Martin Quinn's management and financial accounting blog

I remember some meetings in my past life, when I had to justify expenditure on information to my boss – a chartered accountant with not too much in-depth knowledge of IT. This was in the late 1990′s. Of course, technology has moved on dramatically since then, but I’d be fairly sure that any accountants today would still be questioning the costs if IT/IS infrastructure and software.  And today, it is not only the cost of the equipment that needs to be considered, it is the cost of the information held by companies. This is a very difficult thing to cost, but the problems at Sony in recent months gives some idea. In May 2011, the Los Angeles Times wrote about the cost of the first hacker attack on Sony (there was another one in June 2011). The article reports a cost of  $171 million, which is believe it or not is nearly as much as the impact of the Japanese earthquake/tsunami earlier that year on the companies profit ($208m). I’m not sure what the hackers did to break in to Sony’s systems, but I bet it would have cost a lot less than $171 million to make their systems hacker-proof. And I’d also bet the hacker’s would be happy to repair the damage for a lot less than $171 million too!

If you have studied management accounting, you may remember the long-winded formulae to estimate values to put in a linear equation. Well, it’s a lot easier using MS Excel. Take a look at this video I have put together.

Operating leverage refers to relative amount of costs that are fixed and variable in the cost structure of a business. Some companies will have relatively high fixed costs compared to variable costs and are said to have a high operating leverage. For example, pharmaceutical companies incur up to $1billon to develop new drugs over a 10 to15 period[1], whereas the manufacture cost pennies – just think of the price of a pack of paracetemol in your local pharmacy. Low operating leverage means variable costs are a relatively high proportion of total costs. Retailers like Tesco or Sainsbury have relatively low fixed costs and relatively high variable costs – the variable cost of each item sold (e.g. the purchase price) is likely to be much higher than the associated fixed cost for that item. The degree of operating leverage of a company can be used to assess its risk profile. Companies with high operating leverage are more vulnerable to decreasing sales e.g. sharp economic and business cycle swings. Companies with a high level of costs tied up in machinery, plants and equipment cannot easily cut costs to adjust to a change in demand. So, if there is a downturn in the economy revenues and profits can plummet. On the other hand, companies with lower operating leverage can adapt their cost structure more rapidly as it has more variable costs.

[1] http://www.washingtontimes.com/news/2009/mar/13/blocking-drug-development/ accessed  Dec 4^th, 2009

One of the first few things that I would typically teach students that are new to accounting is that all most organisations need to control what they do in some way.  Control can be of a financial nature, i.e. preparing financial statements, and this is something we typically associate with “for-profit” organisations.

However, many not-for-profit organisations also need to keep accounting records and have intricate financial/accounting based control systems. For example, a charity might like to know its sources of funding and keep a detailed trace on all expenditures. Similarly, any sovereign  state needs to keep track of its income (usually taxes) and its outgoings e.g. expenditure on schools, roads and social welfare. A few months ago, a number of articles on the annual financial report of the Vatican State caught my eye (see here and here). In brief,  the Vatican State had a surplus of about €10 million for 2010. The Vatican is a peculiar organisation in that it is somewhere between a Church and a State.  I can’t find the annual report on-line, but  as far as know one main source of income for the Vatican is the traditional “Peter’s Pence” collection held annually at all catholic churches across the world. The press releases surrounding the 2010 Vatican financial report seems to suggest that deliberate efforts were made compared to previous years to control costs and keep within budget. So, even the Vatican has a use for accounting information – both financial statements of some kind, and management accounting. By the way, if you do find the annual reports of the Vatican on-line, do get in touch

Okay, so I have no much interest in football, but this recent piece in The Economist makes for great reading if you’re into the footie – or like me trying to paint peformance management issues in a lighter way!  You can read the articles for yourself, but the basic theme is that while both banks and football clubs pay high salaries to retain/attract the best talent, the question is does this make economic sense. Arguably, the more successful banks and football clubs get to keep more of their revenues as they make more money by having the best traders/players.  So it seems to make sense that pay and performance are linked in banks and football clubs.  However, if bankers/players pay is capped, they can move elsewhere, which may have an effect on the performance of the bank/club they leave.  So, according to the article, unless a cartel scenario exists in banks it is unlikely that any cap on pay  will be useful in an economic sense. It may be what politicians want, but it’s unlikely to make economic sense.

