Costing Methodologies
September 2nd, 2010
Copyright © 2010 Integrated Profitability TM
There is a continuum of costing methodologies. They range from “None” to frequently updated costing that is integrated with the daily business processes of a company. The continuum goes from “Simplest” to “Most Complex”; from “Least Detail” to “Most Detail”; from “Minimal Insight” to “Strategic & Tactical business-decisioning Insight.”
Here’s one way to view the possibilities:
Do nothing
● Do not spend time on costing work; rather, rely on intrinsic understanding of and familiarity with the business’ revenue, activities, and expenses
● This option works best when the business is simple, monolithic, and small
Use the general ledger reporting
a) As is reporting
● Use general ledger reporting as it comes off the presses: the financial reports automatically calculate net profit
● This option works best when the business consists of one, basically undifferentiated product line
b) With business-relevant normalizations
● Modify the general ledger numbers to remove financial impacts which have nothing to do with normal, ongoing core business activities
Do “Back of the Envelope” analysis
● Spend time dividing the company’s general ledger into the product and services to be costed. Use the 100% Rule to fully allocate all general ledger accounting lines.
● This option is best used when you need a quick, basic understanding of your company’s business by product, service, or other categorizations (e.g., customer segments; service tiers)
● Depending on the needs of the company, Back of the Envelope studies may be:
a) done one time
b) periodically updated
Implement a formal costing methodology
● Invest in one of the formal costing methodologies (see below for further resources) which, while requiring dedicated and skilled resources, also provides the most comprehensive, insightful, and business-decision actionable results.
● Once a costing process is in place, a company is faced with how to maintain the cost numbers. Several inputs to costing continually change:
- New products & services are created; some are retired
- Operational procedures and processing steps change
- Financial numbers change (every month)
- Volume of customer transactions change (every month)
● Here are a few ways a company could proceed:
a) Conduct a one-time costing effort
b) Periodically refresh the cost numbers (i.e., update with current expense dollars and transaction volumes)
c) Periodically re-do the costing (i.e., in addition to the dollar and volume update, re-calculate the detailed components of the costing process, including current products and services)
d) Integrate with ongoing company processes: basically, automating the process and embedding in how the company manages its business
If you are interested in delving more into costing for your company, here are some pertinent websites:
● bnet: The CBS Interactive Business Network
Alternatively, contact me and we can talk about what would make the most sense for your particular business and situation.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 78
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
Cash Flow (Intro)
June 15th, 2009
© Copyright 2009 Integrated Profitability TM
“Cash flow” has been raised as a topic that might be of interest to small businesses. There are excellent textbooks on the different types of cash flow (from 1- ongoing operations, 2- investments and 3- finance activities). Use of an internet search engine is even a faster way to get as much, or as little, information as one wants on cash flow:
● what it is
● how is created
● how it is reported
● how to extract it from a company’s financial statements.
Most of the sources need to delve into the different financial statements that are used to analyze cash flow. One site I found with a lucid, short description of cash flow is at Investopedia®: A Forbes Digital Company.
Unfortunately, if you go much below the surface, there is a lot of accounting conceptual framework and financial statement reading that comes into play to accurately calculate a company’s cash flow; and what that cash flow might mean for the health and long-term sustainability of the company. A key point is that “cash flow” is most important, because it is most hidden, when the company’s accounting is on an accrual basis. For now, the important point here is that the accrual basis of creating financial statements is the best way to align revenue with expense. Accrual accounting is required for most financial reporting because it does give the best alignment of finance flows.
So, how to increase positive cash flow?
In the News: Expense
May 28th, 2009
Of the 45 articles relating somewhat to profit & profitability, six of them have a strong link to expenses. Of the six, four of them involve or are being driven by government actions (or inaction in one case). Well, five, if you include the personal article.
“Waiting for word from Nepal” (April 26, 2009; p. A25) shares the wrenching story of an Alameda family’s odyssey to adopt a Nepalese child. Their journey has been complicated because “…Nepal’s new government hasn’t yet completed developing its adoption laws.” The family has already spent $21,000 and estimates that another $15,000 will be needed. A very personal example of having to spend money before attaining anything worthwhile.
The articles “Firms anxious about new fuel standards” (April 26, 2009; p. A3) and “It’s cost vs. harm in plastic foam ban” (May 2, 2009; p. A3) cover proposed governmental actions that will result in higher costs for certain businesses. In both cases, the push behind the regulation changes are much larger issues: green house gases and the environmental impact of plastic foam containers. Both are examples of conflict between long-term social goals and short-term commercial realities. The better one knows the details of their expenses, the better equipped one will be to anticipate and deal with future events.
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