sixtina presents: how to accurately allocate costs …...abc systems well beyond the point of...

Sixtina Presents:How to accurately allocate costs for intelligent decision makingA Cost Intelligence Seminar

Gary Cokins, CPIM

Analytics-Based Performance Management LLCCary, North Carolina USA

www.garycokins.com(919) 720-2718gcokins@garycokins.com

August 16, 2018

Sixtina Solutions

Cost Intelligence SolutionsColorado Springs, CO USA

www.sixtinasolutions.com(719) 394-4242contact@sixtinaconsulting.com

About Gary CokinsFounder, Analytics-Based Performance Management LLC

B.S. Industrial Engineering & Operations Research; Cornell University, 1971

M.B.A. Finance & Accounting; Northwestern University, Kellogg Graduate School of Management, 1974

Previous Associations:- FMC Corporation - Consultant with: Deloitte,

KPMG,Electronic Data Systems [EDS, now HP]

Managers who have previously struggled at promoting strategic cost management using activity-based costing principles, FP&A, and integrating business analytics (BA) into their decision support systems.

Who will benefit from this presentation?

Managers who intend to “champion” any or all of these improvement techniques and need a compelling call to action.

• Are our product and service-line costs accurate?

• Do we properly “allocate” our indirect expenses (i.e., overhead) to calculate reasonably accurate product and service-line costs based on “causal” relationships? Or do we “butter spread” expenses with cost allocation factors simultaneously over- and under-cost products and service-lines?

• Do we measure non-product channel and customer expenses (e.g., distribution channels, selling, marketing, customer service) to report profit or loss by each customer?

• Do we know which customers are more attractive to retain, grow, win-back and acquire?

What are issues related to measuring costs and profitability?

• How effective is our annual budgeting process? Does its benefit exceed the administrative effort and costs to produce it?

• Is the budget out of date within a few months after it is published?

• Do experienced managers “pad” their department’s budgets?

• Is consolidating cost center budget spreadsheets bottom-up cumbersome?

• Do we understand incremental / marginal expense analysis classifying the behaviour of our resource capacity expenses as sunk, fixed, step-fixed, or variable based on the planning time horizon?

What are issues related to budgeting and planning?

AGENDA

Defining and describing activity-based costing (ABC) Calculating product and service-line profitability Implementing ABC with rapid prototyping Calculating channel and customer profitability Predictive Accounting – Driver-based budgeting and

rolling financial forecasts Barriers slowing the adoption rate of ABC

ACCOUNTING

Financial Accounting

Cost Measurement

Managerial Accounting

Cost AccountingFinancial Reporting

regulatory compliance

Cost Reporting & Analysis

(feedback on performance)

Decision Support/Cost Planning

•[e.g., GAAP, IFRS]•Costs of goods sold•Inventory valuation

• Spending vs. budget variance analysis • Profitability reporting• Process analysis (e.g., lean, benchmarking, COQ)• Performance measures• Learning; corrective actions

• Fully absorbed & incremental pricing• Driver-based budgeting & rolling financial forecasts• What-if analysis• Product, channel & customer rationalization• Outsourcing & make vs. buy analysis

History FutureLow value-add Modest value-add High value-add

Source data capture(transactions /bookkeeping)

Non-financial data capture

The Domain of Costing

Tax Accounting

Source: “A Costing Levels Continuum Maturity Model” by Gary Cokins published by the International Federation of Accountants, 2010Copyright 2018 www.garycokins.com Analytics-Based Performance Management LLC

Source: PABC IGPG “Evaluating and Improving Costing in Organizations” published by the International Federation of Accountants, 2009

Cokins’ IFAC.org Taxonomy of Accounting

GAAP,rules

AGENDA

Direct and Absorption CostingIdeally, all costs should be directly charged, but as variety, complexity, and technology increases, more costs are indirect and shared.

