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Strategic Cost Management – A Profitability Tool, Bp, Fla, November 20, 2010
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Transcript of Strategic Cost Management – A Profitability Tool, Bp, Fla, November 20, 2010
Strategic Cost Management – A
Profitability Management Tool
Presented to Finance Leaders AssociationNovember 20, 2010
Buffalo Grove, Illinois Barrett Peterson, C.P.A.
Manager, Accounting Standards, Procedures & Analysis
TTX
Political risks – laws, regulations, changes in officials Global financial system
Central bank actions and agreements; the impossible trinity “Hot capital “flows
Global trade Wage rates and wage arbitrage – outsourcing/off-shoring Comparative advantage Emerging consumer markets’ growth rates
Commodity distribution and economic power Oil Gas Coal Rare earths minerals Cadmium [think batteries] Fresh Water – a problem now and growing
Strategic Cost Management – Global Drivers
Quantitative Easing 2 and U.S. long-term interest rates:
advantage commodity prices U.S. Health care act [including 1099 political error] US deficit reduction committee chairmen’s “proposal” U.S. new consumer protection agency U.S. near term legislative prospects and the budget Basel III increased capital requirements
Swiss capital requirement increases Turkey capital increases aimed to reduce “hot capital” Bank capital {equity and near equity} requirements
Global Trade G-20 “rebalancing” and trade discussions South Korea trade agreement Commodity prices, including “rare earths”
Strategic Costs – Select Current Considerations
Product and Service Design Product Line Planning Process Design and Planning Capacity Management Market Segment Decisions Sales and Marketing Channel Decisions Logistics and Distribution Outsourcing
The Role of Strategic Cost Management – Impacted
Decisions
Single product entities can use just about any
costing method reliably Entities with few products with little difference
in resource consumption patterns can use simple cost allocation methods: Activity Based Costing will add little or no value
Cost Management Simplification
Price is an input unit measure
Driven by units acquired Usually denominated as amount per unit
acquired Cost is an output measure
Usage inefficiency can drive waste, reducing output volume, and dramatically increasing cost both directly and by slow-down
Quality can affect waste and customer perception of price, perhaps lowering price realization, reducing margin [“increased cost”]
Cost –Key Reminder: Cost is not equal to resource price
Cost objects – key for today
Resources Processes Products
Cost Management Objectives Effectiveness – doing the right things Efficiency – doing things right Economy – maximizing margin [can include cost
reductions, or improving revenues]
Strategic Cost Management Key Aspects
Resource Elements
People – employees, consultants, advisors Facilities, owned or leased Equipment, owned or leased Materials Services – insurance, banking, etc. Capital – Equity, debt, leasing, hedging, etc.
Cost of Business – Elements & Drivers
Cost Management Resources - People
Cost Management Resources – Facilities, Equipment
Cost Management Resources – Technology Improvement
Cost Management Resources - Capital
Drivers
Product Design, including features [market segments], appearance, materials, packaging, and expected life
Process Design Technology – Operations, Support Functions Logistics Requirements Marketing and Sales Methods Capital Markets Value Chain Position Cultural Expectations and customs Legal Compliance
Tax Regulation Financial Reporting Conduct and Social Responsibility
Cost of Business – Elements & Drivers
Cost Management - Drivers
Products Product Lines Processes Customers Distribution Channels Facilities Departments Individual Machines
Cost Accounting Objects
Strategic/Long-Term
Target Costing Activity Based Management (ABM)
Intermediate Activity Based Costing/Management (ABC/M) Marginal Analyses – direct costing
Tactical/Short-term Margin Oriented – Grenzplankostenrechnung
(GPK) Full Absorption – Traditional or ABC
Cost & Profit Management Time Frames
Economic Trade-off based
Target Costing Life Cycle Costing
Allocation Based Methods Traditional Product Based Allocation – Fixed vs. Variable Driver Based Allocation
Resource Consumption Accounting Activity Based Costing (ABC) applied to product objects Theory of Constraints (TOC) “Costed” resource consumption analysis [“Pure RCA]
Allocation Free or Limited – Direct/Attributable Costing Oriented Marginal Analyses [Direct/Attributable Costing] Grenzplankostenrechnung (GPK) [marginal plus fixed]
Cost Practices & Techniques
Full absorption focused
Traditional – organization structure centered, organized around organizational, often “siloed”, departments
Process /Activity focused – relies on assigning costs directly when possible, and using process drivers to allocate indirect cots
Production Management focused Marginal costing and process focused – GPK,
although GPK also contains a strong cost center focus
Cost Practices & Techniques
The Importance of Strategic Cost Management
External Financial Reporting – GAAP: focused on
aggregate inventory levels and consistency to inform investment decisions by investors
Income Tax Compliance – generally similar focus as external financial reporting plus “full absorption” to establish tax liability
Profitability Management – Product, Channel, Customer or Customer Class Focused
Performance Management – Operating Function, Department, Process, Channel, Customer or Customer Class Focused
Costing Method Objectives
External parties
Capital provision determinations – costing at entity level aggregation is all that is needed
Tax compliance – aggregate compliance at the tax paying entity/group level to establish tax liability
Entity management Allocations of resources among entities, products,
geographic operating areas Planning and controlling performance
management Profit maximization/optimization
Costing Method Customers
Assignment to accounting/management periods – some
large costs are inherently imprecise as to period; depreciation; loss contingencies; pensions; facility variable rentals and escalation provisions; hedging costs.
