I probably don’t need to explain the title of this short post, it’s quite obvious. Any business needs to appreciate all costs of the products or services it delivers.
- In past years, manufacturing has shifted to some degree to lower cost locations such as China, and the Foxconn relationship with Apple is a classic case. In the case of a product like an iPhone or iPad, it’s quite easy to see how the assembly costs are probably the higher component, and as they are small, distribution costs are low. But as a recent article in Forbes shows, transport costs are often a reason for manufacturing being close to market. In the article, there is mention of Foxconn planning to $10 billion plant in the US to build larger displays – for say 60 inch TVs. The article notes that the cost of capital in the US is similar to anywhere else, and labour costs and relatively low, although higher than China. However, the transportation costs would be much lower for such larger displays and thus it makes sense to build a new plant in the US.
Regulation of charities in Ireland is not as good as it could be – we have some legislation waiting to be enacted since 2009 as far as I know. But laws cannot prevent what happens within an organisation from happening; they can only penalise after the event.
So what bugs me? Well, the title of this post really – it is something I picked up from the print media in recent weeks. I am sure I have said somewhere on this blog that accounting is the language of business, so what about accounting for charities? My own opinion is that charities must have proper accounting, and there are accounting standards already in place for charities. But I often wonder should we be careful and not allow charities to become too much like a business? For example, we should be using accounting in charities to drive efficiencies, not necessarily monitor revenue and costs like in a business. Nor should we be using accounting just to get funding for a charity. In short, what I am trying to say is that we need to be careful and try to not let accounting (and other commercial sector notions) detract from what a charity should be.
In recent years many operations – both business and public sector – have been closed or reduced in capacity to save costs. Closing an operation is one of the topics I often teach too. When I teach, the basic message is to focus on the fixed costs, and how much can be reduced or eliminated. Of course, some labour costs are increasingly seen as fixed – and this may be a more certain feature in the public sector.There may also be some hidden or unforeseen costs, which are often not included in the analysis. Let me give you two recent examples, both of which are from the public sector.
In Ireland, the government closed down 139 Garda (police) stations due to economic woes. Most of these closures were in rural areas. The total annual cost saving is estimated at just over €500,000 – see here. This is likely due to the fact that only the only savings were operating costs of the stations e.g. light and heat were the only real costs saved. Police staff and equipment simply moved to another station – where costs may have been incurred to accommodate them. There is a big hidden cost though, which is increased rural crime. While there was probably no money value on this cost in any cost estimates prepared, I’d be quite sure it is higher than closing stations. Recently, the decision to close has been reversed.
A second example comes from Lambeth council in London who closed two libraries – see here . According to a report in the Guardian, the daily security cost is higher than the cost of keeping the libraries open. There seems to have been some protests against the closure of one library in particular, which drove up the costs. This unforeseen cost, if included in the closure decision might have changed things.
To this audience I ask two questions
- do you understand short-term versus long-term? If you do, which applies to your decision-making?
- are there any trained management accountants working in banks? I know there are, so read below if you are one of them.
While driving back from Cork recently, I heard a decent sounding lady with six kids telling a story about how a bank was repossessing the house her family rented – it was the Joe Duffy show on RTE Radio 1. The landlord could not afford the loan repayments it seemed and the bank wanted to sell the house. The family worked, and had sufficient income to pay rent into the future. The husband worked in a state-job, so as secure as you could get. She tried to communicate with the bank, but got a “computer says no” type response from the bank. To me, and I am just a management accountant, not a banking expert I could not see the logic in selling the house. Something instinctively told me taking a longer term view is a better choice.
Based on the information she gave during the radio show, when I reach my home I opened an Excel sheet. I checked the rent the lady might be paying – from daft.ie – and then I started to use the simple PMT function in Excel. I made assumptions that the landlord stopped paying the bank loan based on the original house value in 2010; that the bank would allow the lady to take over the mortgage at the present market value of the house and at the present interest rate. I did not adjust for the time value of money. You can see all my workings at this link:
The total time to do the above calculations was about 20 mins. I admit, Excel is not perfect, and I do not adjust for the time value of money – I don’t think it will make things vastly different. To keep it short, if the bank allowed the lady to take over the house as described above, they would gain to the tune of just under €86,000. Based on my simple calculations, the lady could afford to pay this. So, taking a longer term view, the bank (and by definition it’s shareholders) would benefit compared to ditching the house now.
Some further points on costs. I ignore legal costs, as the bank would have to suffer legal costs on either a sale or re-mortgage. But there is a bigger elephant in the room on costs. The lady would be homeless, someone would have to pay this cost – directly or indirectly, and ultimately the state. If I extrapolate the social costs, what is the family (who seemed decent) became homeless, the family fabric was disturbed and the kids turn to crime in the future. How much would this cost in money terms ?
