A CIMA report on the manufacturing sector from August 2010 highlights a number of current issues facing the sector. One of the issues mentioned is making products cost efficient by designing in cost effectiveness at the design stage – and this includes costs of designing in poor quality, just think of the issues with Toyota cars last year. So how can management accountants help at the crucial design stage. According to the report, a number of ways actually. First, the report states that a significant proportion of product costs (up to 80%) are determined at the design stage. Therefore manufacturers will benefit from the management accountant modelling costs for the prototypes or revisiting costs when testing is complete. Another way
Managing your business costs and revenues is a challenge. To survive, you have to sell enough products/services, and collect money and manage your costs. The latter can be more difficult than you think, particularly when you don’t have good breakdown of costs.
Without careful monitoring of costs, any business can find that costs can spiral out of control quite rapidly. The old saying “keep an eye on the pennies and the pounds look after themselves” is a good starting point. This does not mean you spend hours and hours monitored costs in minute details, but you should be able to get an overview of all costs at any time. One way to do this is to use cost centres in your accounting system.
What is a cost centre?
A cost centre some section/portion/unit of a business for which costs can be identified and someone is accountable for these cost. Normally, a cost centre has a budget which includes all costs traceable to the cost centre. These cost could be anything from wages to telephone to motor expenses, once they can be traced to the cost centre
In a small business there may be only one or two cost centres. Because you will be looking at small numbers of transactions, there is no need to split things up into smaller cost centres as costs can be more readily monitored against budgeted figures. However, for larger businesses, operating as a single cost centre is probably not good enough. It is also not going to be an easy task to monitor whether those responsible for cost control are doing their job effectively. A breakdown of costs down into each cost centre helps control cost of each cost centre and the business as a whole.
Identifying cost centres
Some businesses are easy to split into individual cost centres – for example, a manufacturing company with six factories, a head office and a distribution warehouse could be split into 6 individual cost centres for each factory), a head office cost centre and a separate distribution cost centre. This example portrays what I call high-level cost centres. A business may need to go into more detail to keep a tighter control of costs – for example, each manufacturing plant might make several different products, with several different machines/processes for each product. It would be possible to treat each machine or process as a costs centre in this case. This would allow the business to keep a good eye of how profitable each product process is. Sometimes too, a business might treat support activities like human resources, finance and logistics as cost centres too. There is no end to how detailed cost centres can be [i.e. they can become very low-level], but remember to be a cost centre, it must be possible to trace costs directly and someone is responsible for the costs.
You’ve just started out in business, a first time entrepreneur. Maybe you’ve lost your job or given one up. Whatever the reason, you’re now in business on your own. Your business goals should include making some money. Waiting until the end of a year when dealing with an accountant is too late to see if you’re losing money. You need to plan, or budget from the start to avoid that daunting situation. A budget is simply a plan of revenues and costs for the coming year. It will not be the same as what actually happens, but you can adjust it as actual event happen. So where do you start? Below I outline 7 easy steps to help you. You might find these work quite well in a spreadsheet (MS Office, OpenOffice or even GoogleDocs). To keep it simple, let’s assume all costs are paid as incurred.
Step 1. Decide when the period of the budget. It’s normally a year, and this is broken down by month or quarter.
Step 2. Make a list of all the recurrent costs you know. Things like rent, purchase of goods for resale, wages and so on.Try to work out the costs according to month or quarter, as decided in step 1. Some costs may be higher or lower depending on the time of year e.g. heating or air-conditioning.
Step 3. Think about any one off costs you will have. For example, you might buy some new equipment. Add these costs to those in step 2.
Step 4. Now, think about the income of the business. Try to work out by month or quarter what you hope to sell and at what price.
Step 5. Now you have costs and income, so you have a basic budget by month or quarter. Adding all the number up will give you an annual budget. if you’re just starting out in business, you might find that costs exceed income, which is okay in the short term. At this point, you should be able to see how much profit or loss your business might make.
Step 6. As the months past by, compare your budget to the actual income and costs of the business. You might find that you have to revise the budget, which is always a good idea as it gives a better reflection of actual circumstances.
Step 7. Get on with your business, using the revised budgets as a tool to measure your business performance.
Most businesses of course do not pay for items immediately, but often get a credit period from suppliers or spread payments over a number of months or years. This means that a cash budget might need to be prepared also to complement an income and costs budget. I’ll post something soon on cash budgets.