Assignment within accounting periods become increasingly difficult as the level of the costing object becomes smaller in size or time duration, as with products.
Allocation techniques sufficient for entity level results are not reliable for more detailed levels at which management must plan and operate – the driver of “drivers”.
The Cost Management Challenge – Assigning/Allocating
Costs
Direct costing always works, but many large
dollar costs are often not direct, particularly at the product or product line level , introducing a level of uncertainty to detail level decisions.
Time horizon improves the relative amount of costs that are direct, but longer horizons provide reduced tactical flexibility.
Direct margin analyses, at multiple levels, enables comparison of long horizon planning and tactical decision making.
The Cost Management Solution to Assigning/Allocating Costs
GAAP – ASC 330 [formerly FAS 151 & ARB 43]
Production [manufacturing]or acquisition [retail] costs
Full absorption Consistency
IRS – Full Absorption [of production costs] focused Code section 471 – Inventory Code section 472 – LIFO [elimination
considered] Code section 263 – UNICAP [some costs in
addition to production costs]
Inventory Costs – GAAP & IRS
Product [Inventory] and Product Line
Direct Costs Identification of and allocation of indirect costs Determine need, if any, to “tie” to financial reporting
Profitability Management Operations Performance Management
Product design Production Operations Logistics, including Warehouse and Material Handling
Product Costing – Today’s Focus
What do these have in common?Close is sufficient
Product Costing Method
Product Design – Coordination with
Manufacturing and Marketing/Sales Product Mix/Product Line Variations Process Design Complexity
Product Design Manufacturing Techniques Logistics and Material Handling Choices
Regulation and Compliance Manufacturing Technology and Performance Distribution and Logistics
Product Cost Drivers
Utilization Factors
Number of shifts – hours/day of use Time paid not worked – holidays, vacations
Operations Performance Factors Set-Up vs. Run Time Speed/Quality Control of Set-Up and Run - Throughput Maintenance – time used vs. production failure costs Waste Driven Slowing of Production Process Loss of time [slowdown, rework]
Waste Defective Material Production Losses
Costs Drivers to Analyze/Reflect
Assign costs directly as much as possible Determine costs pools for variable type indirect costs for
cost management and control Define around key drivers for allocation based on resource
consumption Include costs which reasonably attach to the pool category Consider two [or three] allocation layers,” indirect” indirect
functions like tools, patterns, printing plates Determine if “reciprocal” relationships will be used
Consider collecting assigning fixed type indirect costs separately using best available allocation basis
Establish Operating Departments for management responsibility evaluation – variable and fixed indirect costs
Effective Cost Accounting
Effective Cost Accounting - Drivers
Machine hours Direct labor hours Material costs Pallets handled Printing plates used Tool forms used Patterns used QC tests performed Cubic feet of
compressed air Mixing tank hours
Mixing tank hours Labels issued KWH used Orders processed Space used Miles traveled Warehouse
insertions/extractions Maintenance labor hours Chiller hours
“Methods” – Resource Consumption
Accounting (RCA), Grenzplankostenrechnung (GPK)
Based on consumption of resources (drivers) Applied to indirect costs The big differences in “pure” application – will
not “tie” to conventional financial reporting Replacement cost depreciation , w/o added
output Capital charge based largely on the
depreciation [capital] consumed or similar measures
Cost Accounting Methods – Resource Consumption Methods
GPK in its fundamental form is a marginal costing
system Use “margin” level definitions, with differing levels of
allocation of indirect and fixed costs Product margins Contribution to production costs, including production
functions’ depreciation Most useful for production scheduling Use for channel scheduling Calculate direct costs for both production or
manufacturing and for warehousing, distribution, and logistics
Cost Related Decisions and Marginal Costing
