Sixtina Presents: How to accurately allocate costs for intelligent decision making. A Cost Intelligence Seminar. August 16, 2018.

Transcription

1 Sixtina Presents: August 16, 2018 How to accurately allocate costs for intelligent decision making A Cost Intelligence Seminar Gary Cokins, CPIM Analytics-Based Performance Management LLC Cary, North Carolina USA (919) gcokins@garycokins.com Sixtina Solutions Cost Intelligence Solutions Colorado Springs, CO USA (719) contact@sixtinaconsulting.com 1

2 About Gary Cokins Founder, B.S. Industrial Engineering & Operations Research; Cornell University, 1971 M.B.A. Finance & Accounting; Northwestern University, Kellogg Graduate School of Management, 1974 Previous Associations: - FMC Corporation - Consultant with: Deloitte, KPMG, Electronic Data Systems [EDS, now HP] - SAS (16 years) 2

3 Who will benefit from this presentation? Managers who have previously struggled at promoting strategic cost management using activity-based costing principles, FP&A, and integrating business analytics (BA) into their decision support systems. Managers who intend to champion any or all of these improvement techniques and need a compelling call to action. 3

4 What are issues related to measuring costs and profitability? Are our product and service-line costs accurate? Do we properly allocate our indirect expenses (i.e., overhead) to calculate reasonably accurate product and service-line costs based on causal relationships? Or do we butter spread expenses with cost allocation factors simultaneously over- and under-cost products and service-lines? Do we measure non-product channel and customer expenses (e.g., distribution channels, selling, marketing, customer service) to report profit or loss by each customer? Do we know which customers are more attractive to retain, grow, win-back and acquire? 4

5 What are issues related to budgeting and planning? How effective is our annual budgeting process? Does its benefit exceed the administrative effort and costs to produce it? Is the budget out of date within a few months after it is published? Do experienced managers pad their department s budgets? Is consolidating cost center budget spreadsheets bottom-up cumbersome? Do we understand incremental / marginal expense analysis classifying the behaviour of our resource capacity expenses as sunk, fixed, step-fixed, or variable based on the planning time horizon? 5

6 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 6

7 Cokins IFAC.org Taxonomy of Accounting ACCOUNTING Source data capture (transactions / bookkeeping) Tax Accounting Financial Accounting Managerial Accounting Non-financial data capture Cost Accounting Financial Reporting regulatory compliance GAAP, rules Cost Measurement [e.g., GAAP, IFRS] Costs of goods sold Inventory valuation The Domain of Costing Cost Reporting & Analysis (feedback on performance) Spending vs. budget variance analysis Profitability reporting Process analysis (e.g., lean, benchmarking, COQ) Performance measures Learning; corrective actions Decision Support/ Cost Planning Fully absorbed & incremental pricing Driver-based budgeting & rolling financial forecasts What-if analysis Product, channel & customer rationalization Outsourcing & make vs. buy analysis History Future Low value-add Modest value-add High value-add Source: PABC IGPG Evaluating and Improving Costing in Organizations published by the International Federation of Accountants, 2009 Source: A Costing Levels Continuum Maturity Model by Gary Cokins published by the International Federation of Accountants,

8 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 8

9 Direct and Absorption Costing Ideally, all costs should be directly charged, but as variety, complexity, and technology increases, more costs are indirect and shared. Cost-Driver Table 1st Preference Resources Labor Reporting Estimates 2nd Preference 3rd Preference Last Resort Activities Final Cost Objects Project Standard accounting costing ABC/M ALLOCATIONS Work Order Standard Routing, Bill of material Activity Driver OUTPUTS, PROCESSES, PRODUCTS, SERVICE LINES, MARKETS, CHANNELS, ORDERS, CUSTOMERS 9

10 A simple explanation of ABC that you can explain to your spouse (or boss) tonight. 10

11 Each Activity Has Its Own Cost Driver From: General Ledger Salaries Equipment Travel expense Supplies Use and occupancy Total Chart-of-Accounts View Claims Processing Department Actual $621, ,200 58,000 43,900 30,000 $914,500 Plan $600, ,000 60,000 40,000 30,000 $880,000 Favorable/ (unfavorable) $(21,400) (11,200) 2,000 (3,900) $(34,500) To: ABC Data Base Activity-Based View Key/scan claims Analyze claims Suspend claims Receive provider inquiries Resolve member problems Process batches Determine eligibility Make copies Write correspondence Attend training Total When managers get this kind of report, they are either happy or sad, but they are rarely any smarter! Claims Processing Dept $ 31, ,000 32, ,500 83,400 45, , ,500 77, ,000 $914,500 Activity cost drivers #of #of #of #of #of #of #of #of #of #of $914,500 11

