Increase Volume, Lower Cost?
Dec 05, 2013
I received a call from a client the other day asking about how much they could reduce their selling price if one of their major customers would dramatically increase their volume of business. The client realized that part of his cost was associated with fixed overhead in the manufacturing environment. He also realized that as volumes increase, that spread of fixed costs can be reduced simply because the base is larger.
Although we have not yet finished our conversation, I am sure that he believes that whatever portion of overhead is being assigned to this customer’s products can be reduced. I believe that he believes if volume is doubled, let’s say, then he can cut his price in half.
We recently worked through a very similar example with another client in a completely different industry. In this case, the owner was attempting to dramatically reduce his selling price thereby capturing a greater share of the market and substantially increasing his volume, and his question to us was how much of a difference would that make?
There are mathematical techniques available that allow cost accountants to make precise calculations as to the nature of the cost being assigned in the current allocation method and readily determine which of those costs are fixed and variable. Even though most business owners think of overhead as purely fixed with careful analysis, it’s easy to determine that there are variable components that need to be recognized separately. With our first example, precise costing was an absolute necessity for this business owner, and he would not tolerate even a few percentages of error in his product costing. As a result, we were able to determine that roughly two-thirds of the costs being allocated to the overhead costs were truly fixed and will result in lower cost per the product if volumes are substantially increased. However, one-third of the cost was clearly variable and had to be considered very similar to any other purely variable component in product costing, such as raw material. With this information he was able to accurately adjust his sales prices purely based on the anticipated volumes with new lower selling prices.
In the second case, the client was looking for some general guidelines that he can use to talk to this customer about what to expect, and I believe based on our preliminary review that some cost reduction is possible but I suspect it will be far less than the customer is anticipating because a good portion of their costs are truly variable and volumes have little effect on that cost band.
We are constantly running across costing issues like these that are generated by an improving economy and customers demanding continuous streams of cost reductions to keep their business competitive in a global economy.
Precise product costing is the foundation for good management decisions related to make or buy, continuation of customer or product line and overall profitability by operation, location, customer, nature of raw material or any other myriad of things that business owners find relevant to maintaining or improving the overall operations they are responsible for.
If your product costing does not provide reliable information that is timely and relevant to your needs, you are limiting the possible effectiveness of your management team.
Categories: Cost Accounting
Fully Loaded
Dec 02, 2013
Since this post is right after Thanksgiving with the title Fully Loaded I’m sure many of you are still stuffed from all of the good food I trust you had over Thanksgiving, and hoping this isn’t about food! No worries, it’s about something much more exciting… cost accounting!
Recently, I was working with one of my clients who we recently updated his costing rates for allocation of overhead. He is thrilled to have accurate numbers again. We updated his rates a few years back, but unfortunately, he did not have all the help he required to keep things functioning the way we had intended. We are now getting him back on track which is an exciting thing for all of us! The other day he called me asking about a fully loaded rate. He said for his quoting he wants to make sure he is including his general and administrative (G&A) expenses also.
I explained him that there are a few different ways we could make sure we are covering all of his costs, not just the overhead and direct expenses for quoting. One such way would be to look at each cost and create a fully-loaded rate in the same systematic process used to determine the original allocation rates. This would be more precise and would only be used in quoting purposes not cost recovery purposes. For his intentions though I do not feel this is worth the extra effort.
Another way is to just look at the G&A expenses in total and compare that to the total machine hours to formulate a percentage to use in quoting. This of course is not as precise, but it is effective and for his purposes I think is the best option. However, we would need to consider updating the percentages if the production changes dramatically since more production would have more hours to spread over the costs.
Have you used any different methods for allocating G&A for a fully loaded rate? If so what have you used and was it effective and efficient for you?
It is important to consider all of the costs of running your business when quoting on jobs, if you are not recovering all of your costs you will not stay in business very long. I’m excited how far this client has come in going from hardly understanding why we would even need to do costing, to now wanting to make sure he has a fully loaded rate!
Categories: Cost Accounting
Are Book Smarts Enough When it Comes To Cost Accounting?
Nov 25, 2013
I have noticed lately on LinkedIn that a lot of accountants are adding “Cost Accounting” as their area of expertise. Not to single out anyone in particular, but there are many accountants that I know personally and I don’t honestly think they could hold a civilized conversation about cost accounting. Even though this is an important point, it is not the focus of my post today.
I consider myself very knowledgeable when it comes to helping companies identify problems and improve their cost accounting systems. That includes both the methodology and the systems that support it. I had a conversation with a cost accountant last week that made me think about how comprehensive my own knowledge really is.
I have spent 20 years in public accounting, and started helping clients with their costing issues nearly 15 years ago. I have toured numerous manufacturing facilities and had meetings with countless cost accountants, controllers, business owners, and other “cost accounting specialists” throughout the years. However, I have not actually worked in a manufacturing facility nor have I been an accountant for a manufacturing facility. My entire experience has been as an outside consultant working in public accounting.
