Cost-of-Quality Auditing For Your Firm

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Have you ever wondered how much it is costing your firm when work is not done correctly the first time and has to be redone?

Cost-of-quality auditing, or more specifically, cost-of-poor-quality auditing, answers this question.

What are some of the things that happen in firms that might fit under this category: billing or payroll errors; computer downtime; unplanned revision of documents; overstaffing; underutilization of office equipment; frequent budget revisions; overtime; revising or recopying of documents due to errors; bad debt write off; time devoted to addressing client complaints; unproductive meeting time; employee turnover; time spent defending lawsuits filed by other parties against the firm; and settlements paid out by the firm.

These costs can really add up. In fact, cost-of-quality experts estimate that for service-based companies up to 30 percent of a firm's operating budget can be devoured by such poor quality costs.

So what can be done about this?

The place to begin in larger firms is with a survey of your managing partner and other staff managers, such as the Accounting Manager, Human Resource Director, the MIS Director, the Marketing Manager, and so on. In a smaller firm, the place to begin is with the managing partner, the person in charge of the accounting department, a senior associate, and a secretary and administrative assistant who have been with the firm for some time. Sit down with each of these people, one at a time. This will allow them to speak more freely. (You also might consider having a quality improvement consultant conduct this audit for you as having an experienced outsider might enable those surveyed to speak even more freely.) Ask each of them to tell you about any chronic process-related problems they are experiencing and get an estimate from each of them about how frequently these things are happening. This will allow you to multiply the estimated amount of time spent by the hourly rate of the person describing the problem.

Tell the people you interview the purpose of the inquiry is to improve operations and to cut costs and increase revenue. Explain that you don't want to hear complaints about other people but any concerns they might have about the way the work is being done. Ask them if they are experiencing any of the cost-of-quality items listed above.
After meeting with all these people and compiling a list of the issues raised, get together with the person in charge of the accounting department to attach figures to these issues. For instance, add up all the overtime expenses incurred by the firm in last year and this is your first cost-of-poor-quality figure.

Overtime costs, particularly if chronic, can be an indication that firm processes are not being effectively carried out. After getting a better mental picture of what your firm is doing, you can come up with a more effective way to operate and eliminated most of their overtime expenses.

On an annualized basis, put a figure to all the issues you can that were mentioned by people from the informal survey. The total amount may surprise you. David Butler, a quality improvement consultant who has worked with more than 500 companies, did a cost-of-poor-quality audit at a company that was both a manufacturing and service business. He found the total cost of poor quality or what he calls price of non-quality (PONQ) to be $7,141,500. This was 12 percent of its annual revenue of $58,200,000. Some of the many costs he was able to put a figure to were: $25,000 for problems with payroll; $5,200 to review complaints and issue letters; $3,900 to work on lawsuit problems; $51,000 for poor planning of projects in the creative department and $75,000 to outsource work that would normally done by the creative group; $30,000 for inefficiencies by using three computer systems; $54,000 in bad debt write off and so on.

When you do your cost-of-poor-quality audit, also known by some as "the cost of nonconformity," make sure to include these kinds of items, if appropriate. No doubt all firms have some amount of bad-debt write off.

Of course, some people might argue that this expense is just part of the cost of doing business and everyone has clients who don't pay. Although eliminating all such clients may not be possible, if more time was invested in determining whether a potential client was creditworthy before any work was taken on, this cost could be substantially reduced.

Prevention and Failure Quality Costs

One thing quality managers know is that the more money and time that is invested up front in the prevention of quality problems, the less money that is spent on what is known in quality circles as internal and external failures. In fact, it is not uncommon for companies to reduce their failure losses by up to $15 for every $1 invested in quality prevention expenses.

This being the case, what are some examples of cost-reducing, prevention-related activities in a firm environment? Adequate training and orientation, conducting client surveys, which help determine "customer" requirements, clear job descriptions and well-documented procedures. When the money or time devoted to such things is low, it has been proven to be the case that "internal failures" such as employee turnover or errors in processing information are high. "External failures," such as a lawsuit against the firm, loss of market share and bad debts, are also significant in such a non-prevention-oriented, environment.

