Solving Manufacturing Costing Obstacles: Complex or Simplified
Nov 20, 2015
A few months ago I was having breakfast with the CFO of a major manufacturing company in Northwest Ohio and we talked about the cost and financial issues faced by his organization. As he described some of the more recent issues, it became clear the biggest obstacle was related to individual job costing. In addition, there were concerns regarding the international pressures exerted by competitors from foreign countries. In order to remain competitive in a world market, it was essential to minimize costs. As we discussed these issues in greater detail, it was evident there were additional underlying issues which required attention to ensure the company’s competitiveness.
During our conversation, he asked, “aren’t most business problems today simple math problems?” As I thought about his statement, I must agree.
Many business issues involve some kind of a math problem. Some of these problems are very simple and can be solved with a straightforward mathematical technique. However, some obstacles may be quite complex and require multiple mathematical techniques or some extremely sophisticated method to both understand the issue and then form a solution. I am constantly amazed by how quickly businesses attempt to oversimplify issues in an attempt to reason a solution or approach for dealing with the issues that are easy-to-understand. Do not get me wrong, an understandable solution is very important, but not to the point that it is unusable.
I am often reminded the first solution may not be the best or lead to expected outcomes. A business’s ability to correctly identify the challenges they are facing and then to grasp all of the implications of those challenges, both positive and negative, is critical. Often times a solution cannot be determined without fully understanding the problem at hand. Solutions require structure in such a way that all of the considerations, again both positive and negative, are considered which frequently leads to a successful conclusion.
It is often the quick, unstructured course of action that does not identify or consider all of the possibilities that will most frequently lead to an unsuccessful result. I have worked on models in the past that included dozens of moving factors with varying elements of impact on the end goal. A business manager’s ability to identify and quantify those factors dramatically affect the development of a solution. I do not mean to over simplify and say all business problems today can be reduced to mathematical terms; however, there are significant benefits for solutions to problems that are mathematically based that clearly outweigh non-mathematical based courses of action.
Many personnel, management, and leadership predicaments must be resolved with the consideration of personality traits. A mathematician would argue you can build some variable into a formula for emotion, but I think using real emotion to determine how to deal with emotion tends to be best. These represent a large number of the issues American businesses are dealing with today and certainly do not lend themselves to mathematical solutions. However, many of the financial problems businesses face today with regard to price reductions, sales volumes, profitability by product line, could be solved in mathematically based manners. Far better outcomes can be obtained if the team analyzing the issues can seek out mathematical solutions which are all-encompassing and correctly structured.
Have you ever thought about problems from a mathematical point of view? If so what have you done? If not, will you start now?
Categories: Cost Accounting
Budgeting & Forecasting: Creating A Roadmap For Success
Nov 17, 2015
Like most organizations, you are probably putting the finishing touches on your 2016 budget. There are a number of budgeting techniques, and I would imagine at one time or another you have utilized all of them. These methods include same as last year (SALY), zero-based budgeting, percent increase over last year, etc. Which of these systems do you currently apply. If your manager asked you to do a forecast, how would you respond?
- I have already outlined a budget, I am not doing anything else
- A budget and a forecast are one in the same
- Sure I’ll get right on it!
You may not be as forceful as the first bullet, or as enthusiastic as the last, but I would imagine you would respond in some fashion similar to these points. And if you did, you would be somewhat correct. In order to understand the reasoning, we need to define the difference between a forecast and a budget.
A budget is:
- A detailed representation of what you expect the future to be and goals to achieve
- Generally prepared and updated once a year
- Serves as a starting point to compare actual results to, i.e. a variance
- a live document which management holds departments accountable to and attempts to achieve the goals it outlines
- It is not a pie in the sky guess as to where you hope to be
A forecast is:
- Typically less detailed with just major revenue and expense items
- Typically does not cover financial position other than cash flow
- Can be updated frequently, quarterly or even monthly
- Goals are tracked, but actual results are rarely compared back to the forecast
- Management typically does not hold employees accountable to the forecast
- Is based on historic trends and future contracts
In a nutshell, a budget is a picture of where the company currently stands. A forecast is where you hope to be and prediction as to where you are going. Both are valuable tools You can build a forecast from a budget, and try to work backwards. A budget tends to be more expected and a forecast is slightly more hopeful. Although, if you expect sales to increase by 15% as your forecast predicts, you may want to set your budget with a 15% sales increase, or with an increase of revenue. Consistently having positive variances in sales numbers is not always a good thing. Sure it may make the sales team look good, but there are capacity issues and other costs. For example, overtime may come into play with increased sales. You may not plan for such in your budget. It is essential to be realistic about your budget but also employ your forecast as a tool to anticipate possible issues, both positive and negative, in the future.
It can be cumbersome to do a budget and the thought of doing a forecast on top of it may seem ridiculous, but it could be the most valuable time you spend if done correctly and utilized fully.
Categories: Cost Accounting
One Year-End Overhead Calculation
Nov 13, 2015
At a recent seminar we were teaching concerning cost accounting, one of the participants started a conversation about how insignificant the application of overhead and other non-material costs of production was in the overall determination of their prices. In his operations, raw materials represented a huge portion of the total cost of their product and their conversion costs were a minor part of the overall cost.