12 Multiple-Stage Cost Flowing Resources Resources Activities Activities Objects Objects Simple ABC Expanded ABC 12

13 ABC/M Cost Assignment Network Resources (general ledger view) Salary, Fringe Benefits Direct Material Phone, Travel Supplies Depreciation Rent, Interest, Tax Work Activities (verb-noun) Support Activities Equipment Activities People Activities cost-to-serve paths Final Cost Objects Costs Measure the Effects (1) Demands On Work Costs (2) Suppliers Products, Services Customers Business Sustaining 13

14 ABC/M Cost Assignment Network Resources (general ledger view) Work Activities (verb-noun) Salary, Fringe Benefits Direct Material Direct costs Support Activities Phone, Travel Supplies Depreciation Rent, Interest, Tax People Activities Equipment Activities cost-to-serve paths Final Cost Objects Costs Measure the Effects (1) Demands On Work Costs (2) Suppliers Products, Services Customers Business Sustaining 14

15 Organizational shock from the truth Net Revenues Minus ABC costs = profit Unrealized profit revealed by ABC $ 30 sales - 28 expenses = $ 2 profit $ 2 profit 15

16 Activity Costs pile up into outputs. ABM provides insight for the product s or service s cost drivers and driver quantities. Work Activities each activity s driver quantity x unit activity driver cost (eg. # of registrations) Price/Fee (Revenue) Activity Costs 16

17 Gary Cokins Best-Selling ABC Book Published by John Wiley & Sons An+Executive%27s+Guide-p

18 Mid-seminar Question #1? 18

19 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 19

20 Misconceptions about ABC Many believe that activity-based costing (ABC) can be complex and that an organization needs to determine if the benefits are worth the effort. Many have this perception, but it is a misconception. I next describe why this is a fallacy and how this problem can be resolved by right sizing the ABC system to be good enough. One reason that many perceive ABC to be excessively complex is because in the 1990s accountants and consultants way over-designed ABC systems well beyond the point of diminishing returns of higher cost accuracy for the extra levels to collect, calculate, validate, and report the cost information. The ABC models were not understandable and so large that they collapsed under their weight and were unsustainable. Sometimes executives pulled the plug before completion viewing it as another meaningless exercise by the bean counters. The ABC rapid prototyping with iterative re-modeling implementation approach resolves this problem. The ABC production system can be implemented in weeks, not months. 20

21 Rapid Prototyping with Iterative Remodeling (crawl, walk, run, fly) Each iteration enhances the use of a ABC system. ABC Models ABC System (repeatable, reliable, relevant) #0 # #2 #3 Make your mistakes early and often, not later when the system is too hard to change. 21

22 Balancing Levels of Accuracy with Effort 100% Accuracy of Final Cost Objects A B World Class ABC System Design 0% Little Modest Great Level of Data Collection Effort 22

23 Benefits from ABC/M Rapid Prototyping - Accelerated learning - Solving the thorny leveling problem - Preventing over-engineering ABM model size - Peer group: Pre-determining uses for the information - Replacing misconceptions with reality. - Getting ROI from earlier insights and decisions. 23

24 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 24

25 What has Caused Interest in ABPM? The shift from being product-centric to customer centric. 25

26 Value of Company = f(value from Customers) The only value a company will ever create is the value that comes from its customers the current ones and the new ones acquired in the future. To remain competitive, one must determine how to keep customers longer, grow them into bigger customers, make them more profitable, serve them more efficiently, and acquire relatively more profitable customers. Source: Don Peppers and Martha Rogers, Peppers & Rogers Group (edited) 26

27 But what about the Other Below-the-line Calculated Costs? Products and standard service-lines are not the only thing for which accountants should compute costs. What about costs that have nothing to do with making products and delivering standard service-lines? The problem with traditional accounting s product gross profit margin reporting is you don t see the bottom half of the picture. 27

28 Costs from Sales & Marketing are not Products Customer + Channel + Product Direct material, Direct labor & Equipment Indirect expenses Distribution, Sales & Marketing Sales, general, and administration (S,G&A) 28

29 Why Do Customer-related Costs Matter? The Perfect Storm # 1- Customer retention versus acquisition costs. # 2 Sources of Competitive Advantage Commoditization leading to service-differentiation. # 3 From mass selling to one-to-one customer relationships. # 4 The internet s irreversible shift of power from sellers to buyers. 29

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31 ABC Customer Profit & Loss Statement CUSTOMER: XYZ CORPORATION (CUSTOMER #1270) Sales $$$ Margin $ Margin (Sales - ΣCosts) % of Sales Product-Related Supplier-Related costs (TCO) $ xxx $ xxx 98% Direct Material xxx xxx 50% Brand Sustaining xxx xxx 48% Product Sustaining xxx xxx 46% Unit, Batch* xxx xxx 30% Distribution-Related Outbound Freight Type* xxx xxx 28% Order Type* xxx xxx 26% Channel Type* xxx xxx 24% Customer-Related Customer-Sustaining xxx xxx 22% Unit-Batch* xxx xxx 10% Productrelated costs Channel & Customerrelated costs Business Sustaining xxx xxx 8% Operating Profit xxx 8% * Activity Cost Driver Assignments use measurable quantity volume of Activity Output (Other ActvityAssignments traced based on informed (subjective) %s) 31

