Martin Quinn's management and financial accounting blog

Paul Downs is a US business owner who writes on the NY Times Small Business blog. Here is a nice post in a series he wrote on “the numbers I track”.  In this post, he focuses on the importance of tracking labour costs. This quote from the post gives a good summary of Paul’s thinking:

“I’m not sure what to think about my labor costs. I have two conflicting theories running through my head. The first: pay people what they deserve. The second: pay people just enough so that they don’t leave. In reality I’m somewhere in between the two. Payroll is our biggest single expense, and it’s easy to let it get out of control and suck up all of the profit in the company”

I’m sure many small businesses experience this same sentiment. Read the full post for more.

I have written before about key financial ratios which can be used to analyse a business. Here is a great current example – the price earnings ratio for Facebook. The post is from a New York Times blog.

John Teeling founded Cooley Distillery in 1987. In January this year, he signed off on a deal to sell the business to global spirits firm Beam (see here)  US firm to buy Cooley Distillery – The Irish Times – Fri, Dec 16, 2011. On January 14th 2012, Dr Teeling gave a very useful radio interview on his life is business. Have a listen to the podcast here (January 14th, 2012). There are a few things of interest. For example he tells the story of why Irish whiskey sales declined from 60% to 2% of the world market in the past. And how in 1960, he was one a few people in Ireland you could do Discounted Cash Flows – something we take for granted nowadays.

I’m a bit lazy today, sorry, so I’m directing you to a nice post on setting prices in small online business:  Top 5   pricing tips for small business

In January 2011, a long-planned €350 million plan to build a 600,000 tonne incinerator near Dublin port finally seen work commence on the build. As you might imagine there have been many protests against the project, which would be privately operated. At the same time, the four Dublin local authorities were also planning a land-fill site north of the city.  However, in January 2012, the Irish Times reported that the land-fill site plan has been scrapped. It seems that the volume of waste now being generated in Dublin does not merit a new land-fill site.  And, indeed the need for the incinerator too is being questioned. It seems that due to a combination of increased recycling and lower economic activity that the volume of waste has decreased dramatically. As a management accountant, I think of this from two angles. First, from a capital investment view, someone had to decided the ultimate size of an incinerator. This would be based on a combination of commercial viability and waste volume I assume. Second, from a cost-volume-profit (CVP) view, I wonder has anyone considered the effects of volume on the “profit” (i.e. viability) of the incinerator. According the to the Irish Times article, the volume of the incinerator should be halved – which I think should mean a full re-examination of the costs and investment involved. Of course, the counter argument is it is better to have spare capacity for cover for future increases in waste generated (e.g. improved economic activity, increasing population)

Back in the late 1980′s and early 1990′s when I was young enough to be frequenting pubs/clubs around Dublin city centre, one of the biggest problems was getting a taxi home. At that time, the number of taxi’s was regulated, with (if my memory serves me right) about 1,200 taxis for a city of about a million people.  The effect of this was a market for taxi licences. Many taxi drivers depended on this for their pensions, with a licence yielding IR£ 60,000- 80,000 (about €75-100,000).  Now, Dublin has a de-regulated taxi system and has more taxi’s than New York (see here for a taxi-eye view). The price structure is also heavily regulated, and a common price structure  applies to all fares throughout Ireland.  And, of course, a taxi licence is nowadays worth very little.

Why and I writing about taxis you might ask? Well, while on holiday near Leipzig (Germany) over the Christmas period, I read an article in a local paper (Doeblener Allgemeine Zeitung, Dec 27, p.7) about how a taxi firm is dealing with rising costs. The taxi sector in Leipzig is de-regulated too as far as I know, and competition is strong.  The article interviewed a manager from a local taxi firm, 4884.  Rising fuel prices seem to be a major problem for the firm – and indeed for Dublin taxis too.  However, as I read on I realised that Dublin and Leipzig taxi firms/owners, while having a lot in common (over/high supply, rising costs, relatively declining static/declining market), the Leipzig firm 4884 seemed to adapt well to become attract and keep customers. For example, in June 2011, 4884 launched an app to order taxis (using GPS). They also (according to the Dec. article) regularly train and annually update their drivers on things like customer service skills – it is  even written into the drivers’ contracts.  In Dublin too, there is at least one taxi app I am aware of (Irish Taxi), but I am not sure it is as advanced in terms of GPS. London too has a GPS service available for ordering a taxi.

