1st Quarter is Coming to a Close, Now What?
Mar 31, 2014
If you live in or around the Ohio area, like I do, you are probably thankful that 1st quarter is ending and maybe that means the snow and cold weather will finally be gone! It is supposed to be 62 and sunny today, but in a few days back to the 40s and 50s! Oh well, you can’t have everything and at least with April on the way we can get out of these winter blues! And truthfully I’ll take the 40s and 50s over what we had! Perhaps more importantly, with the close of first quarter I am also hopeful that everyone is comparing their budget to actual.
First of all, I hope a budget was established in late fall of 2013 for the 2014 year. If you did not, consider creating a budget for the remainder of the year now. As I am sure many of you have heard me say, if you do not know what something should be, it’s easy to believe it is correct. It’s like taking an exam that you didn’t study for: all the answers may seem to be the right answers.
If you did a budget, I hope you have been taking the time to compare your estimates to what actually did happen? A budget is only useful tool if it’s used! Not spending the time to reconcile it to actual completely negates the time spent creating it.
The best use of a budget is comparing the actual results to the anticipated results and then answering the question why. Why were things better/worse/different than expected. Is the cost of material higher, but scrap lower. Or, is cost of material lower and scrap higher, for example. Just looking if the numbers are more or less than what you expected and not asking why, again is not a good use of time.
Looking at the budget at the end of the quarter is a necessity, but even more frequently could be very useful. Reconciling every month is a good practice and sometimes every week, every day, every hour is necessary. You need to know what you are looking for and the correct time frame to look at it. Comparing the monthly utility charges every hour would not make sense, but reconciling material usage every hour may.
Categories: Cost Accounting
Direct Labor – Is It Fixed or Variable?
Mar 28, 2014
For many of my clients, this question is almost laughable. They have considered direct labor a variable cost for so long to think of it in any other terms would be outside the realm of reality. But in today’s ever increasing mechanized manufacturing environment, the question of whether or not labor should be accounted for as fixed or variable is being asked more often.
I was having lunch with the CFO of one of my clients recently and he was struggling with this very issue in his organization. His question, however, was the reverse of what you might think. His manufacturing environment was highly machine controlled and for years his entire manufacturing team had considered direct labor as fixed overhead and part of the machine cost. The problem that he was facing was the entrenched thought process in considering labor a fixed cost, and therefore, not available for modification as volumes changed. Above this, his primary concern was that short-term fluctuations in volume should be met with short-term fluctuations in cost where possible. The CFOs goal of course was to have good management. Rather than considering labor fixed, he recognized that some portion of his crew was talented and experienced in their operations and was not readily replaced by other inexperienced, untrained individuals. However, a portion of the fixed labor crew truly was relatively untrained and could more easily be replaced if necessary after a downturn in volume.
The real challenge was to convince his management team that such fluctuation in crew size makes sense in an environment where virtually all of the costs are related to machinery and all production was in a machine controlled environment.
His thought process did call to mind other components of his operation, which could be available for modification in times of decreased volumes. As volumes fall off, a good cost manager will attempt to match the lower volumes with decreased costs where possible.
In many cases, truly fixed costs are unavailable to be modified by temporary changes in volume. However, it’s worthwhile thinking through the process of those costs that might be available and assuring that changes in volume are met with changes in expenses.
Years ago one of my largest manufacturing clients experienced substantial reductions in volume as their industry protracted in the early stages of the recession. However in this case, the cost manager was able to significantly reduce manufacturing costs and in fact used the volume variance calculation to help guide cost cutting initiatives by providing a guide post about how many dollars in cost need to be removed. At the end of that year, there was a very large negative volume variance which was almost completely offset by a very large positive spending variance.
The ability to manage a cost in spite of their nature in times of fluctuating volumes is one of the hallmarks of a good cost manager.
Categories: Cost Accounting
Preventative Maintenance: Is It Broken Yet?
Mar 24, 2014
Have you heard the term “world class maintenance”? I am by no means an expert on the subject, but my understanding is that it refers to performing consistent preventative maintenance on machines and other equipment on a regular basis before a breakdown occurs to minimize or eliminate downtime.
When I first heard it, it made perfect sense. Anyone who works in manufacturing surely knows that unscheduled down time can be costly. I was speaking with someone the other day who works for an auto manufacturing plant, and they follow the WCM theory. I found it very interesting however when he started telling me about all of the overtime he worked two weeks ago because of a particular robot that kept going down.
The production line that he was working on was machining with two mirror lines both feeding into an end line washing station before heading to staging and assembly. The robot was in the washing component of the line. The purpose was to pick up the part after it had been machined and rotate it around for thorough washing. He proceeded to tell me that the motors on the robot had been replaced twice in the past few months and management did not want to stop the line to do so.
So my first reaction was why are we fixing the robot after the fact? If we were doing our preventative maintenance (PM) wouldn’t we have known there is a problem with the motor? Now I know you can’t catch everything in a preventative fashion because sometimes things break unexpectedly. But twice? The new motor breaks again and no one wonders what is going on? I do not have the knowledge, nor the skill to fix a machine of such nature. However, as I kept probing with questions I found out the Company had all of the parts to perform the PM for nearly a year, and did not do it. Anyone as intrigued as I was?