Review the Chart of Accounts

Armed with the information from the survey of key staff members, then it's time to review the chart of accounts with the accounting manager as part of the quality audit process. Being alerted to potential quality problem areas, look at those particular items or processes mentioned first and ask the question, "If this process had been done right the first time, would this charge have been necessary?" Being able to break down firm costs by activity, rather than by department or function, makes this review of the books to quantify costs even easier. Conducting this exercise will help give you a more accurate picture of your actual costs of poor quality. Additionally, you may be alerted to other potential quality problem areas by reviewing the general ledger or chart of accounts.

Lastly, as part of the quality audit process, make sure to review the time sheets or the firm's automated timekeeping system, paying particular attention to where time was spent redoing work, tracking errors or dealing with internal or external failures, such as employee turnover. For instance, any time spent by you, the business manager, or by the human resources director, interviewing and training candidates to replace staff who left because they were dissatisfied with internal operations should be part of the equation. For instance, if two staff members left because of dissatisfaction they experienced with the accounting department in the last year, you should add the cost of your time spent interviewing and training their replacements to your total cost-of-quality figure. (So you would multiply your effective hourly rate by the hours you spent writing and placing a help wanted ad, interviewing candidates and then training their replacements to get your figure on this item.)

If your time sheets do not include a classification for rework or error adjustment in any job classifications, you might want to ask staff members to start including such an element in their timekeeping records, along with adding a rework category and code to the current timekeeping system. Of course the more detailed people can be about the type of rework or error chasing that was done, such as rework on a brief as a result of overlooking an important case citation or time spent by the firm bookkeeper tracking down billing errors, the better able the business manager is to understand what processes are ripe for improvement within the firm.

Once all the figures are nailed down and estimates established for those processes for which not enough data is yet available, it's time to do two things:

  1. Start keeping better track of cost-of-poor-quality data where only estimates are available.
  2. Establish cost-reduction goals for those costs for which accurate data already exist.

Ask for help from the firm's managing partner, other staff managers, and perhaps from the firm's department chairs or practice group leaders, for the creation of cost-of-quality goals. These might include such things as a 10 percent reduction in staff turnover, a 5 percent reduction in computer downtime, a 15 percent reduction in rework as measured by administrative staff's time sheets; a 20 percent drop in client complaints. (If you are not yet keeping a log of client complaints to give you an indication of where improvements in client satisfaction and internal operations could be made, it's time to do so.)

At the same time, the firm needs to take action to remedy the problems brought to light by the quality cost audit. The areas most in need of improvement should be pursued with a step-by-step plan developed with the help of the people who must carry it out. In most instances, the first thing that must be done is to eliminate the root causes of the poor quality problems, be that inadequate training, poor documentation of procedures or whatever it may be. In those instances where the root cause is not clear, the next step would be to form a team made up of persons most connected with the particular process in need of improvement. This team might want to flowchart the current process and then brainstorm together about ways the work could be done in a more cost-effective, high quality manner in the future. Keeping track of the costs related to the analyzed process on an on-going basis will then tell the firm whether the suggested solution to the problem is working.

In summary, monitoring your costs of poor quality is one sure way to enhance firm operations because the data you gather will guide you to which areas of the firm are most in need of improvements. And then taking action to remedy these problem areas will, in turn, reduce costs, increase revenue and boost the bottom line of the business.

This article provided by Nancy Blodgett, President of Performance Excellence, Inc.

Profit Beyond Measure: Extraordinary Results Through Attention to Work and People, by H. Thomas Johnson and Anders Broms.

Linking Quality to Profits: Quality-Based Cost Management, by Hawley Atkinson, John Hamburg, Christopher Ittner. This book gives directions for companies making quality improvement an element of financial performance, and discusses tools and methods linking quality and the bottom line in companies such as Xerox Corp., Heinz Co., and Westinghouse Electric Corp. Covers strategic quality planning, quality-based cost management, cost-driver analysis, and project selection, measurement, and reporting. Appendices offer cost- of-poor-quality assessment guides and standard cost-of-poor-quality element listings. Book review compliments of

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