Cost Identification. Slide 1 Cost Identification Welcome to this module on cost identification.

Transcription

1 Slide 1 Cost Identification Welcome to this module on cost identification. Slide 2 Module Overview In this module we will look at the following: Tax and inter-company considerations in defining structure and decision processes Fundamentals of finance and accounting Costing and pricing the bid Price vs. Cost of relationship Slide 3 Total Cost of Ownership (TCO) Total Cost of Ownership (or TCO) attempts to identify all costs over the useful life of the asset. This can include obvious costs like: purchase cost, implementation costs, And Maintenance & support costs. A thorough approach to TCO takes a cradle to grave view of costs: looking at everything from the resources required to develop the business case, draft the RFP, and manage the bid process, all the way to decommissioning and disposal of the asset. TCO can also include calculations for the Cost of Capital, as well as address factors for risk or experience. However, it does not address alignment with strategy, or the desirability of an investment. Performed thoroughly, TCO should provide valuable understanding of the magnitude of the investment. Slide 4 - Activity-Based Costing (ABC) Total Cost of Ownership (TCO) models are useful for evaluating an investment, but fall short when complex analysis is needed. Activity-based Costing (ABC) provides an understanding of the true and complete cost of an activity. So for example, TCO could estimate the cost of upgrading computer equipment in a manufacturing center, but Activity-Based Costing can provide a process view across several investments, to give more insight into pricing and profitability. Activity Based Costing would be used to evaluate the costs of all design activities and their contribution to the Cost Of Goods Sold (COGS). This makes it possible to calculate all the costs involved in different scenarios with different conditions, for example if a customer wants to make changes the materials used, or the colour. All the knock-on effects of maintaining different inventories, the costs of incremental design and testing, environmental and regulatory impact, and so on can be included in the calculation. Because it deals with complete process costs, Activity-Based Costing can become the foundation for a selecting a vendor. Knowledge of process costs also gives a better understanding of cost structures and is therefore a source of information to support risk analysis, contract development and negotiations planning. Slide 5 Tax Consequences Tax consequences need to be considered, because these can represent significant savings or costs. But ultimately, how much could be saved or owed will depend on other activities and the company s overall tax status, so statements of tax impact need to be kept separate from the fundamental cost/benefit analysis. IACCM 2015 Page 1

2 Depreciation allows companies to write-off the pro-rated value of the asset over each year of the asset s useful life, which is regulated by taxing authorities and generally accepted accounting principles to be 3 years, 5 years, or some other time span, depending upon the type of the asset. The write-offs allow companies to deduct the depreciation amount to reflect lower earnings, without affecting cash flows. The amount of the depreciation deduction and the eventual tax savings will depend on the companies overall profit picture. Because the ultimate impact is dependant upon other factors, depreciation is often eliminated from cost-benefit analysis. Other tax benefits include Tax Credits that are driven by the governing tax authority s policy. For example, local taxing authorities can provide tax incentives for investment in locations designated as free enterprise zones to drive economic revitalization. Other tax credits can reflect environmental initiatives. How these credits are realized depend greatly on the specific provisions and the company s over-all tax status, so again, these may be excluded from consideration in the business case. On the other hand, an investment can present tax liabilities, such as sales tax or ongoing property and use taxes. These taxes need to be considered as costs in the costbenefit analysis and the aggregation of costs related to the investment. Slide 6 Allocations How allocations are treated depends upon who is doing the cost analysis. There is greatly differing relevance at the corporate and Business Unit levels. Business units need to consider allocations as a part of their cost structure, whether or not the allocations represent true costs. Most allocations are somewhat arbitrary, but they directly reflect in the operating units profitability reports. However, at the corporate level, only true costs will actually impact the parent company s bottom line. While allocations will impact reported costs at the business unit level, they usually have no impact in the overall cost structure. As a result, consideration of allocations can influence decisions such that they support a business unit, but are contrary to corporation s best interests. The cost-benefit analysis should show outcomes with and without allocations so the best decision can be made. Slide 7 Opportunity Cost Opportunity costs represent the potential impact of options not chosen when an investment decision is made. By selecting a project or a vendor, a company chooses to focus its resources on a specific path. In some cases, there is no value in considering the cost of not making another investment. In other cases, the investment can mean real sacrifice in other areas for the company. If access to capital is limited, the impact can be large. Opportunity costs usually represent soft, less-quantifiable costs, and can only be based on forecasting and analysis. Prior to final vendor selection, opportunity costs should be explored and validated. Exploring the alternatives to the procurement choice fulfills governance requirements. Slide 8 Cost Of Poor Quality In some cases, companies will make cost-cutting decisions during the procurement process that increase risk and exposure to alternative costs. The potential costs associated with such risk exposure can be documented as part of risk analysis. IACCM 2015 Page 2