So back to my questions. The scenario I describe above is being repeat all across Ireland. As a person, and an accountant this annoys me. The view of banks seems to be short-term only, driven by profit only. Now don’t get me wrong, profit is good, it creates jobs and investment. But we must not view profit from a short-term perspective. So, to the bankers, give me an answer to the above questions. If you are a trained management accountant, you should be thinking long-term, and if not, don’t think you cannot fail by taking short-term views. As you know banks have failed, as the leading image here should remind you.
Big data has been the feature of many articles in professional accounting journals such as CIMA’s Financial Management. But what exactly is big data? Originally it referred to more data than information systems could process. But today we have systems capable of processing and analysing millions of transactions in seconds . So what does it mean now? Well, I think the answer to this question will depend a lot on who you ask. To me big data is still data analytics, with maybe some external or social data sources thrown in., with a defined purpose of adding value or saving resources (such as cash or time). This is of course a very broad understanding of what big data is, as value will not mean the same thing to all organisations.
I read an article on Forbes recently which has a similar approach to big data as that I suggest above. The key point the author notes is not to care too much about defining things like big data, but to remember “who cares”. To quote directly from the article “the goal should be to solve a business problem by using new analytics, not to worry about defining a term. That’s because definitions are a distraction from the simple question of “Does this data contain information that is valuable for my business?”
Image from Tesco.ie
A few weeks ago, a news story broke about an accounting scandal at Tesco – see here for example.
So how can this happen? It’s very simple actually. Now, we don’t know if it’s an error or something deliberate, but from an accounting view the entries in the books are the same.
When I was in college 20 years ago, one of our accounting lecturers asked is how would we account for this “hello money” as he called it. Within a decade I was calculating and accounting for what were termed “long term agreements” in my role.
For the likes of Tesco, the amount involved are large and I would guess they account for hello money as a separate income stream – although it’s not shown in the published accounts. Another way would be to reduce purchase cost, but this would probably be for smaller amounts. But how can Tesco make such an error you ask? Simple, just ” over accrue”. This means recording future hello monies now. Of course, I have no idea this is what actually happened, but it does show how easy errors or manipulation can happen by using the good old accruals concept.
As an accountant, when we think of the costs of letting staff go, we probably think redundancy costs and so on. These can be quite substantial. But maybe these short run costs are better than longer term damage costs. I know the example I give here may be less likely to work in Europe for employment law reasons, but I’m just trying to think about costs, not the HR side.
I read recently that Amazon (and others) are offerings employees a cash sum of up to $5000 if they wish to leave. Maybe this is a bit strange, but there may be an argument which suggests such a payment actually saves money longer term – employees who are not engaged with their company are probably less productive. I don’t know if companies like Amazon have done a cost analysis on this, but it seems to make sense.
To give another example, a few tears ago an employer told me that a substantial redundancy payment made to an employee probably was a good deal. The employee in question was creating a poor image with customers, which was starting to effect turnover. Again, maybe no cost analysis was done, but the short term cost of redundancy was compared with unknown longer term effects.
Ok, the title of this post is not really correct. It should be more like “does my milkman and his supplying dairy use activity-based management principles”? First, let me explain that where I live we still have milk delivered to our door twice per week. This is quite common in Ireland and has been happened for as long as I can remember. The only difference nowadays is that deliveries are no longer daily due to refrigeration technology improvements. Second, what is Activity-based Management (ABM)? In a co-authored text book (see burnsetal.com), ABM is defined as “The
use of ABC information to identify operational and strategic improvement possibilities”. We could extend this to say that ABM assumes a business manages itself based on activities (as in Activity-based Costing) rather than functions.
So what has this to do with my milkman? Well, despite its very traditional nature, technology has made its way into milk delivery. A new website (mymilkman.ie) has been set up by several dairies in Ireland to streamline milk delivery. Through the website, I can pay for my milk, change my order, pause my order if I go on holidays and so on. And when I signed up, I got €10 credit on my account.
I asked my milkman what he thought about the site. He told me that even if he gets only 50% of customers to sign-up, he will save 8 hours work per week. Why? Well he does not have to call to the door to collect money for one thing.
So what has this to do with ABM? Well the €10 credit on my account makes me think that someone is thinking that it costs less to manage a customer if online – and I would suggest this is a customer service activity. And if we think about it, how many businesses charge us more if we do things through call centres versus online for example. So there may be many businesses out there using the ideas of ABM – managing activities. But would they all use ABC? I doubt it. For example, the dairy industry probably used some form of process costing. Nevertheless, I think many businesses may use the basic idea of managing activities they perceive as costing more/less in different ways.