This was important because this part of the classroom discussion was focused on methods of allocating overhead and other indirect costs of production. Specifically, we were discussing the methods which could be employed to make overhead application as accurate and as useful as possible. This participant had concluded conversion costs were such a small portion of their total overhead that the effort to adjust it every month was not worth the improved accuracy of results.
I believe in his case, he thought activity costs associated with the overhead labor and other indirect costs of production were less than 5% of the total cost of the product. As a result, the company was setting up a standard inventory amount for activity cost and not changing it throughout the year unless there was an obvious and radical change in those costs. Every year-end the calculations were completed by December 31 and whatever minor modification were required in the conversion inventory were made at the same time. Thus, all of the other minor adjustments which could’ve been made throughout the year were ignored until year-end.
This is a viable alternative, particularly in those businesses which have very low inventory changes and/or their conversion cost are a much lower part of their year-end inventory.
By not making any of the other conversion calculations during the year, the business loses the opportunity to help control indirect costs through variance analysis. Had they been monitoring and reporting on conversion costs to standard throughout the year, it would have been available.
Just because the company does not choose to make inventory adjustments monthly, does not mean they are not using the rest of the possible management tools associated with an efficient costing system. I would imagine they are utilizing tools related to activity levels and budgeted amounts compared to actual amounts on the spending side of the various computations. However, it was my impression during this discussion that that entire side of the calculation, meaning the entire activity measurement and variance analysis that would be otherwise associated with the calculation of a conversion cost inventory, was being ignored until the end of the year. The work associated with making those calculations and monitoring the results must be carefully weighed against the benefits of making those monthly changes. Another important measurement is the cost-benefit approach which should always be the final judgment tool to determine if these calculations should be made and posted. It may be adequate to hold off until year-end and use a standard amount every month as the minor modifications would not provide useful enough information to make it worthwhile.
Does anyone else do this with their overhead allocation? If so why, and what benefits/risks do you see?
Categories: Cost Accounting
Moving Beyond Excuses, Reaping The Rewards
Nov 09, 2015
To all of my blog readers, I have missed you! I have been actively working on an exciting project, but have been unable to dedicate my time to anything else. At times, projects develop which require our complete attention, but it is important to remain balanced and give each of your responsibilities the proper focus. If not, your environment may crumble.
I have conversed with groups about having excuses and not taking action. We, of course, can have excuses in every-day life, but I am specifically talking about costing. Do you have a highly functional efficient costing system? If not, is the reasoning due to affordability? Do you think it is unnecessary? Or, is it due to a lack of time?
Most controllers wear many hats. As a result, having time to implement, restore, or redo a costing system may not be feasible. Does this mean not having enough time is a valid excuse? You know the benefits of an efficient cost system. You also know the risks you face without one. Yet, your time is limited, so your system will have to remain the same. Have you said something like that before?
You may not have the time to do it on your own. So take a little time and find the right people to help you achieve clarity. I’ll add a shameless plug here and say contact Bill or I today, and let us help you stop with the excuses and start with the rewards!
Categories: Cost Accounting
Complex Manufacturing Environment
Nov 03, 2015
A few days ago, I met with a potential client to discuss some of the costing issues faced by their organization. In this particular case, the CFO was relatively new to the organization and was being called upon to a help set for a complex series of manufacturing processes. The company offered a variety of products and services from one location and the diversity of offerings created a convoluted web of all the possible cost recovery methods, which were not easy to resolve.
The CFO came to us for advice on how to structure a cost recovery system in an extremely complex manufacturing environment. The system would need to sort out complexities in both cost and customers, as well as recovery methods. For example, one of the processes was merely a rental where customers were renting space and equipment both on a long and a short-term basis. In this instance, the company was attempting to determine how to recover all of the costs associated with owning, maintaining and supporting the rental space being made available to the customer. This was particularly complicated because some customers only needed the space for a short period of time with a limited number of processes while others required a much more extended period of time and numerous processes. These differing processes and differing time frames made it difficult to compute any rates. specifically, for what equipment and space and for how long! Further complicating this side of the business was that of differing needs by similar customers. In one case, customer A would need equipment for a given period. A few weeks later, the same customer would rent a different array of equipment space.
Another aspect of this operation was the manual labor controlled environment in which products were being produced. Processes were not dependent on any machine but rather a crew of people doing simple manual tasks. Although the processes were simplistic in nature, the sheer number and types of processes to be completed varied along with the crew sizes necessary. It was apparent by touring the operation that this part of the process was relatively simple to understand, but was highly diverse in both crew sizes and run lengths. Therefore, it would require an entirely different recovery system than that of the space and machinery rental process described above.
The third process being used in this operation was a complete machine controlled environment where labor was merely a supporting cost for the operation of the machine. In this case, the company was producing products through an entirely machine-controlled environment, again, at varying run lengths and speeds dependent on the nature of the product. It was a relatively new process for the company and they were attempting to settle on appropriate rates of production, crew sizes, and other operational decisions related to the process and the speed. The CFO recognized the costing for this process would have to evolve as the process became more defined.
Although we did not discuss this topic as part of our initial meeting and tour, it seemed quite likely that in several of these operations there may be byproducts being produced which should have some costing effects. The materiality of the amount and frequency of which it would concur was not a topic of discussion but will be addressed sometime in the future as we get closer to getting the start of our project for this business.
Categories: Cost Accounting