3 For example, a company may decide to reduce its investment in training on a new information technology system in favor of having employees learn on the job. The decision makers must balance the time and cost associated with developing and implementing a training program with the costs that will be associated with users diminished productivity due to lack of training. As with opportunity costs, costs of poor quality are hard to quantify and difficult to predict. However, they are an important component framework. Slide 9 Example It Systems Costs Let s take a look at an example of cost identification with respect to a hypothetical investment in an Information Technology (IT) system, since IT investments present a significant degree of complexity in technical and non-technical areas. Slide 10 Example It Systems Costs In the text box below type in a few examples of IT system costs. Please separate your answers with commas. When you are ready click submit. Slide 11 Example It Systems Costs Looking at the answers. The costs can be expressed in terms of: Direct vs. indirect costs Initial vs. ongoing costs Hardware, software and infrastructure costs Personnel costs (for users and support personnel) And other costs associated with the investment Slide 12 Hardware Costs In most cases, hardware is essentially a commodity item, in the sense that it is relatively easy to specify. Many companies have enterprise relationships with manufacturers, so sourcing may be as simple as placing the order. However, hardware related to a specific project may have unique requirements, and may even indicate sourcing outside pre-existing enterprise agreements, particularly for larger servers or specialized equipment. Other project-specific hardware may include desktop workstations, laptops and portable, wireless devices. Hardware set-up, including development environments, can add significantly to hardware costs. Indirect costs include acquisition and installation costs, which may be significant if specialized environments are required, such as 24 x 7 power back-ups, special routing equipment, etc. And there may be necessary upgrades to existing equipment to support initial or future incremental volume or performance requirements. Slide 13 Software Costs Software related to projects becomes more complex. Some software companies require companies to purchase licenses for developers, even if they are employed by independent consultants working off-site. There may be fees paid to outside software developers for custom applications. Some applications may require integration software, database software, reporting software, quality assurance software, Extraction, translation and load (or ETL) software, the list can be endless. These costs may vary depending upon vendor selection, so thorough disclosure in the RFx process is important. IACCM 2015 Page 3

4 Slide 14 - Infrastructure Costs Infrastructure costs are generally incorporated in allocations or use-based fee system within corporations. However, infrastructure improvements directly related to the project such as increased bandwidth, new directory systems or infrastructure upgrades may be fully charged to the project. Corporate Help Desk support is usually figured as an allocation, however there may be a specific charge for training help desk personnel on any new, custom-developed applications. Slide 15 Personnel Costs Personnel costs are often the most underestimated since it is hard to track staff who are not directly involved with development. Other personnel costs include infrastructure and support staff, business personnel who participate in requirements definition, evaluation, testing and data reconciliation, and user time allocated to training and learning the new application. In addition to productivity lost to learning, workflow backlogs and bugs in the new application compound the costs. Slide 16 Other Costs Other costs directly attributable to the project include the full range of contracting activities: requirements definition, business case justification, RFx, negotiations, and project management. Communications, change management and other support costs to drive acceptance and adoption should be considered direct costs attributable to the project. Cost calculations should also consider performance measurement, accounting, taxes and costs associated with retiring legacy systems. Slide 17 Consensus on approach It s critical to be thorough and accurate with your approach to cost identification. Reliable estimates are fundamental to the budgeting process, and are more likely to win approval for additional funding as the projects are upgraded and expanded. Reliable cost identification also allows more accurate allocations and better budgeting for future projects. Slide 18 Credibility of Assumptions Accurate cost identification relies on solid assumptions: are there cultural and language issues that need to be addressed, are users ready to adopt a new system? Are resources available to adequately define the requirements, validate data migration and test the system? On the technical side, is system capacity and compatibility sufficient, have business processes been fully defined, has there been clarification and harmonization of change requests? The best approach is to eliminate assumptions through research, analysis and proactive management. Slide 19 Risk Assessment While hopefully the majority of cost components can be identified, there is always opportunity for unanticipated challenges. Part of cost identification includes risk analysis. IACCM 2015 Page 4

5 Through use of knowledge management and performance measurement programs, contracting professionals can anticipate risks and identify cost scenarios associate with those risks. They are also able to minimize those risks through detailed requirements sessions, investment in risk mitigation technologies and other governance programs. Slide 20 Next Steps This concludes our Module. Please take the time to complete the Module Feedback. Once you have completed the Module Feedback, we recommend that you go to the Attachments to review the additional information. A Module Test is available for you to take in order to check your understanding of the material or practice for the Certification Exam. The required pass rate for all Module Tests is 80%. You may take this test as many times as you wish: please allow 24 hours between each attempt. Once you have passed all the Module Tests with at least 80% you will be invited to take the Certification Exam. IACCM 2015 Page 5