What is big data? And what does it mean for management accountants?
Image Copyright The Economist
You may have heard the term “big data“, or perhaps not. Here, I’ll try to explain it and pause for a moment to consider what it means for management accounting.
The fact that many businesses capture vast amounts if data is not brand new (see this article from The Economist in 2010), but the focus of collecting and analysing what marketing people call big data is now beginning to come firmly under the radar of management accountants too. Before looking briefly at what big data means, we need to define. First, back to basics. Data is simply facts, numbers, statistics etc. For example, 175,80,40 are just numbers. They are in fact my approximate height, weight and age. This is information, as you now know some facts about something i.e. me. The problem with big data is getting the information value from it.
Here is where a management accountant can help – assuming of course (s)he has some technical proficiency. Here is an extract from an item on CNET back in May of this year (bold is added by me):
Put simply, the analysis that big science brings to the table makes big data relevant. I envision big science combining with big data to create big opportunities in three significant ways: real-time relevant content, data visualization, and predictive analytics.
When I read the above, I immediately thought isn’t this what management accountants have been doing for years now? If you remember the basis definition of what management accounting is, you’ll remember it is about providing decision-relevant information to managers. This includes real-time data, forecasts and predictions and is often aggregated (or visualised). Personally, I believe management accountants, IT people and marketeers (who might be responsible for collecting all this big data) can all work together to make big data work as information. In particular, management accountants are well placed to assist as they know what information drives a business.
What does a management accountant do?
I read this interesting article from CGMA magazine a few months ago. It brings out some of the actual roles of management accountants in business. Personally, I never liked the term “management accountant” at all and have always thought of myself as more of an advisor and information provider. Have a read of the article.
Integrated reporting
Some recent items in the CGMA magazine summarise some of the features and issues with integrated corporate reporting. Integrated corporate reporting means reporting means more than just reporting the traditional financial/economic type reports to shareholders. Instead, an integrated reporting approach considers social, economic and environmental factors. In the longer term, it can be argued that if firms ignore the environment and society, then firm itself may not be sustainable.
Ideally, a business should be able to prepare a single report which shows now only the typically legally required financial reports, but also how its financial performance affects society and the environment. Some global companies are already doing this. For example, PUMA publishes and environmental profit and loss which values its impacts in terms of resource usages (see here). The CGMA has embarked on an integrated reporting pilot programme over the next two years. They asked an investor, accounts preparer and an integrated reporting advocate for their views. They make for some interesting reading – click on the links to read more. One of the key points emerging is not the difficulties faced in preparing the report or getting the information. Instead, trying to introduce more non-financial data without increasing the information loads (mainly legally driven) given to investors is a great challenge.
What is a step fixed cost?
by maccie1, flickr.com
From previous posts, you know what a fixed cost is. There is another type of fixed cost called a step (or stepped) fixed cost.
A step fixed cost takes its name from the fact that the cost can take a “step up” if certain things happen. This usually means a cost increases when the activity of a business exceeds a certain level, and the fixed cost then suddenly increases, but remains fixed at this new higher level.
Here are two examples which may help you to understand.
1) Employer liability insurance costs may remain quite stable until a certain threshold is reached. For example, it may cost €10,000 to have cover for up to 100 staff, but €15,000 if the staff number exceeds 100.
2) Typically, internet hosting costs include a high allowance for data traffic volumes. But if a company exceeds this, they may have to change to the next package up. This typically would give a much greater data traffic allowance, and the cost would increase in a step fashion.
What is a mixed-cost?
A mixed cost is a cost that contains both variable and fixed costs (see my previous two posts for more on these). Utility bills traditionally were a food example of a mixed cost. Take a telephone bill. Traditionally, a phone bill had a fixed cost which you had to pay even if you made no calls – the line rental in other words. Then you paid for each call, and the more calls you made the greater the total cost – in other words the call cost was variable. Nowadays phone bills tend to be fixed costs – all calls, line rental and Internet are bundled together into a flat monthly charge. Electricity and gas bills still tend to have a small fixed cost – the standing charge – which is paid regardless of use.
What is a fixed cost
From Flickr by Medieval Armour
In the previous post, I explained what a variable cost is. Now here, let’s look at fixed costs.
A fixed cost is a cost which does not change with the level of activity of a business. For example, there are some costs that a business will incur even if it is closed – such as buildings insurance. Other fixed costs might include a managers salary or other similar payroll costs which are fixed, taxes or business rates paid to a local authority or rent paid to a landlord. The term overhead is frequently used with reference to fixed costs.
