CFO Services & Transformation

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Cost Accounting

The history of today’s cost accounting stems from the textile mills of the 1800’s. The cost of homogeneous products was derived by simply dividing the total cost of operations by the number of units of production. As products became more complex, many costs, especially overhead costs, were grouped or “pooled” together and allocated to products as a small percentage of direct labor. Today, labor represents less than 10% of output costs, and combined with a multitude of diverse products and services, conventional cost accounting (that relies on allocated pooled costs), does not address the needs of management who need more accurate product and service costs. More than 75% of manufacturing companies still allocate overhead as a percent of labor using burden rates often in excess of 1000%. The emergence of the service economy further exacerbates the problem as most service companies have little to no cost accounting or cost management. Even more contemporary approaches to cost accounting such as activity-based-costing still rely on numerous activity “pools” where resource costs are aggregated and allocated to products and services using averaged driver rates.

MRT has developed a cost accounting tool that costs products and services without using outmoded allocated methods, averaged driver rates, or cost pooling. Every resource cost is directly assigned to activities, products and services maintaining a complete audit trail necessary for validation.

 CASE STUDY   A financial services company wished to understand the cost and profitability of its various Lines of Business (LOB), or service offerings.  MRT was engaged to build a cost accounting model whereby all costs were directly assigned to the LOBs.  The result was that a number of LOBs were unprofitable while approximately one-half of the LOBs accounted for 175% of profits.  Financial performance was significantly enhanced by focusing corrective action on those offerings that failed to meet financial objectives while expanding those LOBs which contributed to the overall profitability of the company.

Sarbanes Oxley

A natural extension of MRT’s AVM® service offering is the ability to identify and document critical processes. Included in the AVM® software is the capability to capture and record:

  • Process/activity objectives
  • Process/activity risks
  • Key controls associated with processes and activities
    • Control tasks — those actions that must be taken to test and ensure the quality of the process and activity outcomes
    • Comments from employees can also be captured and assigned to specific processes and activities forming a repository of issues, concerns, roadblocks, improvements, and corrective action

In addition to the requirements set forth in Section 404 associated with documenting management’s assessment of controls, capturing process and activity costs across product and service offerings and market channels will also contribute to requirements associated with Section 409 — providing timely information regarding changes in financial condition or operational performance.

Organizations not subject to Sarbanes-Oxley compliance should consider implementing these controls to improve their value. For example, organizations seeking acquisition or capital infusion would benefit by having such controls in place.

A major advantage of using MRT’s AVM® process is that it can turn a costly compliance initiative into an opportunity to improve financial and operational performance. In addition to documenting activities, alternatives that improve performance and lower costs are often uncovered.

Predictive Forecasting & Budgeting

Forecasting and budgeting are major parts of effective planning. However, in most cases this arduous task consumes significant resources and time. MRT’s approach, based on its flagship service offering Activity Value Management®, makes this task much easier, more predictable, and is based upon the cost behavior of each organizational activity.

During an AVM® study, all costs and efforts are assigned to the activities that support each major product or service offering. Within each activity, in total or for each product/service offering, a determination of fixed and variable costs is computed. Next, the behavior of the effort associated with each activity is determined. The result, the capability of forecasting and budgeting costs based on an assessment of the unique behaviors of the activity costs related to each major line of business.

This tool can be used as either a self-contained forecasting and budgeting model or as a check to validate forecasts and budgets constructed in a conventional manner.

CASE STUDY   By forecasting on the basis of process and activity cost behavior a financial services company was able to demonstrate that an under-performing line of business would never reach desired profitability, based on the behavior of the activities necessary to support that line of business. These findings led to a major restructuring of the service offering to achieve desired performance levels.

Financial Planning & Analysis (FP&A)

Once process and activity costs have been captured across lines of business, it becomes necessary to analyze these costs to identify opportunities to improve bottom-line performance. MRT has developed a unique set of tools to identify opportunities to improve financial and operational performance. As an extension of the AVM® process, a host of tools designed to uncover opportunities to improve financial performance have been developed.

  • Process-based income statements that depict the cost and profitability of each Line of Business.
  • Overlap and duplication between functional groups that adds unnecessary and avoidable costs within the organization.
  • Divestiture modeling which identifies the specific resources affected by an elimination of a product or service offering. In an era of shared costs within many organizations, MRT’s tools identify which costs would be eliminated and which costs remain when a decision to divest or eliminate a portion of the business.