Use, carefully, throughput measures –
profitability, not optimization, is the business objective Minimize down time – set-up, maintenance,
materials not ready Speed and efficacy of machine operation
Optimize margin dollars per month Be very aware of system constraints [bottlenecks]
& consider Theory of Constraints – margin dollar optimization will usually require optimizing the constraint process, not all processes
Cost Measurement & Performance Management
Direct [final] departments – product volume variable costs
only Separate each process containing different
cost/operations/unit output characteristics Identify relevant output units
Fixed costs are separately collected and not assigned to products
Indirect [primary] departments – variable costs only Separate departments with different cost incurrence or
output patterns Identify application basis or bases To extent possible organize indirect cost pools with the
department structure
Product Cost System Design Considerations – RCA/GPK
General design aspects –
Consider replacement cost depreciation as more realistic despite not readily reflecting potential process improvements such as faster set-ups, or increased throughput speed and accuracy/quality
Minimize design complexity by not allocating costs from one indirect department to another indirect department, unless significant to the product
Consider a cost of capital charge, as a function of replacement cost depreciation
Derive a “full absorption” estimate by using percentage reduction for capital charge and replacement cost depreciation ratio to recorded depreciation [by included processes]
Product Cost System Design Considerations – RCA/GPK
Best used for –
Product pricing decisions Outsourcing evaluations Product design evaluation Manufacturing process improvements
Cost Design System – RCA/GPK
Similar to GPK, except that the system is “full
absorption” focused and thus assigns depreciation – usually actual book depreciation – to direct and indirect departments
Costs are the sum of: Direct costs Direct operating departments costs – including
fixed costs - assigned by a relevant driver Indirect departments costs – including fixed
costs - assigned by one or more drivers consumed by the product or the direct process
Cost System Design – Activity Based Costing (ABC)
Target Costing – cost management and
planning, follows six principles: Price-led costing Customer focus Focus on design of products and processes [point
at which most life cycle costs are effectively committed]
Cross-functional teams [for comprehensive perspective]
Life cycle cost reduction Value chain involvement
Costing – Other Important Applications
Attempts to address:
What are the sources of idle capacity? How much unused capacity is assigned to
product cost? How large of a threat is the hidden unused
capacity? Who is responsible for capacity management? How are manufacturing activities
communicated in a common language? How can we obtain more capacity without
buying it?
Costing – Capacity Management
Productive
Good production New product Process development
Non-productive Standby, waste, maintenance, and setup Process balance & variability; scrap; rework and yield Scheduled & unscheduled maintenance: time, volume,
changeover Idle
Marketable (idle) and non-marketable (excess) Off limits; legal, contractual, management policy
Costing – Capacity Management – Categories of Capacity
Utilization
Hydrox Laboratories: production and purchasing
Production planning and scheduling Waste reduction through process improvement Capital to improve quality – capping equipment Bulk purchasing of hydrogen peroxide Components purchasing
Hydrox Laboratories: logistics – per pallet shipping cost reduction by altering truck load factor [per pallet, LTL, truckload]
Graphic Direct Printing press speed Scheduling by cut-off and color similarity Personalization sizing test [MWWWWM] Sorting and envelop filling speed improvements with more
experienced personnel
Cost and Margin Management Examples
www.goldratt.com www.tocc.com www.cam-i.org www.bpminstitute.org www.supplychainmetric.com www.rcainstitute.org http://
www.focusedmanagement.com/knowledge_base/articles/fmi_articles/middle/German_Cost_Accounting_pt2.pdf
Google text string: GPK accounting Google text string: Resource consumption accounting
Cost Management Resources