Cut the Accounting Gimmicks!
Mar 13, 2014
I recently attended the “Monster Jam” Monster truck event at the local arena in town and it was a lot of fun. There were of course gimmicks or tricks among the racers, the announcer had his own gimmicks. Basically, the whole event itself was fa gimmick. That was all in fun and made for an enjoyable night! However, as much as gimmicks/tricks have a place in “Monster Jam” they do not, however, have a place in your accounting books.
I recently read an article about new measures for profitability. The article talked about how it is possible to use gimmicks to show profitability the way you would want to. Things like increasing debt in order to increase return on equity or moving locations to a lower taxing areas to “increase profit.” These type of tricks do not necessarily mean you are running the business any better. What types of gimmicks have you witnessed companies try in order to make things appear differently?
In this article the author, Shawn Tully, talks about Jack Ciesielski’s approach called “COROA” Cash Operating Return on Assets. This is where you measure actual cash returns. It is not about expected cash returns or inflated cash returns, but what is actually occurring. This approach does not allow for an addback of interest expense or deprecation expense, but includes that in the actual cash spent to earn profits. According to Jack, the best measure of profitability is comparing this actual cash to total assets. He also reminds us that using GAAP accounting, although important, often does not have a place when you’re trying to determine true profitability.
I am wondering if anyone has heard about this approach or maybe even used it in your metric calculations? I hope to hear from you if you have. Regardless, make sure you cut the gimmicks and are not fooling yourself and those around you. It’s important you are getting the best results and best metrics you can get, be honest with yourself and your boss, or eventually reality will have no choice but to hit you in the face!
Categories: Cost Accounting
Change A Number, Change Views
Mar 10, 2014
Even though my true passion lies in costing models and the profitability of businesses, during tax season I must return to my true job, tax returns! This week, I made a mistake. Well, actually two! I am sure I made more than that, however, these two tax related seemed to be so colossal in nature that it was almost hard to recover mentally.
Fortunately for me, at the end of the day the mistakes were really just a “position” and had I taken a different position, there would have been negligible positive or negative effects to the business and owners. In short, I could file the taxes taking various “positions” and in this particular situation, there was no net effect. However, with another client in another situation, the results could have been vastly different. I was lucky. In the meanwhile, it took a short while to sort out and I couldn’t help but feel like it is somewhat of a game.
Numbers, a game? Let me quote something I read from Reginald Tomas Lee, “you must live with the fact that another equally valid approach will calculate a different number, leaving confusion about which number is better.” He is referring to the fact that a Company can calculate a product cost using many different methods, and come up with many different results. He then goes on to question the ability to trust any number when faced with such results.
I agree with him wholeheartedly. We continually work with new companies that are struggling with costing issues. They have outdated systems, their method of allocating costs is antiquated, their logic does not make sense and no one can understand it. This list of issues could go on. What I have found nearly every time I consult with one of these companies is that trouble comes when ONE number in the cost model is changed (because someone has a new idea) and the product costs change drastically. It just does not make sense. Usually it’s because the cost accountant decided to “allocate” the fixed costs using some NEW method that makes more sense than the old one did.
I often tell companies that trying to come up with a cost model is not a “one size fits all” consulting job and what Reginald is saying proves it. While he advocates a complete change in theory, gravitating away from a “cost model” per se, the bottom line is still the same: the analysis of what costs you are incurring to achieve your intended results can only be viewed and altered from your vantage point. If a “new viewer” (CFO, Controller, Cost Accountant, Plant Manager) participates, most often the analysis gets reworked. Hence, Reginald’s quote, “someone else’s view might make just as much sense as his predecessor, yet yield insanely different results.”
While I am relatively new to these concepts, they definitely have merit, and should be considered before changing your NEXT vantage point.
Categories: Cost Accounting
Barriers to Transitioning Your Cost System?
Mar 06, 2014
A frequent topic in today’s business news relates to current management’s unwillingness to accept new and more robust cost systems and how the delay in adopting a new cost system is expensive to American businesses in both time and money. Many proponents of the a newer cost system point to the benefits and discuss how its solutions are far more superior to many of the older systems. It leaves the author and reader pondering why there hasn’t been a more universal adoption of these new methods by American business leaders. This is especially true since most often these methods promote, ease of conversion, flexibility, and high accuracy.