Defining lean accounting is a bit odd to me, as I don’t really buy the idea that there is a technique called “lean accounting”. Having said that, there is definitely a concept called lean manufacturing. In a nutshell, lean manufacturing implies three concepts – pull, flow and waste reduction. Pull means product is produced (or pulled) according to customer demand. Flow means product moves through a facility as efficiently as possible and no delays. Both of these should imply waste reduction.
So what does this mean for accounting. Well one thing is inventory reduction. Another may be capital investment to get things working well. Both might put accountants off! But rather than me rattle on, here is a very nice article from Forbes which explains lean accounting and some issues.
As a management accountant, when price is dropped we probably want to be sure that we still make a profit- or at least cover cost. An article I found on inc.com gives some very useful hints to ensure that price promotion is effective in the longer term. Your can read is at this link.
In October of this year, Michelin star chef Derry Clarke had a go at Dublin restaurants selling “cheap meals” – see here. I guess Clarke was thinking from his own view when he said “the number of restaurants offering meal deals at economically non-viable prices just isn’t sustainable, it’s the same cost in McDonalds, but we have all of the overheads”.
He may have a point about the number of restaurants being sustainable, but Derry, stick to the cooking. Any management accountant could figure out that even if meals are sold cheap (and I doubt they are below cost as Clarke suggests), they still make a contribution towards overhead costs. It would be better to have 50 guests in a restaurant earning a contribution of €5 a head (€250 in total) than having an empty restaurant. In the latter case, costs such as labour, heating, rent and so on are still incurred.
In this post, I recount a conversation I had with a great mentor some years ago. It questioned my notion of what costs are relevant and how to set prices once a plant/factory is not at full capacity.
In a factory ( or any business perhaps ) when there is free capacity we can start to look at the make up of costs a little closer. Traditionally, management accounting would suggest we should at least cover all variable costs in the selling price. But think about it like this – if we have spare capacity, then perhaps the only additional cost is the material cost. Let’s assume we have a machine with a full crew, but not at full capacity. The fixed costs of the machine are just that – fixed, and we cannot avoid them. The labour costs are in effect fixed too, as workers will be paid. So, in this case, only the material costs are relevant. And this, any selling price above the material cost contributes to profit.
Yes, there may be many simplistic assumptions in the above. However, it made me think back then and I always give this example to my students. It is of course an example of throughput accounting, which I will mention next week.
The term “hidden cost” is one which we are probably quite familiar – the media like to use if a lot. But what is a hidden cost? Where do these costs hide? Can we avoid them in decision-making? Too many questions to answer in a single post, but let’s start with the term itself.
If you do a google search, you will get many definitions which define hidden costs as a similar concept to opportunity costs. I disagree with such definitions as if you have identified an opportunity cost, then it is not hidden is it? Ok, perhaps I am being a bit unfair here, but to me hidden costs are those which you may not foresee when making a decision. Of course, it’s never possible to foresee all costs when making a decision, but perhaps the hidden costs might emerge if more time is given to the decision – easier said than done in a business scenario.
Take the example of a house purchase decision. This is a big decision in anyone’s life, and we normally take the time to make the right decision on location, size, internal layout, price, amount to borrow and so on. After a few years in the house we might discover we are far from schools or work, or that it is hard to heat the house – these would be hidden costs of our house purchase as we probably did not factor them into our initial decision. There’s a good chance though that we would include such things in a second house purchase decision.
It’s probably fairly obvious that product development costs affect the overall profitability of any product. Some products like drugs and new technology incur huge development costs. New technology, at least at the consumer end, often incurs huge advertising and promotion costs too. And simply, if sales are not sufficient, then losses occur.
As an example, consider a report from the Irish Times on Microsoft’s efforts in the tablet market.
“Microsoft’s Surface tablets have yet to make any profit as sputtering sales have been eclipsed by advertising costs and an accounting charge, according to the software company’s annual report.
The two tablet models, introduced in October and February to challenge Apple’s popular iPad, have so far brought in revenue of $853 million, Microsoft revealed for the first time in its annual report filed with regulators yesterday.
That is less than the $900 million charge Microsoft announced earlier this month to write down the value of unsold Surface RT – the first model – still on its hands.
On top of that, Microsoft said its sales and marketing expenses increased $1.4 billion, or 10 per cent, because of the huge advertising campaigns for Windows 8 and Surface. It also identified Surface as one of the reasons its overall production costs rose.
The Surface is Microsoft’s first foray into making its own computers after years of focusing on software, but its first attempts have not won over consumers. By comparison, Apple sold almost $24 billion worth of iPads over the last three quarters.”
(Above is copyright of Irish Times/Reuters)