So what’s the management accounting point? Well, if we compare the market for taxis now to compared to the past (in most countries, but certainly Ireland), there is a far greater supply (volume). The cost structure is typically beyond the control of all taxis. Most costs are fixed – radio rental, advertising, taxi licence fee, insurance – with fuel being the main variable cost. With more taxis in supply, a static market, fixed prices and little ability to control costs, then the ability to earn a profit is likely to be more difficult now. So what can be done by taxi owners/firms to sustain profit.  Most have joined forces to create firms/co-ops, which can share some costs (e.g. central booking). Other options are to increase customer retention through things like apps and improved customer service.  At the end of the day, with so many costs beyond their control, taxi drivers/firms can only but be adaptive to stay in business. If they are not, they can (and do) go out of business.

Photo (techlabs.com)

Accounting is often criticised, and one of the common criticisms is that too much focus on money in a business causes a short-term focus which may not be good for a business. I would agree to an extend, probably because I am more into management accounting and have seen businesses take bold decisions which eventually paid off. Of course, financial accounting (the external reporting of results basically) is less helpful (or “completely useless” as one business owner told me a few weeks ago) in situations where decisions need to be made. And sometimes, these decisions involve a lot of brave and bold creativity and innovation which accountants seen to have a reputation of pouring cold water on.

I read two articles recently which made me think about  accountants and creativity/innovation. The first one was a few months back on Forbes. The piece by Eric Savitz mentioned how creative type toys (like Lego) can be crucial to later creativity. Here’s a quote from him:

Lego, loosely translated, means “to put together” in Latin. But “to put together” doesn’t fully encompass the value – and purpose – of those buckets of colorful bricks. Legos are about putting together, then taking apart, then reassembling in new ways. That’s why I got so upset recently when a friend told me that she and her daughter had built a pirate ship out of Legos, arranged the pieces until they were just right, and then glued the whole thing together. That, I exclaimed, is not the point.

Legos unleashed my creativity when I was growing up. They drew out the part of me that had to know what things looked like from the inside out, how they worked, how they might work better. The hours I spent with them — sprawled on the floor, building and rebuilding, puzzling and visualizing — became my first lessons in engineering. There was magic in those little bricks.  There still is.

Reading this I wondered how what Savitz be as an accountant.  I think he would have a good chance of being creative, but not in a bad way. I think, like the Lego, he might be throwing away the rule book and creating accounting information which might meet the needs of the organisation he was working. This of course is what good management accountants should do, but do they all? I don’t know, perhaps its partially our fault (i.e. educators) and we need to encourage lateral (but always ethical and proper) thinking about accounting.

The second article I read was in this weeks Time, “What would Steve do?”.  Steve Jobs was an obviously brilliant innovator – and eventually made Apple one of the richest firms in the world. In the article the author (Rana Foroohar) makes a strong claim, but she is probably fairly correct. She states ” Jobs stands out as an exceptional leader not so much because of his in-your-face style, but because American business has become dominated by bean-counters focusing on hyper-efficiency rather than by innovators focused on real growth”. I suppose this is a classic case of too much focus on short-term financial goals over longer-term business development and growth. I don’t have a quick-fix solution for such a problem, but certainly an open mind by accountants towards innovators would help.