Here’s the cincher, the robot used to perform the washing function was NOT waterproof! Hence, the motor kept getting wet and burning out. This particular person had only been privy to the last two motor changes. Apparently there had been more. They were waiting on the robot to “die” before they replaced it with the one that had been “waterproofed”.
I can tell you that this individual spent almost three full days including overtime working on the second breakdown. Did anyone look at this? Does it really make sense when we have the replacement robot to keep repairing the old one? The cost of new motors that are going to knowingly fail, the downtime on the line, the wages and overtime of the maintenance crew, all for what? I asked him why and this was the answer I received: “we don’t stop. Management does not want to stop the line for anything and to schedule a shutdown of the line to replace the robot is failure because we are unable to produce anything.”
Can someone please explain? In my world, we would have saved more money by scheduling the down time and replacing the robot one time as opposed to the numerous times spent trying to repair it, knowing that it would not work. This one seems obvious to me. Better decision making will result in better costs. Matter of fact, just being logical will result in better costs!
Categories: Cost Accounting
Profit Does Not = Cash
Mar 20, 2014
Recently, I was talking with one of my new business tax return clients and she commented to me that she realized she had a tax profit this year but it did not seem to have much to do with her cash. We have scheduled a meeting to discuss this with her further. I am sure many of you have had this same issue. What answer would you give?
There are many different ways to determine what your “profit” is for the year. There is GAAP reporting that would calculate profit a certain way, accounting for accruals, prepaids, depreciation over longer periods than tax, etc. Then there is tax reporting that may be similar to GAAP, but most certainly would have accelerated depreciation methods. Tax may also be on a cash basis where the accruals and prepaids, receivables, and payables would need to be reversed. Then of course there is management profit, which may still be a different number. Which number is right is only relevant for what you are trying to do. If you are doing a tax return, then you need to determine your taxable profit, or loss. If you are having an audited financial statement then GAAP basis profit, or loss, would be necessary. Neither of these may be the best methods to look at to make management decisions.
Many things effect our profit. In a manufacturing environment, you may be costing your product ineffectively which is effecting your bottom line. You may also have excessive inventory at the end of the year that you are unable to expense and have not sold, which again effects your bottom line and cash. You still spent the money to build the inventory, you just have not sold it to recognize profit, or the full expense.
Other simple reasons exist as well. If you are a company with a large amount of debt the principle payments of that debt is not an expense but it most certainly takes cash. If you pay a lot of your debt, you may still have a high profit, because the cash was not left for deductible expenses. Also you may be a cash basis taxpayer where your receivables have dramatically decreased from the prior year, which will add income to your bottom line, etc.
It is important to realize what your goal is and what rules you should be following for that goal, and understanding income does not necessarily equal cash flow.
Categories: Cost Accounting
What Is The Most Effective Way To Teach?
Mar 17, 2014
The other day, I was talking to the senior financial executive of one of my clients regarding what sort of training program they should be providing their new executives in training. I originally thought we were going to discuss job costing but the conversation developed much further. Costing issues in this manufacturing company were an important concern, particularly since some of the trainees had limited accounting training and perhaps no training whatsoever in job costing.
The real issue at hand was what sort of a basic background should these executives in training be provided related to a whole series of topics, many of which they had never seen in practice before. At the conclusion of the conversation, I agreed to put my thoughts in writing to this executive so that it can be used as part of the training process for overall development in their firm.
There are numerous topics that could be covered in a financial training program for non-financially trained executives. However, I do believe that there are several basic truths about how to train anyone in a subject that is new to them. I certainly believe that training should be offered in small manageable sessions rather than long extended training sessions without any real application. For instance, I believe it would be difficult to train somebody in cost accounting concepts for 40 or 80 hours then ask them to begin using those concepts in practical applications without more hands-on training as part of the academic learning process. Especially if they’ve never seen the subject.
The entire training process should take place over several months and include short training sessions, maybe two to four hours. The sessions on a specific technical subject should be followed by actual work experience. This allows concepts to be put into practice and followed by a debriefing session, which gives each of the participants a chance to talk about what they learned and what the training was able to provide. This debriefing session should not only allow the participants to recognize what they missed in the training, but also allow those doing the training to receive feedback on how future training could be modified. The next step should be to build upon additional training so that the participants can see the building block components of each of the steps and deal with those on the practical applications they are seeing in their actual day-to-day work experiences.
My personal experience has shown me that any time you can link segments of practical experience with classroom training there is a direct increase in training effectiveness. In addition,participants are much more proficient with that kind of experience rather than long periods of classroom training followed by long periods of work experience without the opportunity to compare results in one with the results in the other.
One of the key features that I intend to include on my notes related to this entire process is that whatever the financial training is provided, every step must to be linked to the operations so that changes in operations can be demonstrated by changes in financial results in a way that is obvious to the participants.
Categories: Cost Accounting