Activities

Resources

Final Cost

Objects

Project accounting ABC/M ALLOCATIONS

LaborReporting

Estimates

OUTPUTS, PROCESSES, PRODUCTS, SERVICE LINES, MARKETS, CHANNELS, ORDERS, CUSTOMERS

1st Preference

2nd Preference

3rd Preference

Last Resort

Cost-Driver Table

WorkOrder

StandardRouting,

Bill of material

Standardcosting

ActivityDriver

A simple explanation of ABC …that you can explain to yourspouse (or boss) tonight.

Activity-Based View

To: ABC Data Base

Key/scan claimsAnalyze claimsSuspend claimsReceive provider inquiries Resolve member problemsProcess batchesDetermine eligibilityMake copiesWrite correspondenceAttend training

$ 31,500121,000

32,500101,500

83,40045,000

119,000145,500

77,100158,000

$914,500

Claims Processing Dept

Salaries

Equipment

Travel expense

Supplies

Use andoccupancy

$621,400

161,200

58,000

43,900

30,000

$914,500

$600,000

150,000

60,000

40,000

30,000

$880,000

$(21,400)

(11,200)

(3,900)

––

$(34,500)

PlanActualFavorable/

(unfavorable)

Claims Processing Department

Chart-of-Accounts View

From: General LedgerActivity

cost drivers

#of#of#of#of#of#of#of#of#of

$914,500

Each Activity Has Its Own Cost Driver

When managers get this kind of report, they areeither happy or sad, but they are rarely any smarter!

Multiple-Stage Cost Flowing

ExpandedABC

Resources

Activities

Objects

Activities

SimpleABC

ABC/M Cost Assignment NetworkSalary, Fringe

BenefitsDirect

MaterialPhone,Travel

SuppliesDepreciation

Rent, Interest,

Customers

BusinessSustaining

Products,Services

Resources(general ledger view)

Work Activities(verb-noun)

FinalCost

Objects Suppliers

ork Co

e Effe

cts”

SupportActivities

EquipmentActivities

PeopleActivities

“cost-to-serve”paths

ABC/M Cost Assignment NetworkSalary, Fringe

BenefitsDirect

MaterialPhone,Travel

SuppliesDepreciation

Rent, Interest,

Customers

BusinessSustaining

Products,Services

Resources(general ledger view)

Work Activities(verb-noun)

FinalCost

Objects Suppliers

ork Co

e Effe

cts”

SupportActivities

EquipmentActivities

PeopleActivities

“cost-to-serve”paths

Direct costs

$ 30 sales- 28 expenses

= $ 2 profit

$ 2 profit

Unrealized profit revealed by ABC

Net Revenues

MinusABC costs =

profit

Organizational shock from the truth

ActivityCosts

each activity’s driver quantity

unit activity driver cost

(eg. # of registrations)

Price/Fee(Revenue)

ABM provides insight for the product’s or service’s cost drivers and driver quantities.

WorkActivities

Activity Costs “pile up” into outputs.

Gary Cokins’ Best-Selling ABC Book

https://www.wiley.com/en-us/Activity+Based+Cost+Management%3A+An+Executive%27s+Guide-p-9780471443285

Published by John Wiley & Sonswww.wiley.com

Mid-seminar Question #1 ?

AGENDA

Many believe that activity-based costing (ABC) can be complex and that an organization needs to determine if the benefits are worth the effort. Many have this perception, but it is a misconception. I next describe why this is a fallacy and how this problem can be resolved by “right sizing” the ABC system to be “good enough”.

One reason that many perceive ABC to be excessively complex is because in the 1990s accountants and consultants way over-designed ABC systems well beyond the point of diminishing returns of higher cost accuracy for the extra levels to collect, calculate, validate, and report the cost information. The ABC models were not understandable and so large that they collapsed under their weight and were unsustainable. Sometimes executives “pulled the plug” before completion viewing it as another meaningless exercise by the bean counters.

The ABC rapid prototyping with iterative re-modeling” implementation approach resolves this problem. The ABC production system can be implemented in weeks, not months.

Misconceptions about ABC

Rapid Prototyping withIterative Remodeling (crawl, walk, run, fly)

Each iteration enhances the use of a ABC system.

