Self Fulfilling Prophecy
May 08, 2014
I was reading an article recently concerning how companies set standards based on budget, and that when coordinating the budgeting process with the standard cost revision, proper technique would require that companies not plan variances in relationship to setting standards for both direct costs and overhead.
If your company goes through an annual budgeting process and coordinates that with an annual review of costs and makes appropriate changes in standards related to the upcoming year’s activities and costs, then I believe this concept would apply to you.
In times of stability or growth, the method of coordinating standards to the annual plan particularly in the area of overhead recovery seems to work pretty well. In times of stability in cost, as well as stability in volume with relatively modest increases in volume or even slight decreases, the application rates and the development of standards is a reasonably comparable process from one year to the other and does not result in radical changes across the board. It is still possible to have significant changes in one product or product line as the standards that were used to cost the product originally or in times of revised processes warrant major changes in that products cost structure. However, there are many different scenarios where across the board cost changes would result if a company attempted to tie their standard cost revision processes to their annual plan.
The example that I think of most frequently relates to a company that has dramatically decreasing volumes because of temporary changes in their industry or the overall economy is significantly reduced which makes anticipated volumes for the next year significantly lower than in earlier years.
The question that arises is: Do I modify my overhead application rates to reflect this temporary change in volume? Companies that do modify their overhead rates could be looking at substantial increases in product costs simply because volumes have been reduced. Accordingly, that may affect selling price and force even greater reductions in volume as selling prices go up, customers resistance in searching for lower-priced alternatives drives down the volume of the companies products. Sort of the self fulfilling prophecy in the fact that the company anticipated lower volumes and then arranged their costing so as to ensure volumes were reduced.
This calls in to question the possibility of planning for a volume variance. This means not making radical changes in your product costing to avoid even further reductions in volume. It would also include planning for reduced volumes but not adjusting the costing downward to reflect this change in activity. The companies that I work with who are dealing with such issues generally try to maintain strict controls over costs so as to reduce overhead cost as much as possible in relationship to planned lower volumes. The end result is for those able to accomplish this would be significantly negative volume variances offset by significantly positive spending variances. The end result is that the planned change in overhead did not materialize thereby making our original application rates correct for this companies current year in which lower volumes were experienced.
Categories: Cost Accounting
Taking it to the Next Level
May 05, 2014
This was the first Saturday “post-wrestling” season. Last Saturday, my son was awarded the prize for points leader in his age group for Monroe County wrestlers. He won first place at every tournament other than one, which ironically, was last Saturday. His birthday was Friday, so he moved up to the 9-10 age group at his last match. We thought he was going to have a tough time, but my son held his own and even managed to place. He has decided he is willing to work a little harder in order to reach the next level, so we will support him. We are the “leaders” if you will, and the coaches provide his system, and the input (his effort) is determined solely by him. It is very easy for him to determine whether he wants to escalate this and he can affect the results he wants.
I had lunch with a former colleague last week who spent many years working in the lead costing position for a mutil-million dollar company. She had worked her way up through the ranks and basically had the costing down to a science. They transitioned into new systems with which she assisted and then she decided it was time to move on to a new position. She took some time off and has now found herself working as a consultant helping other companies with their costing and systems. She enjoys what she is doing, but never imagined herself quite where she is at today.
I am going through all of this as a precursor to a statement she made to me over lunch that really made me think about companies, their need and their capacity to present accurate costing information, and the roadblocks that I and many others have come up against in our efforts to facilitate change. Here is the comment: “I led the costing division for this multi-million dollar company, and had one person to support me. That was it. For the WHOLE COMPANY- GLOBALLY.” Her point? Why would the smaller players ever feel the need or want to invest the money to take their costing to the next level? For a Company that big to have only two people dedicated to this analysis, how realistic is it for a company that generates $25 million in revenues to hire a cost accountant and invest in the systems?
She had a very valid point and we have faced that same question many times. As we have pointed out, designing a good management accounting system with accurate product costing is a process and it will never provide 100% accurate information. The process determines the outcomes and it is always dictated by the systems (technology), the input, and the driver (leader of the cost department). A change in one of these dynamics can provide widely varying results.
And isn’t that what this is all about? The results? We use that information to make important, relevant decisions for the Company. It is not about valuing the inventory! In a mass statement, we really want to know if each product is profitable, how profitable, and if it’s not, how do we make it profitable. So really, this decision is up to YOU. How much is it worth to you to increase your knowledge and visibility of the financial side of your operations? You don’t need to hire a whole new position to track volumes of information that you will likely never use. Decide what results are significant to you and with our help, figure out how to take it to the next level.
Categories: Cost Accounting
Why Guess?
May 01, 2014
You may have heard our costing department tagline: Why Guess? If you have not, well now you have! Recently our entire firm has been tasked with coming up with a tagline for the firm as a whole. Our separate departments may have our own, but we want a firm tagline that represents our brand. It has been fun getting accountants to be creative and to think outside of the box. I know in my designated group a lot of us were setting up tents inside our box as we were challenged with the thought of stepping outside!
