Sixtina Presents: How to accurately allocate costs …...ABC systems well beyond the point of...
Transcript of Sixtina Presents: How to accurately allocate costs …...ABC systems well beyond the point of...
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Sixtina Presents:How to accurately allocate costs for intelligent decision makingA Cost Intelligence Seminar
Gary Cokins, CPIM
Analytics-Based Performance Management LLCCary, North Carolina USA
www.garycokins.com(919) [email protected]
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
August 16, 2018
Sixtina Solutions
Cost Intelligence SolutionsColorado Springs, CO USA
www.sixtinasolutions.com(719) [email protected]
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About Gary CokinsFounder, Analytics-Based Performance Management LLC
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)Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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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.
Who will benefit from this presentation?
Managers who intend to “champion” any or all of these improvement techniques and need a compelling call to action.
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• 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?
What are issues related to measuring costs and profitability?
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• 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?
What are issues related to budgeting and planning?
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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
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ACCOUNTING
Financial Accounting
Cost Measurement
Managerial Accounting
Cost AccountingFinancial Reporting
regulatory compliance
Cost Reporting & Analysis
(feedback on performance)
Decision Support/Cost Planning
•[e.g., GAAP, IFRS]•Costs of goods sold•Inventory valuation
• Spending vs. budget variance analysis • Profitability reporting• Process analysis (e.g., lean, benchmarking, COQ)• Performance measures• Learning; corrective actions
• Fully absorbed & incremental pricing• Driver-based budgeting & rolling financial forecasts• What-if analysis• Product, channel & customer rationalization• Outsourcing & make vs. buy analysis
History FutureLow value-add Modest value-add High value-add
Source data capture(transactions /bookkeeping)
Non-financial data capture
The Domain of Costing
Tax Accounting
Source: “A Costing Levels Continuum Maturity Model” by Gary Cokins published by the International Federation of Accountants, 2010Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
Source: PABC IGPG “Evaluating and Improving Costing in Organizations” published by the International Federation of Accountants, 2009
Cokins’ IFAC.org Taxonomy of Accounting
GAAP,rules
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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
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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Direct and Absorption CostingIdeally, all costs should be directly charged, but as variety, complexity, and technology increases, more costs are indirect and shared.
Activities
Resources
Final Cost
Objects
Project accounting ABC/M ALLOCATIONS
LaborReporting
Estimates
OUTPUTS, PROCESSES, PRODUCTS, SERVICE LINES, MARKETS, CHANNELS, ORDERS, CUSTOMERS
1st Preference
2nd Preference
3rd Preference
Last Resort
Cost-Driver Table
WorkOrder
StandardRouting,
Bill of material
Standardcosting
ActivityDriver
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A simple explanation of ABC …that you can explain to yourspouse (or boss) tonight.
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#of
Activity-Based View
To: ABC Data Base
Key/scan claimsAnalyze claimsSuspend claimsReceive provider inquiries Resolve member problemsProcess batchesDetermine eligibilityMake copiesWrite correspondenceAttend training
Total
$ 31,500121,000
32,500101,500
83,40045,000
119,000145,500
77,100158,000
$914,500
Claims Processing Dept
Salaries
Equipment
Travel expense
Supplies
Use andoccupancy
Total
$621,400
161,200
58,000
43,900
30,000
$914,500
$600,000
150,000
60,000
40,000
30,000
$880,000
$(21,400)
(11,200)
2,000
(3,900)
––
$(34,500)
PlanActualFavorable/
(unfavorable)
Claims Processing Department
Chart-of-Accounts View
From: General LedgerActivity
cost drivers
#of#of#of#of#of#of#of#of#of
$914,500
Each Activity Has Its Own Cost Driver
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
When managers get this kind of report, they areeither happy or sad, but they are rarely any smarter!