I was in Germany a few months ago and seen a copy of Handelsblatt  (a leading business newspaper) on July 20th last at a hotel bar. As you do, I scanned it while ordering a local beer (Moritz Fiege Pils). I noticed that the German Green Party wanted to ban F1 from the Nurburgring and Hockenheim. I read the article and it made me laugh to be honest. The reasoning was that the F1 circus is bad on CO2 emissions and all that stuff. Now a few facts first – I love motor sport, I am a management accountant, I like the old ways of doing things (now called environmentally friendly/recycling/grow-your-own) and I could not resist the picture of the F1 girls for this post.

But, being serious. Research and development expenditure is one of those things a management accountants might find hard to deal with. It’s normally a substantial cost, but the return is often uncertain. Now back to F1 and the German Greens.  Motor manufacturers like Mercedes, Honda and Renault (among others) have over time spend $billions on F1. And what do they get out of it? Well, every car nowadays has an EMU (Engine Management Unit) or “brain” that controls and monitors every thing a car does – do you know most cars have no accelerator cables at all; it’s a sensor on the pedal which the EMU monitors and the pedal is tensioned to give the feeling of a traditional pedal. Where was this technology perfected? F1 of course. And nowadays, F1 cars are lighter, faster, more fuel-efficient and even capture energy under braking (the KERS system). Surely this will pass on eventually to normal road cars, which will mean lower fuel consumption and lower CO2 emissions and so on. So, to bring it all back to management accounting. If we were to do as the German Green Party suggests, there would be no F1 in Germany (home of Mercedes), which might mean less research and development expenditure in F1, which in turn might halt the development of  more fuel and energy-efficient road cars for you and I.  Okay, it might be hard to put a money value on the benefits of F1 research and development in the long run, but it seems daft to try to ban it. So far, the history of F1 has shown us what the cars of tomorrow will have on board.  If that means efficient, energy harnessing cars for the future, we need to encourage it. The costs (monetary and environmentally) may be easier to ascertain and outweigh the benefits in the short-term. However, I can only see future benefits from F1 for car manufacturers who should be able to produce (in time), better, safer and more environmentally friendly cars for Joe Bloggs.  Kind of goes against what I thought any Green Party stands for to go against such progress. But, hey I am no politician! But it seems a classic case (from the Green’s view) of not looking at all costs and benefits of an activity over the long term.

Bromwich & Bhimani wrote a interesting short book in 2010 called “Management Accounting – retrospect and prospect” (see cimapublishing.com). In the book, they give a number of examples from modern business that makes us think about management accounting techniques. For example, what exactly does a company like Facebook or LinkedIn actually do? Do they offer products, services or what?  Changing technologies, business markets and new ways of making/delivering products often causes changes to management accounting. For example recently I read that amazon.com now sells more e-books than paper books. Taking this e-book example, it is easy to visualise a shift in product costs. Arguably, an e-book has almost no variable costs. Instead the vast majority of costs are probably fixed – costs of running a data centre for example. This new way of doing business changes the information management accountants need and how that same information is collated and analysed. I have no idea what publishers or distributors like amazon.com do in their management accounting functions, but it is not too hard to think about how basic techniques like breakeven (CVP) analysis would change due to the changing cost structure.

 With some commodity prices on the rise, and continued economic woes, some businesses are holding retail prices and reducing margins. Associated British Foods, which includes the low price high-street retailer in Primark (UK/Ireland and some European countries) is an example.  In late April 2011, the company reported it wished to absorb material price increases rather than pass them on to end-consumers. Increasing sugar and cotton prices reduce the company’s margins. However the CEO reported that the company did not want to relent it’s status as a low price retailer in the clothing sector.