As I think about this dilemma and my daily experience working in the cost arena, I am struck by several reoccurring situations.
In the first case, today’s business leaders aren’t using their existing, although antiquated, cost system anywhere near the possible level of activity that it is capable of producing. Many business leaders allow their cost systems to become hopelessly outdated with financial information that is years old, as well as, obsolete work standards and production processes. Often times these things have long since been replaced or improved, but the costing program continues to rely on the information without much concern towards their ultimate accuracy and flexibility.
I believe in the above case, those business leaders are unwilling to make any investment in time and money into a new system since they are not even fully utilizing their current system. They figure why waste the money! Also, since that is a job that can be easily put off, it is sometimes ignored for years on end. Repeatedly it’s simply because the resources needed to make that conversion are not readily available, nor is management willing to portion any.
Further, I see that the transparency of the system is of utmost importance to senior business managers. Their willingness to put into place what seems like a more complex and less transparent system when they’re already struggling with an older system that seems complex and lacks transparency is very low on their list of important projects to be completed.
I believe today’s business leaders are simply saying let’s not start down the path of implementing a new system when we aren’t even using our existing system properly. If they were using their existing system to its full capability, I actually think owners would consider making the investment of financial and human capital necessary. They may then see their goal of implementing a new and more accurate system, which would hopefully no longer be offset by a fear of further lack of understanding and transparency in addition to a significant investment of capital.
Categories: Cost Accounting
Revenue or Expense: Which is Better?
Mar 03, 2014
I recently was looking on LinkedIn and I came across a discussion about what adds more to the bottom line: increasing revenue or decreasing expenses. This really is an age-old question and if you think about it systematically they both theoretically do the same. If you have $50,000 in revenues and $30,000 in expenses then you have $20,000 in profit. If you had $5,000 to revenue and decrease expense by $5,000 either way you now have $25,000 in profit.
The LinkedIn discussion thread talked about the various short-term and long-term effects of each. In my opinion, in the short-term it is often easier to reduce expenses. Increasing revenues often takes more resources, which in the short-term will most likely just increase your expenses. Things like marketing expenses, networking, etc are often quite necessary to increase revenues. Frequently, in the short-term, you can delay a purchase, cut costs, or even push production to do processes in a shorter time frame, thereby reducing costs.
However, in the long-run you can only put expenses off for so long. Eventually you have to purchase those items necessary for profitability and efficiency. You can only improve your processes by so much. If you increase your marketing efforts and push your sales team to bring in more revenue, you should be able to have a larger impact on your bottom line profitability. You are of course somewhat limited by your own capacity, but this still should be more overall.
In the end there are many things that can be done to improve overall profitability. The key is deciding which are the most important and would have the biggest impact. Often times this is looked at in the short-term, but looking at it in the long-term and having a good balance is key. Without increased revenues and market-share you could very quickly find yourself out of business.
Categories: Cost Accounting
Don’t Forget About G&A and Your Profit!
Feb 27, 2014
Last week I talked about my client who had a change in his sales volume and was wondering if he whether or not he should take on an additional low margin job. If you read my blog, you know that I said he most likely should take on the job. However, the real question (in many of these cases) is, how does general and administrative expenses and profits figure in to the overall job costing process?
There really are two distinct alternatives here. Option one, when businesses develop their quotes based on variable cost only and then apply a standard percentage for G&A and profitability. When a business like my client’s receives a request for quotation, they develop the direct costs of production. Then figure out what the cost would be and finally determine the selling price by adding on a factor for overhead and profitability. This is based on recent volumes the company has been experiencing and it’s standard application rate for G&A and profitability.
Option two would be when businesses attempt to do all of their quotes based on a fully loaded rate which already includes G&A and profitability built-in to the quote rate. In this case the rate is presumed in some relationship to the activity level anticipated for the year and built right in to the labor rates or machine rates so that it is recovered along with the profit factor that’s part of every quote when it’s being issued. So in effect, developing the cost by using this method is also concurrently developing the selling price because the profitability and the G&A recovery is built right into the rates.
Neither way is necessarily better than the other, it depends on your operation and what your end goal is. Regardless, general and administrative expenses, as well as profit, are very real and important to your business. If you do not consider these in your quoting you may be covering your direct costs, but without covering all of your costs and maintaining some profit you are only asking for trouble.
Categories: Cost Accounting