The one thing I noticed is that regardless as to how creative we were being, we were all very positive about our firm company. We all focused on how we are much more than just compliance; how we pride ourselves in providing excellent service and how we are very well-rounded given the various areas of specialization. I think that says a lot about us as a firm and the respect we all have for one another and the bigger picture: our company. How would that look at your company? Would everything be painted in a positive light? Or do you think your 3 second tagline would be something like: don’t come to us; we’re no good, etc? How your internal customers (your employees) feel, says a lot about your company!
Back to our costing tagline of “Why Guess?” – What would your cost accounting department say to this: because we always have, we don’t know any other way. Or would they say I agree we do not!
Guessing on your costing is a huge gamble to take. If your costing is wrong you could be setting your prices too low and you will not be able to cover your costs, or you could be setting your prices too high and pricing yourselves out of the market. Either way you will be out of business before you know it. Cost information is way too valuable and too many people’s livelihoods depend on it being accurate. So Why Guess?
Categories: Cost Accounting
Setting a Selling Price
Apr 29, 2014
There are huge differences in the way businesses or industries set their selling prices. From my point of view, they break down into two general categories. First, an industry where there is selling price competition and industry selling prices are primarily driven by the market. Hence, you are driven by what the market will bear and there is not much you can do to influence your selling price. In these cases, the market presumes a level of service and quality that is built-in to the sales process.
This type of industry could be comparable to a commodity where in there is little difference from supplier to the next as far as the quality of the product and the level of service required to deliver the product to the customer. Industries such as steel and lumber or perhaps grain might be examples of products that are difficult to differentiate from other products in the same industry. The market is price driven and competitors are quick to note changes in market prices and adjust their prices almost instantaneously. I have worked in industries like this where in times of rapidly rising prices, selling price quotes are only good for a few days and in some case only a few hours because the market was moving so quickly.
In cases like this the costing process for determining selling price is really aimed at determining profitability for “a-go/no-go” decision. Once the minimum floor of profitability that will be accepted by the business is set, all future potential sales are measured to that standard with “a-go/no-go” decision process.
The second category is an industry where the company setting the selling price has more discretion based on its own targeted goals and is less influenced by the industry. This would be true in industries that have few competitors or unique niche products that can demand premium pricing. Some companies can find themselves in such a selling price setting market by delivering extraordinary service or quality in an industry that might otherwise be controlled by market prices.
In either case, businesses in this industry then can use product costing information that is prepared accurately and timely to have set selling prices. Competitors, if there are any, are always a factor in this process but if your company happens to be in an industry that allows you to have more discretion over how you set your prices then your costing information can help drive company profitability. This is a unique situation that requires accurate and timely cost information that is updated periodically to be able to maximize company profitability in a unique marketplace.
Whether the costing information developed to be used in the selling price setting process is also integrated into the control of the operations is dependent on management’s desires and is not mandatory as part of the overall costing process. However, those companies that are most successful in setting and using costing information to set selling prices do find useful purposes for applying that same cost information to the operations as processes change, cost change or activity levels are forced up or down.
Categories: Cost Accounting
ABC – A Budget Communication
Apr 24, 2014
I know. . I know. . do not say the “B” word right now. You finally got everything into place, running smoothly and do not want to think about a budget again until November! I’m sorry, but I recently read an article about better communication called, “How to better connect – and communicate – planning, forecasting and budgeting.”
The article’s title focused on communication, but really it is not until the last paragraph that it seemed to really touch on communicating. I think as accountants we try to communicate, but we are just not that great. I do agree, however, that budgeting itself has to evolve as times change. It needs to be a dynamic tool that can be updated as needed and can be used to compare to actual results. A static document can easily become outdated and ignored.
I am surprised and not surprised that spreadsheets still rule. Excel is so widely used and I think it is an excellent tool but there can be critical errors that ruin the forecast. I am surprised because there are many software companies that have developed programs specifically for budgeting. I am not sure if people are apprehensive to try the new software or if the developers do not do a good job promoting it.
Once the budget is established, its falls back to communication. If people know what their budget is and what the expectations are, they will be more likely to try to meet their goal. If they are unaware or do not understand the consequences, then why will they try? As accountants we often think a lot of what we do is common knowledge. We need to recognize we do not understand everything the sales team, or the developers do and vice-versa. We must TELL them!
It is also very important to be balanced between optimism and some skepticism. Be careful to say the sky is falling if it isn’t, but also make others aware when things need to change to be able to continue. You would be surprised how often the manufacturing team can change things up to save money if they are given specific parameters to maintain. If you tell them we need to cut costs they may say no. But if you effectively communicate and say we need to cut costs by 2% you would be amazed at what they can do.
Categories: Cost Accounting