Someone rightfully so pointed that out to me last week. At first I was taken aback, it was kind of like the comment regarding consultants: “those who can do, those who cannot, consult”. Funny, huh? I got to thinking – am I missing some big foundation of knowledge because I have not had that “hands-on” experience? Am I really providing a disservice to my cost accounting clients because I am lacking in “real” world experience? Of course I am going to lean towards NO. After a significant amount of consideration , I believe I have the facts to support my NO.
I have said before, product costing is not black and white, and always requires a great deal of knowledge and subjective judgment. As I iterated previously, my experience as a consultant has afforded me the opportunity to experience numerous costing theories. These theories have been played out by experienced cost accountants and extremely inexperienced controllers using systems ranging from simple one-page excel spreadsheets to million dollar ERP systems. I have assisted clients with the simplest of problems to the most complicated and in a wide range of industries. In comparison, many of the individuals I am helping have performed in a narrow range of capacity for one, or a few different employers.
My conclusion? The diversity of my experience has provided me exposure far beyond what I would have obtained as a long-term controller or cost accountant at a manufacturing facility. I have a unique perspective each time I enter a new facility and I am able to quickly identify potential discrepancies in a system. It is true that as a cost accountant, especially if you are involved, you should know the details of the operations and how they are applied in the cost model. However, sometimes you are TOO CLOSE to the process to take the aerial view, and make sure the puzzle fits together. So, for now I will rephrase the age old saying, “Those who can do, those who can do better, consult!”
Categories: Cost Accounting
Current Cost Information
Nov 21, 2013
I recently attended a meeting with a group of accountants that are specialist in manufacturing. The purpose of the meeting was to review common practices, look for opportunities to serve clients within the manufacturing industry and to assist one another with projects where one accountant has specialized knowledge and skills that another would find useful in their delivery of services to their client. This group was diverse, representing firms from all over the country and having extensive experience in manufacturing processes and the delivery of accounting and tax services to that industry.
More specifically, the group shared extensive experience associated with the tax issues manufacturers face and how to tailor their resolutions to be more beneficial to one type of manufacturer compared to the other. Additionally, there were a series of specialized assignments in six sigma and lean manufacturing. Some of the group was comprised of consultants who specialized in those kinds of processes and delivering those kinds of improvements to manufacturers. However, I was surprised to find that very few people in the group had any current working knowledge on costing matters.
It seems to me, as result of our experience with our cost forums and also my general experience working with manufacturing clients over the years, that the one reoccurring theme, regardless of the size of the business or the type of manufacturing, relates to figuring out what things cost. Furthermore, what’s profitable and what’s not profitable. There of course are a whole range of subjects associated with knowing what things cost at various stages of the process to make informed decisions related to all kinds of manufacturing changes.
During the meeting, I described the kinds of things that we have been doing with costing over the years that and that generated a whole series of questions from the attendees. These questions ranged from what sort of skills were needed for training inexperienced people all the way to experienced. I also discussed what we found as the general outcome of many of these assignments.
It was clear to me that as the meeting continued that many of the manufacturing specialists, particularly in the tax and accounting area, are relying on others to provide some sort of advice relative to product costs and the various concepts surrounding that whole area. I’ve heard Doug Hicks say more than once that many decisions today are not placed on solid cost information but rather senior managers perception of what the circumstances are and how they should react. The example that I’ve heard Doug use more than once relates to our shipping offshore manufacturing processes to China under the presumption that such off shore production is cheaper than doing it in house especially considering all the cost included related to shipping offshore.
If the specialists who make a living advising manufacturers have limited experience working in this area I can only imagine that the overall level of sophistication among many manufacturers is less than optimal because there is no readily available source of information guidance or review to provide expertise that will be useful.
Categories: Cost Accounting
Hope for the Best or Have a Game Plan?
Nov 18, 2013
I recently saw a billboard that said if you don’t have a disaster plan, to hope for the best! Man that really is true, unfortunately, I think that is a lot of people’s plan. Do you personally or your business have a disaster plan in place? Yesterday we had some high winds and possible tornados in our area causing some major localized damage. Thankfully myself nor anyone I know was directly affected. However, it sure could have been worse. I hope no one reading this blog or anyone they know was affected either. I know there were storms all over the country. Don’t be one of those people who have to learn the hard way. Have a disaster plan in place before disaster strikes and know what you need to do.
Obviously if a disaster would take place, some cost would incur to return things to working order. How would you account for those costs? Hopefully those are one-time expenses that you can just expense and never have to do again. Regardless, how are you going to over your costs?
If you live in tornado alley or somewhere that gets a lot of hurricanes or earthquakes you may be having these expenses a lot more frequently. You of course would not change your standards necessarily for these costs, but if it is something that happens every year or every few years you need to make sure you can cover the costs. If your margins are not large enough to withstand these kinds of expenses that are somewhat reoccurring you will not be able to stay in business.
Even if a disaster happens only once and you do not have enough profit or the ability to finance, then you too may not be able to stay in business. Most organizations have insurance to cover these types of incidents, but you still have to stay operational if possible during rebuilding, or whatever other efforts may be necessary.
Natural disasters are a very tragic thing, do not be left without a game plan! Chances are if your business has been effected, the homes of those that work for you have also been effected. Do not add to the devastation by having to close your business.
Categories: Cost Accounting