As you many know, many scorecard type systems used to report on business performance often use some form of traffic-light system to display whether or not targets have been met (see one of my previous posts). While looking for examples of scorecards, I came across a German blog post, which equated the use of scorecards to Formula 1 (F1) flags – well taking the mick a bit really on the use of ideas such as traffic light type reporting. You can see the original post here, but below is a brief translation. It’s a bit funny, the idea being that the management accountant can be signalled by the security guard on whether or not to drive past the main gate.

Green – all is clear. Drive to the bank and plan to take over the competition.

Blue – a competitor is about to outperform us. The security guard has the phone number of a recruitment agency.

Yellow – not sure if there is real danger. The management accountant has not yet received a recent consultants report. Meet colleagues in the car park first.

Red – the business has been taken over or merged. The accounting department has been centralised. Go home

Red/Yellow stripes – danger of slippage. The board has discovered a good Business Intelligence software suite. Time for a training course

A year or two ago I set a hypothetical assignment for some of my students on a comparison of CO2 emissions on road freight versus rail freight. I based on the assumption that a CO2 charge would have to be paid by firms, and they could in fact save money by using rail freight. Of course the problem with rail freight is that is does not go door-to-door, but it might still be an option for transporting between cities or depots – depending on volume.  At the time when I set the assignment, I did not find many examples (at least in the UK/Ireland), but I came across a Tesco press release in November last. According to the release, Tesco are expanding their use of rail services, which will mean 24,000 tons less CO2 and 72,000 less road journeys. Yes, this is a great thing for the environment, but the management accountant in me really wants to know the cost  savings generated by this.

 If you have studied management accounting, you’ll have heard the term balanced scorecard. A scorecard is a report of key performance indicators – both financial and non-financial – of an organisation.  Many organisations not only use some form of scorecard, but also publish it on their websites or display it in a public place within the organisation.

Take for example London’s Heathrow airport. As you can see on the graphic here, they produce a monthly report (see here) which looks at many areas of performance for each terminal.  Like many firms, they use a colour-coded system, where red usually means a target has not been achieved – for example, seat availability seems to be an issue in Terminal 3 on the example here.

This scorecard is a great example – if you click the link above you’ll see it has much more than I show here. I have only one negative thing to say about it – and this falls from a recent trip through Terminal 1. I discovered this wonderful colourful (and positive) scorecard on my way to the gents – on the corridor into the toilets to be specific. Surely there’s a better place to display results? Or maybe it does not matter as only us management accountants take any notice of such things.

In my former life as a management accountant in industry, I worked in a number of projects which automated either production itself, production planning, or both. A term I was use to at that time was Manufacturing Execution System or MES. So what is an MES and why should management accountants know about them?  Well, an advertisement in the November 2011 edition of Financial Management  (CIMA’s monthly magazine) prompted me to write about it. AN MES is a system which basically communicates from sales through to the actual making of a product or a the start of a process.  An MES may include a sales order module, which would gather customer orders and pass these on to planning modules or directly to process equipment. Typically, an MES will improve a production process as production is scheduled more efficiently and can be monitored for back-logs and jams.  Also, an MES will also typically integrate with an ERP system, which means that a businesses systems are fully integrated. According to the advert in the CIMA magazine, Carlsberg (yes the brewer) improved performance in several areas once it used an MES; sales increased bu 1.5%, gross margins up 1.2%, downtime decreased from 28% to 13%, material loss decreased by 1%. All of these translate into increased profitability, which of course is of interest to managers and management accountants. I would argue that understanding how an MES works in a business is a vital piece of kit for any management accountant, particularly if such performance improvements can be made. If you are interested in reading some more, here are two websites I am familiar with which offer MES systems; Kiwiplan and ATS.

