Many businesses use advanced accounting techniques to analyze their cash flows in order to target where their value comes from and how they can make more profit by changing their processes. For instance, targeting how much it costs to produce a certain good is a common accounting step among manufacturers. This leads to specific methods used for manufactured products, including the engineering approach.
The industrial engineering method is used for cost function estimation and is a general term describing how the accountant looks for value. In many systems, costs can be traced by following value through a good or service. But in heavily industrial processes, the engineering method calls for examination of primarily physical terms. Physical resources enter the factory, are processed, and come out as goods. By measuring the input and output in such physical terms, analysts can create accurate representations of industrial cost functions.
The engineering approach can also refer to a more simplistic approach to inferring the cost of a product. In this case, the engineering approach requires close study of the product itself, the good that the manufacturer produces. Materials costs, direct labor costs, overhead costs and other expenses all play their part. It is called the engineering approach because much of the data is based not on previous product sales but on the evaluations and opinions of industrial engineers with experience in the business.
The engineering approach may seem like a complex and uncertain way to create cost functions for a manufacturer, but it does have one key use. The engineering approach has high value for companies considering producing a new good but do not have any experience in the field. Without any past data from which to draw, other cost function methods will not work. This makes the engineering method suitable when the company wants to forecast costs for a new product or system without any previous experience.
The engineering approach also has inherent difficulties. It is a vague approach compared to the detailed studies of past production analysts can use for goods the manufacturer has produced before. The estimates made by the engineers when it comes to costs can be inaccurate and lead to bad data. Analysts try to use concrete data from other firms to minimize the potential for errors.