ABC Models

ABC System(repeatable, reliable, relevant)

Make your mistakes early and often, not later when the system is too hard to change.

Balancing Levels of Accuracy with Effort

Accuracyof

Final CostObjects

World ClassABC System Design

Little

Level of Data Collection EffortGreatModest

Benefits from ABC/M Rapid Prototyping

- Accelerated learning- Solving the thorny “leveling” problem- Preventing “over-engineering” ABM model size- Peer group: Pre-determining uses for the information- Replacing misconceptions with reality.- Getting ROI from earlier insights and decisions.

AGENDA

What has Caused Interest in ABPM?

The shift from being product-centric to customer centric.

Value of Company = f(Value from Customers)

The only value a company will ever create is the valuethat comes from its customers – the current ones and the

new ones acquired in the future.To remain competitive, one must determine how to keep customers longer, grow them into bigger customers, make

them more profitable, serve them more efficiently, and acquire relatively more profitable customers.

Source: Don Peppers and Martha Rogers, Peppers & Rogers Group (edited)

Products and standard service-lines are not the only thing for which accountants should compute costs.

What about costs that have nothing to do with making products and delivering standard service-lines?

The problem with traditional accounting’s product gross profit margin reporting is you don’t see the bottom half of the picture.

But what about the Other Below-the-line “Calculated” Costs?

Indirect expensesDistribution, Sales & Marketing

Sales, general, and administration (S,G&A)

Customer+

Direct material,Direct labor &

Equipment

Costs from Sales & Marketing are not Products

Channel+

Product

# 1- Customer retention versus acquisition costs.

# 2 – Sources of Competitive Advantage –Commoditization leading to service-differentiation.

Why Do Customer-related Costs Matter?The Perfect Storm

# 3 – From mass selling to one-to-one customer relationships.

# 4 – The internet’s irreversible shift of power from sellers to buyers.

CUSTOMER: XYZ CORPORATION (CUSTOMER #1270)Sales $$$ Margin $ Margin

(Sales - ΣCosts) % of SalesProduct-Related

Supplier-Related costs (TCO) $ xxx $ xxx 98%

Direct Material xxx xxx 50%Brand Sustaining xxx xxx 48%Product Sustaining xxx xxx 46%Unit, Batch* xxx xxx 30%

Distribution-RelatedOutbound Freight Type* xxx xxx 28%Order Type* xxx xxx 26%Channel Type* xxx xxx 24%

Customer-RelatedCustomer-Sustaining xxx xxx 22%Unit-Batch* xxx xxx 10%

Business Sustaining xxx xxx 8%Operating Profit xxx 8%

* Activity Cost Driver Assignments use measurable quantity volume of Activity Output(Other ActvityAssignments traced based on informed (subjective) %s)

Product-relatedcosts

Channel & Customer-relatedcosts

ABC Customer Profit & Loss Statement

Customer Sales Volume Versus Profits

Sales Volume (logarithmic scale)

Profitability

$ (unprofitable)

$ profitable

Customers tend to cluster. Medium-volume customers can be much more profitable than large-volume customers!

These losers drag down

profits

$ small $ large

Low HighCost-to-Serve

Product MixGross Profit

Margin

VeryProfitable

Veryunprofitable

Types of Customers

Migrating Customers to Higher Profitability

The spending budget for sales and marketing is critical … but it should be treated as a preciously scarce resource to be aimed at generating the highest long-term profits.

This means answering questions like:

Which type of customer is attractive to newly acquire, retain, grow, or win back? And which types are not?

How much should we optimally spend attracting, retaining, growing, or recovering each customer micro-segment?

The CFO must now help Sales and Marketing … to better target customers.

A Shift in the CFO’s Emphasis

AGENDA

Why is the budgeting process broken?

The budget is typically a fiscal exercise by the accountants that is:

-- disconnected from the executive team’s strategy.

-- not based on future driver volumes.