32 Customer Sales Volume Versus Profits Customers tend to cluster. Medium-volume customers can be much more profitable than large-volume customers! $ profitable Profitability $ 0 $ (unprofitable) $ small $ large Sales Volume (logarithmic scale) These losers drag down profits 32

33 Migrating Customers to Higher Profitability Very Profitable High Product Mix Gross Profit Margin Low Types of Customers Low Cost-to-Serve High Very unprofitable 33

34 A Shift in the CFO s Emphasis The CFO must now help Sales and Marketing to better target customers. The spending budget for sales and marketing is critical but it should be treated as a preciously scarce resource to be aimed at generating the highest long-term profits. This means answering questions like: Which type of customer is attractive to newly acquire, retain, grow, or win back? And which types are not? How much should we optimally spend attracting, retaining, growing, or recovering each customer micro-segment? 34

35 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 35

36 Why is the budgeting process broken? The budget is typically a fiscal exercise by the accountants that is: -- disconnected from the executive team s strategy. -- not based on future driver volumes. 36

37 Match the Budget Method to its Category Integrated Budget (Rolling Financial Forecasts) Demanddriven Projectdriven 37

38 Match the Budget Method to its Category Budget method Demanddriven Recurring expenses volume & mix of drivers production and ABP/B Integrated Budget (rolling financial forecasts) Projectdriven Non-recurring expenses Strategic & risk mitigation projects strategy map and risk grid 38

39 Linking Strategy and Risk to the Budget Strategy Modeling (by executives) Strategy methods (e.g., SWOT) Strategic objectives Define and adjust strategy and risk, and create strategy map Identify and manage strategic initiatives KPI targets = financial information (e.g. $) knowledge Create balanced scorecard Managerial Accounting (e.g., Activity-based Costing) priority projects and processes Forecast drivers (e.g. sales) ; develop production plan KPI dashboard feedback Driver volumes and mix Approve strategy risk and capital budget (2) capital budget (3) strategy budget (4) risk budget e.g., hours, Pounds, # employees Traditional and driver-based budgeting (e.g. PBB) (1) Operational budget Financial Modeling Driver consumption rates Capacity resource plan Changes and responses Derived budget (and rolling financial forecasts) Operational Modeling (by employee teams) Manage and improve core processes Revise plan Acceptable? Results and outcomes No Yes OK 39

40 Continuous refreshing the rolling financial forecast More frequent forecast intervals assure better accuracy. 100% accuracy 0% time 40

41 Predictive Accounting Accounting Treatments and Behavior of Capacity (expenses) Descriptive Predictive Past Now Future unused sunk unused Traceable to products, channels, customers, sustaining used fixed (unavoidable) variable (adjustable capacity; avoidable) 41

42 The Intelligence Hierarchy Power of Information Prescriptive Analytics / Optimization Predictive Modeling $ROI Raw Data Standard Reports Ad hoc Reports & OLAP Descriptive Modeling (with analytics) Data Information Knowledge Insights Decisions 42

43 Mid-seminar Question #2? 43

44 AGENDA Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting Driver-based budgeting and rolling financial forecasts Barriers slowing the adoption rate of ABC 44

45 The Buy-in to Performance Management Why has the adoption rate for profitability reporting with ABC been so slow? 45

46 Why is the adoption rate so slow? What are the barrier categories? (1) Technical barriers include IT related issues. (2) Perception barriers are excess complexity and affordability. (3) Organizational behavior barriers involve resistance to change, culture, and leadership. 46

47 Typical Excuses Preventing Being Progressive We are profitable, so why does it matter? We will purchase software that will fix our problems. We already know our true costs from our general ledger financial reporting system. We have done it this way forever. And we don t do that here. We already know everything. It is in our heads. We are a small organization. We ll worry about better methods when we get larger. All this hype is just made up stuff from highly paid consultants. No one looks at the reports I create, so there is no point generating better reports. We cannot afford better software to fix our problems. We are way too busy doing other things. We don t know where to start or how to get started. Source: William Vaughn Company CPAs; IMA conference, June 20,

48 Getting Started Actions and Resources Action steps Get educated. Get buy-in. Rapid prototyping. Start small; think big. Improve incentives. (Motivational theory) Resources: A suggestion: Have your management team read either or both of these educational pieces. Then schedule a meeting for discussion. Have each manager answer, What did I learn? What issues and concerns do I have about EPM? This will stimulate needed conversations. 48

49 From Theory to Practice Your success depends on how well and how fast the right information and intelligence gets to the right people. 49

50 Questions? 50

51 Thank You A copy will be sent to your in the next few days. Sixtina Solutions Cost Intelligence Solutions Colorado Springs, CO USA contact@sixtinaconsulting.com Gary Cokins, CPIM Analytics-Based Performance Management LLC Cary, North Carolina USA gcokins@garycokins.com 51