolved a lot since those early days. Similar to law, accounting is reactive in nature in that it adapts to changes in the environment only when the problems are too big to ignore.
The Industrial Revolution
The industrial revolution led to the creation of large factories, where most value creating activities happened in-house. Through that, completely new accounting challenges arose. A company producing fabric, for example, did not have a system that helped them figure out the cost of one square meter of the cloth they were producing.
Calculating the Cost Per Unit (CPU) of producing something subsequently became very important and remains so today. CPU is essential in assigning a value to the inventory for the balance sheet, as we usually don’t value the inventory by its fair market value but rather, by its cost. Following from that, the calculation of Cost of Goods Sold for the income statement (profit and loss statement for Aussies) can be made and so on. CPU is a measuring unit that we can hardly live without today, but we didn’t always have it.
The birth of Management Accounting
The earliest widespread implementation of management accounting is credited to Alfred Sloan, who was the CEO of General Motors (GM) from the 1920s through to the 1950s. Before the introduction of management accounting, GM had problems with managing its various departments and factories, interstate and overseas. The problem was so bad that at the end of a given financial reporting period there were huge unexpected swings in inventory, expenses and revenue that the head office had no direct way of controlling or forecasting. Sloan’s introduction of management accounting allowed these departments and factories to be responsible for their own budgeting and reporting that could be funnelled into the corporation’s accounts.
To us, today, this sounds so obvious it hardly seems worth mentioning. Most of us have worked in a department where invoices come in, they get stamped and approved for payment and the approver adds the account code for the type of expense with a prefix that designates the department. This amount is then shown in the department’s P&L for the corresponding period and the department’s manager is held accountable against their budget. If the P&L shows an amount that is well over the budgeted amount, questions from a manager will undoubtedly follow.