Match the Budget Method to its Category

Demand-driven

Project-driven

IntegratedBudget

(RollingFinancial Forecasts)

Recurringexpenses

Non-recurringexpenses

Demand-driven

Project-driven

volume & mix of drivers

productionand

strategymap andrisk grid

IntegratedBudget

(rollingfinancial

forecasts)

Budget method

Strategic & risk mitigation projects

Match the Budget Method to its Category

Define and adjust strategy and risk, andcreate strategy map

Create balanced scorecard

Identify andmanage strategic

initiatives

Approve strategyrisk and capital

budget

Managerial Accounting

(e.g., Activity-basedCosting)

Derived budget(and rolling

financial forecasts)

Strategy methods(e.g., SWOT)

Manage andimprove coreprocesses

Financial Modeling

KPI dashboard feedback

(2) capital budget(3) strategy budget(4) risk budget

Operational Modeling(by employee teams)Strategic

objectives

knowledge

= financial information (e.g. $)

Strategy Modeling(by executives)

priority projects and processes

Forecast drivers(e.g. sales) ;

develop productionplan

Traditional and driver-based

budgeting (e.g. PBB)

Capacity resource plan

Driver volumesand mix

Results andoutcomes

Changes andresponses

e.g., hours,Pounds,

# employees

(1) Operationalbudget

KPItargets

Driver consumption rates

Acceptable?

Reviseplan

Linking Strategy and Risk to the Budget

Continuous refreshing the rolling financial forecast

…accuracy

More frequent forecast intervals assure better accuracy.

Accounting Treatments and Behavior of Capacity (expenses)

NowPast Future

Descriptive

Predictive

unused

fixed(unavoidable)

variable(adjustable capacity;

avoidable)

Traceable to products, channels, customers, sustaining

unused

Predictive Accounting

Power of Information

Raw Data

Standard Reports

Ad hoc Reports &

Descriptive Modeling

(with analytics)

Predictive Modeling

Data Information Knowledge Decisions

Prescriptive Analytics / Optimization

The Intelligence Hierarchy

Insights

Mid-seminar Question #2 ?

AGENDA

Why has the adoption rate for profitability reporting with ABC been so slow?

The Buy-in to Performance Management

Why is the adoption rate so slow? What are the barrier categories?

(1) Technical barriers include IT related issues.

(3) Organizational behavior barriers involve resistance to change, culture, and leadership.

(2) Perception barriers are excess complexity and affordability.

Typical Excuses Preventing Being ProgressiveWe are profitable, so why does it matter?

We will purchase software that will fix our problems.

We already know our “true” costs from our general ledger financial reporting system.

We have done it this way forever. And we don’t do that here. We already know everything. It is in our heads.

We are a small organization. We’ll worry about better methods when we get larger.

All this hype is just made up stuff from highly paid consultants.

No one looks at the reports I create, so there is no point generating better reports.

We cannot afford better software to fix our problems.

We are way too busy doing other things.

We don’t know where to start or how to get started. Source: William Vaughn Company CPAs; IMA conference, June 20, 2018

Action steps Get educated. Get buy-in. Rapid prototyping. Start small; think big. Improve incentives. (Motivational theory)

Getting Started Actions and Resources

Resources:http://www.epmchannel.com/2013/04/09/exceptional-epm-cpm-systems-are-an-exception/

https://opexsociety.org/body-of-knowledge/enterprise-corporate-performance-management/

A suggestion: Have your management team read either or both of these educational pieces. Then schedule a meeting for discussion. Have each manager answer, “What did I learn? What issues and concerns do I have about EPM?” This will stimulate needed conversations.

From Theory to Practice

Your success depends on how well and how fast the right information and intelligence gets to the right people.

Questions ?

Thank You

Gary Cokins, CPIM

Analytics-Based Performance Management LLCCary, North Carolina USA

www.garycokins.com919 720 2718gcokins@garycokins.com

A copy will be sent to your email in the next few days.

Sixtina Solutions

Cost Intelligence SolutionsColorado Springs, CO USA

www.sixtinasolutions.com719 394 4242contact@sixtinaconsulting.com

sixtina presents: how to accurately allocate costs …...abc systems well beyond the point of...

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