According to an article in Time (April 18, 2011), a lot of money can be saved by retro-fitting old buildings. I have written a few posts already about this, but this article gives some really good examples of the kind of money that can be saved from some relatively simple initiatives. According to the article, older skyscrapers are one of the worst type of buildings in terms of energy efficiency. Some investment in lighting, heating and insulation can make a huge difference to costs and energy efficiency. For example, the Empire State building spent $13m in 2010 on a retrofit. The result is a 38% decrease in utility bills and a payback period of less than three years. Another example is a re-fit of a federal building in Cleveland, which saves $600,000 per annum. The city of Melbourne, Australia is also mentioned. The city’s Lord Mayor sums up well – “this is not some feel-good environmental initiative. It is a hard-headed economic business decision.

Many young Irish people (and other nations too of course) are making their way to Australia to seek employment and/or better their career prospects. The Australian economy seems to be booming based in its natural resources and its closeness to the Chinese markets – who consume huge quantities of these resources.  This boom may be affected somewhat by the imposition of a carbon tax from 2012 on all firms emitting more than 25,000 tons of CO2 per annum. This will increase the output costs, which may affect consumer spending. To balance the affect, the Australian Prime Minister has promised some tax reductions.  Read the full story here

(Image from Economist.com)

A few weeks ago I was listening to the radio in the car. A news item  came on about why Ireland is attractive to companies like Google and Microsoft to set up data centres. It wasn’t tax, or our educated workforce.  Much to my surprise it was the Irish weather. Well, I suppose all three are important, but with an ambient average temperature well below 20 celsius, the cost of cooling the data centres falls considerably. Here’s a post I read earlier from Babbages’ blog on The Economist. It gives some great detail on the costs of running these data centres Data centres: Social desert | The Economist. I have to say, as a management  accountant weather conditions would not be the first thing I’d consider in cost decisions – a good reason to talk to other people in the organisation to find out what’s going on.

As a management accountant, I’m always interested in what products cost to make. In today’s global manufacturing economy, it’s even more interesting as product components are sources from all over the world.  Time [May 16, 2011] provides a great example, the iPhone. According to the article, the total cost of the iPhone 5 is $179. Of this amount, $61 goes to Japanese suppliers, $11 to US  suppliers, $30 to Germany, $23 to South Korea, $7 to China [where the phone is assembled], and $48 goes to other unknown sources. Given that the selling price is around $500, this means that the loins share of the added value in an iPhone about, or $321, stays within the US company. I have to say I was surprised that China contributed so little to the final value.

Following the earth quake and tsunami in Japan earlier this year, car manufacturers faced many problems. One I have wrote about previously, namely the fact that supplies of components dried-up after the disaster due to the close-knit just-in-time management systems used. The Economist provided another example from Honda recently. Honda launched their new Civic model in April/May this year. The problem of course was whether or not the company could actually deliver enough cars to meet demand, due to production disruption and supplier problems. Other car manufacturers, particularly US ones, would of course benefit.  However, for Honda the short term seems still slightly troublesome

Following the earth quake and tsunami in Japan earlier this year, car manufacturers faced many problems. One I have wrote about previously, namely the fact that supplies of components dried-up after the disaster due to the close-knit just-in-time management systems used. The Economist provided another example from Honda recently. Honda launched their new Civic model in April/May this year. The problem of course was whether or not the company could actually deliver enough cars to meet demand, due to production disruption and supplier problems. Other car manufacturers, particularly US ones, would of course benefit. However, for Honda the short term seems still slightly troublesome

Setting a price for a small business can be a challenge.  Cut the price too much and you loose money. Raise the price and you loose business. An article in the New York Times recounts the experience of some US small business. The basic message is that price is not everything. One  business owner recounts how the quality customers gained outstrips those lost due to a perceived high price. Here’s one story

“About three years ago a computer error caused all of the prices on Headsets.com to be displayed at cost rather than retail. With the lower prices on display for a weekend, Mike Faith, the chief executive, expected sales to soar. Instead, the increase was marginal. “It was a big lesson for us,” Mr. Faith said.”

The basic lesson from this experience is that customers don’t think price is the be all and end all.  The experience of a gluten free flour business showed that competitors prices may not  matter as much as one thinks too. The company managed to raise its price by 20% in the first year in business by convincing customers that the product had more added value than competing flour. The most important lesson mentioned is that costs must be covered in the price charged.  Seem so obvious, but I have written several pieces on this blog about breaking even.