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Multiple-Stage Cost Flowing
ExpandedABC
Resources
Resources
Activities
Objects
Objects
Activities
SimpleABC
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ABC/M Cost Assignment NetworkSalary, Fringe
BenefitsDirect
MaterialPhone,Travel
SuppliesDepreciation
Rent, Interest,
Tax
Customers
BusinessSustaining
Products,Services
Resources(general ledger view)
Work Activities(verb-noun)
FinalCost
Objects Suppliers
(1) D
eman
ds O
n W
ork Co
sts
(2)
“Co
sts M
easu
re th
e Effe
cts”
SupportActivities
EquipmentActivities
PeopleActivities
“cost-to-serve”paths
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ABC/M Cost Assignment NetworkSalary, Fringe
BenefitsDirect
MaterialPhone,Travel
SuppliesDepreciation
Rent, Interest,
Tax
Customers
BusinessSustaining
Products,Services
Resources(general ledger view)
Work Activities(verb-noun)
FinalCost
Objects Suppliers
(1) D
eman
ds O
n W
ork Co
sts
(2)
“Co
sts M
easu
re th
e Effe
cts”
SupportActivities
EquipmentActivities
PeopleActivities
“cost-to-serve”paths
Direct costs
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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$ 30 sales- 28 expenses
= $ 2 profit
$ 2 profit
Unrealized profit revealed by ABC
Net Revenues
MinusABC costs =
profit
Organizational shock from the truth
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ActivityCosts
each activity’s driver quantity
unit activity driver cost
x
(eg. # of registrations)
Price/Fee(Revenue)
ABM provides insight for the product’s or service’s cost drivers and driver quantities.
WorkActivities
Activity Costs “pile up” into outputs.
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Gary Cokins’ Best-Selling ABC Book
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
https://www.wiley.com/en-us/Activity+Based+Cost+Management%3A+An+Executive%27s+Guide-p-9780471443285
Published by John Wiley & Sonswww.wiley.com
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Mid-seminar Question #1 ?
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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
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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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.
Misconceptions about ABC
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Rapid Prototyping withIterative Remodeling (crawl, walk, run, fly)
Each iteration enhances the use of a ABC system.
ABC Models
3
ABC System(repeatable, reliable, relevant)
#0
#1
#2
#3
210
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
Make your mistakes early and often, not later when the system is too hard to change.
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Balancing Levels of Accuracy with Effort
Accuracyof
Final CostObjects
100%
0%
World ClassABC System Design
Little
Level of Data Collection EffortGreatModest
AB
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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.
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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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
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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What has Caused Interest in ABPM?
The shift from being product-centric to customer centric.
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Value of Company = f(Value from Customers)
The only value a company will ever create is the valuethat 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)
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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.
But what about the Other Below-the-line “Calculated” Costs?
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Indirect expensesDistribution, Sales & Marketing
Sales, general, and administration (S,G&A)
Customer+
Direct material,Direct labor &
Equipment
Costs from Sales & Marketing are not Products
Channel+
Product
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# 1- Customer retention versus acquisition costs.
# 2 – Sources of Competitive Advantage –Commoditization leading to service-differentiation.
Why Do Customer-related Costs Matter?The Perfect Storm
# 3 – From mass selling to one-to-one customer relationships.
# 4 – The internet’s irreversible shift of power from sellers to buyers.
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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CUSTOMER: XYZ CORPORATION (CUSTOMER #1270)Sales $$$ Margin $ Margin
(Sales - ΣCosts) % of SalesProduct-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-RelatedOutbound Freight Type* xxx xxx 28%Order Type* xxx xxx 26%Channel Type* xxx xxx 24%
Customer-RelatedCustomer-Sustaining xxx xxx 22%Unit-Batch* xxx xxx 10%
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)
Product-relatedcosts
Channel & Customer-relatedcosts
ABC Customer Profit & Loss Statement
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Customer Sales Volume Versus Profits
Sales Volume (logarithmic scale)
Profitability
$ 0
$ (unprofitable)
$ profitable
Customers tend to cluster. Medium-volume customers can be much more profitable than large-volume customers!