CASE STUDY #1   An organization having numerous product offerings and significant shared costs discovered that a number of LOBs were underperforming.  As a result, the analysis identified which LOBs should be eliminated and the resources that can be freed to either work on more important activities or used to increase capacity (without incurring additional costs) — improving bottom-line performance.  Of note, it is also important to discover which LOB, although not profitable, should not be eliminated as it contributes positive contribution margin — if eliminated, the results would have a negative impact on overall financial performance as well as the other LOBs which must absorb the freed capacity.

CASE STUDY #2   A financial services organization discovered a considerable amount of overlap and duplication between the Sales organization and Customer Support (which was part of the Operations organization).  This was discovered during a financial analysis of the cost related to providing customer support.  The solution was to move all customer support under the primary process owner, Customer Support, and relieve the Sales organization from these activities.  This resulted in revenue growth due to greater focus on revenue generation and improved customer loyalty as customers received much improved customer support.

Strategic Pricing & Analysis

Pricing is another source for profit improvement. Because only a few companies are achieving breakthroughs in cost performance, an alternative action to improve profitability is through different pricing strategies. However, pricing is not an arbitrary nor is it a minor task. Too high and customers will leave, too low and profits will suffer. Identifying the optimum price is another tool for profit improvement. MRT has developed pricing models that optimize pricing without sacrificing customer loyalty.

There are a number of scenarios currently used to establish pricing, some of which may contribute to sub-optimized operations while others are limited to market pressures and/or commodity markets.

  • Cost-Plus Pricing   the average unit cost is used as a base to which a “reasonable” markup is added. This method entails circular reasoning as the cost often contributes to sales volume, which in turn, drives fully-costed unit costs (fixed costs within capacity limits are distributed across the volume of production or the delivery of service). However, market pressures may alter the “plus” in cost-plus pricing — quality, features, benefits, competition, market maturity, etc. are all contributing factors to pricing.
  • Target Pricing   often related to target costing, target pricing is typically used to establish prices which the market will bear. This scenario is applicable to those that have little influence to modify market prices (e.g., commodity pricing). Profitability in such instances is managed by controlling costs. Target costing has become a primary tool of Japanese companies used to aggressively gain market share. For example, target costing is used to arrive at a cost which would generate desirable profits at a given, or target, price.
  • Contribution Pricing   contribution pricing is often based upon covering marginal, direct, or variable costs. Any price above the variable costs would contribute to overhead and/or fixed costs. This pricing scenario is often used during the introduction of new products and/or services to gain market share. However, contribution pricing is often abused as variable costs may be substituted for full costs and would lead to disastrous pricing models and long-term losses due to uncovered fixed and/or overhead costs.

Complicating the pricing decision is whether the strategy of the organization is short- or long-term profitability. Attempting to maximize short-term profitability is often accomplished by aggressive pricing strategies that may attract others to enter the field, which may eventually drive down prices in a competitive market. Conversely, a long-term strategy might maximize long-term profitability by accepting more modest short-term profits to limit future competition — such a strategy might be used to garner market share and leadership from which more aggressive value pricing may be established later in the product/service lifecycle at the risk of encouraging competitive encroachment.

Based upon the fixed and variable cost information generated through an AVM® study, the optimum value of the profitability equation can be determined using price/volume behavior. MRT has developed pricing models that optimize pricing and profitability without sacrificing customer loyalty and protecting market share.

CASE STUDY   A service bureau decided to review its pricing strategy. After computing the marginal costs of each of their service lines, a team dedicated to each line was responsible for computing the relationships between price and volume. Using this information, new prices were established that maximized profitability. A total revenue improvement exceeding 10% was achieved without affecting overall customer satisfaction and loyalty. During this exercise, it was found that some unit prices needed to be adjusted downward to gain significant market share which not only increased volume but profitability as well.

Turnaround

Management Resource Technologies offers business turnaround services which includes:

  • Restructuring
  • Re-financing
  • Operations management
  • Vendor negotiations
  • Business plan assessments
  • Strategy implementation

MRT consultants have proven turnaround experience in the following industries:

  • Telecom
  • Tire manufacturing
  • Agriculture - fertilizer - micronutrients
  • Equipment rental
  • Data duplication
  • High-end printing
  • Web developer

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