When I teach management accounting to students, I am always looking for examples to relate what I say to a real life example.  So, a while back I was trying to think of an example which might convey the fact that management accountants are not (or should not be)  just bean-counters. The role of a management accountant/business analyst/business partner is much more than just accounting. My experience tells me that a good management accountant (and manager too) get’s their hand dirty i.e. knows a good deal about the business in terms of how things are made/delivered. If you don’t know the business, then how for example can you actually undertake a cost-saving exercise. So now for the example. I read a blog post on The Economist website a while back. The title caught my eye actually “Reducing the barnacle bill”. The article post mentions how barnacles attached to a ships hull below the waterline can increase drag so much that fuel costs increase 40%.  The post then mentions several chemical solutions currently available and some being worked on. The point from this example is that should a management accountant at a shipping company know such detail of operations. I’d like to suggest, yes they should.  Only such detailed knowledge of the operations would highlight the need to control the “barnacle cost”. I’m sure there are many more similar examples out there.

When a business or manager refers to their cost structure, they are talking about the composition of the costs of the business. Typically, costs are either fixed or variable. Fixed costs stay the same regardless of what happens e.g. how much is sold. Variable costs increase or decrease in line with business activity e.g. the more product sold, the higher the purchase or manufacturing costs. It goes without say that a business manager needs to have a full knowledge of how their business responds to changes in output and how the business itself actually operates.  I read a great example of this back in June this year in the Guardian.  The article mentioned how Ryanair had started talks with a Chinese aircraft manufacturer (Commercial Aircraft Corporation of China) in an effort to build a cheaper alternative to its current aircraft, the Boeing 737. What struck me was not the cheaper cost of the aircraft, but attempts by Ryanair to design the aircraft with exactly 200 seats – about 15 more than the Boeing. Why 200 seats? Simple answer actually, anything above 200 seats and one additional crew member is needed.  Keeping the seats at 200 means that each extra seat could yield anaverage profit of about €40 per seat.  Now that’s knowing your cost structure and operations in detail

CIMA’s e-zine (June, 2011) suggests a more responsive corporate reporting system is  need for organisations.  The report by CIMA, PwC and a think-tank called Tomorrow’s Company suggests that an evolving reporting system is necessary to reduce risk within organisations and meet the changing needs to both organisations and society. From from brief reading of the report, a central argument seems to be that the traditional (and incumbent) corporate reporting system is still primarily aimed at the providers of capital. Other elements or reporting have been appended on to this system e.g.  environmental reporting, rather than the full reporting system itself called into question. You may ask why change what is currently there. I’m not sure this is the definite answer, but changes in technology, the business environment and business risk (to mention but a  few) have been arguably more drastic in the past 20 years than the previous 100 years.

The report argues that a new corporate reporting systems needs to have six characteristics, which I summarise below. It argues that if these are incorporated within internal reporting and management processes, the external reporting will likewise improve.

1. Encourage innovation and change.  This should allow a reporting system to respond effectively to shifts in the business environment.
2. Balance judgement and compliance i.e. go beyond compliance reporting solely. What information is needed as a basis for good decisions.
3. Focus more on long-term value, by more integrated management and external reporting.
4. Make reporting accessible, timely and relevant.
5. Give shareholder and investors more information in long term sustainability and value creating capabilities.
6. Ensure some balances and checks are incorporated into the overall reporting system and make someone responsible for this.

In the May 2011 edition of Financial Management (CIMA’s monthly journal), Richard Young writes a very nice summary of how managements accountants can provide good and relevant financial information and feedback to business units. I’ll summarise the main points below:

1. Think strategically – in essence, the key metrics will the ones which support strategy. This may be cost, revenues or a non-financial measure
2. Focus on accountability – limit the feedback to factors which are controllable by managers/business units
3. Be clear – keep it very simple, use  only a few key metrics
4. No surprises – keep the information useful, less detailed and relevant to the manager/business unit
5. Be clear – explain figures to non-finance people, highlight how finance can help managers
6. The big picture – target feedback so that no managers/units get enveloped in too much information. They need to able to see the “big picture”
7. Two-way process – finance can also be the receiver of information. Reports/metrics can be challenged by operational managers
8. Persevere – it may take some time for finance’s metric to be accepted by some managers/business units. But persevere