These losers drag down
profits
$ small $ large
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High
Low
Low HighCost-to-Serve
Product MixGross Profit
Margin
VeryProfitable
Veryunprofitable
Types of Customers
Migrating Customers to Higher Profitability
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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?
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
The CFO must now help Sales and Marketing … to better target customers.
A Shift in the CFO’s Emphasis
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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
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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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.
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Match the Budget Method to its Category
Demand-driven
Project-driven
IntegratedBudget
(RollingFinancial Forecasts)
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Recurringexpenses
Non-recurringexpenses
Demand-driven
Project-driven
volume & mix of drivers
productionand
ABP/B
strategymap andrisk grid
IntegratedBudget
(rollingfinancial
forecasts)
Budget method
Strategic & risk mitigation projects
Match the Budget Method to its Category
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Define and adjust strategy and risk, andcreate strategy map
Create balanced scorecard
Identify andmanage strategic
initiatives
Approve strategyrisk and capital
budget
Managerial Accounting
(e.g., Activity-basedCosting)
Derived budget(and rolling
financial forecasts)
Strategy methods(e.g., SWOT)
Manage andimprove coreprocesses
Financial Modeling
KPI dashboard feedback
(2) capital budget(3) strategy budget(4) risk budget
Operational Modeling(by employee teams)Strategic
objectives
knowledge
= financial information (e.g. $)
Strategy Modeling(by executives)
priority projects and processes
Forecast drivers(e.g. sales) ;
develop productionplan
Traditional and driver-based
budgeting (e.g. PBB)
Capacity resource plan
Driver volumesand mix
Results andoutcomes
Changes andresponses
e.g., hours,Pounds,
# employees
(1) Operationalbudget
KPItargets
Driver consumption rates
Acceptable?
Reviseplan
OK
No
Yes
Linking Strategy and Risk to the Budget
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Continuous refreshing the rolling financial forecast
…accuracy
100%
0%
More frequent forecast intervals assure better accuracy.
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Accounting Treatments and Behavior of Capacity (expenses)
NowPast Future
Descriptive
Predictive
unused
used
sunk
fixed(unavoidable)
variable(adjustable capacity;
avoidable)
Traceable to products, channels, customers, sustaining
unused
Predictive Accounting
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Power of Information
$ROI
Raw Data
Standard Reports
Ad hoc Reports &
OLAP
Descriptive Modeling
(with analytics)
Predictive Modeling
Data Information Knowledge Decisions
Prescriptive Analytics / Optimization
The Intelligence Hierarchy
Insights
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Mid-seminar Question #2 ?
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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
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Why has the adoption rate for profitability reporting with ABC been so slow?
The Buy-in to Performance Management
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Why is the adoption rate so slow? What are the barrier categories?
(1) Technical barriers include IT related issues.
(3) Organizational behavior barriers involve resistance to change, culture, and leadership.
(2) Perception barriers are excess complexity and affordability.
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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Typical Excuses Preventing Being ProgressiveWe 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, 2018
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Action steps Get educated. Get buy-in. Rapid prototyping. Start small; think big. Improve incentives. (Motivational theory)
Getting Started Actions and Resources
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
Resources:http://www.epmchannel.com/2013/04/09/exceptional-epm-cpm-systems-are-an-exception/
https://opexsociety.org/body-of-knowledge/enterprise-corporate-performance-management/
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.
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From Theory to Practice
Your success depends on how well and how fast the right information and intelligence gets to the right people.
Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC
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Questions ?
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Thank You
Gary Cokins, CPIM
Analytics-Based Performance Management LLCCary, North Carolina USA
www.garycokins.com919 720 [email protected]
A copy will be sent to your email in the next few days.
Sixtina Solutions
Cost Intelligence SolutionsColorado Springs, CO USA
www.sixtinasolutions.com719 394 [email protected]