Although the total fixed cost is that, fixed, as the level of activity of a business increases (more goods made or more services provided) the fixed cost per product/service actually falls. Let’s say for example if a business has total fixed costs of £48,000. If the business sells 24,000 units of product, then the fixed cost per product is £2, but if it can manage to sell 48,000 units of product, then the fixed cost per unit is just £1. As more and more units are made, the fixed cost will become negligible on a per product basis. Thus, I think it is easy to see how the level of fixed costs can affect the level of profit – high fixed costs with low volumes might spell trouble.
Are fixed costs fixed forever? No is the simple answer. As a business increases activity, then quite often more fixed costs are incurred e.g. more managers or a bigger premises. So fixed costs are not “fixed” indefinite, but they are fixed within what is called a “relevant range” of activity. A good example of this kind of effect is employer liability insurance – normally the cost is fixed with a range of employees (maybe 1-100) and the cost jumps once this range is exceed (i.e. 101 staff or more).
What is a variable cost
(photo from Flickr.com)In this post and the next few, I’ll explain some basic terms used to understand costs in management accounting.
A variable cost is a cost which change in accordance with the activity of a business. For example, if I order a meal at a restaurant, the food itself is a cost that would not be incurred had I not walked in. As the restaurant fills up, then the food ingredient costs go up. Another variable cost example might be fuel in a car or truck. The more the car or truck is used, the higher the cost.
In a business, variable costs can usually be saved by simply not making any product or delivering a service, but this of course may not always be possible. Typical variable costs are labour and materials associated with a product or service. Such costs would not be incurred if the product or service was not delivered i.e something triggers the incurring of variable costs.Think of the chef in the kitchen of a restaurant – a customer order means food costs increase, or a variable cost has been incurred. You may be thinking of the chef’s wages – I’ll come back to that in the next post.
Balanced scorecards – an airport example
Photo from thisislondon.co.uk
I have written before on balanced scorecards at London’s Heathrow Airport. London Gatwick too has a balance scorecard which has similar performance measures (e.g. security wait time, seat availability, flights on time etc.).
I noticed the monthly performance report at Gatwick was displayed publicly again, on the walk-way to the departure gates – better than a corridor to the gents for sure as at Heathrow. Both the Heathrow and Gatwick scorecards are linked to a scheme operated by the UK Civil Aviation Authority (CAA), and the main objective of these scheme is to reward for meeting targets that improve customer service. If targets are achieved then, extra public funding can be paid to the airport, whereas failure to meet targets results in payments by the airport.
The performance measures in both these scorecards are no doubt related to a strategic objective something like “to improve and maintain customer service” – which I imagine would be quite an important objective to any airport. It seems the targets too are reviewed on a regular basis by the CAA, which means customer performance improvement is at least possible. Have a look at the scorecard web page to see more.
Cleaner transport (and cost savings?)
Back in February this year I wrote a short post about how Tesco were increasing their use of rail travel to reduce CO2 emissions. It was a good example of how to change your business to both deliver cost savings and be more environmentally friendly. In the February 2012 edition of CIMA’s Financial Management (pp 26.30), there is a great article written by Ben Schiller which provides a number of examples of firms which are seeking ways to reduce transport costs and CO2 emissions. One quote from the article sums up the problems around transport costs “many ships operating today were built to run on $150 a tonne bunker fuel, not a price four times that”. Of course, it is not only ships but all forms of transport which are facing these price increases, such as road haulage and even company cars (for example, when I bought my first diesel car just over 3 years ago, diesel was 99 cent per litre at my local station, now it’s over €1.50). As a result of these increasing costs, we can see more sleek looking fuel-efficient trucks for example on our motorways.
I found Ben Schiller’s article really great less for some examples we might know about – chip fat being converted to biodiesel, electric vehicles – but more for some real examples from firms we all probably know well. The first way firms can save on transport costs (and green up) is to bring production closer to the market – L’Oreal for example have brought some of their supply chain in-house, by producing thinks like packaging on-site. A second way, is to change the modes of transport. For example, both Philips and Tesco use canals to transport bulky product. Phillips use barges to transport goods to Rotterdam port, while Tesco ship wine between Liverpool and Manchester. In Spain, SEAT rebuilt a short rail line to Barcelona port, carrying 80,000 cars annually using 2 trains a day. Even large shipping companies like Maersk are doing things like “slow-steaming ” (or sailing slower) to reduce CO2 emissions and fuel costs.
There are more examples in the article itself. You can read an online summary here.
Thinking about labour costs
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.
Facebook price earnings
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, founder of Cooley Distillery talks about his business
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.
Pricing tips for small business
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
The effect of volume on viability – a CVP and investment example
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)
Costs, volume and profits – an example from the taxi sector.
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.
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