Within our client base, we see many different applications of our cost management software. Although we see some interesting exceptions, like modeling CO2 emissions or replacing a general ledger journal entry tool, most of the issues our clients face can be divided into three categories:
- Overhead allocation: insights into, and the execution of, transparent allocation of indirect costs.
- Cost prices and cost structures: correct calculation of cost prices and performing profitability analysis on products, clients, and channels.
- Operational and financial management to continuously improve processes, quality, and eventually, financial performance.
Before we describe the common issues that our clients face before they start using cost management software, we would like to stress that although many could see these as an increase in a company’s maturity, that may not always be the case. We have seen situations where implementing and calculating a correct and transparent overhead allocation was very complex. However, we have also seen situations where building an operational management model was relatively easy.
1. Overhead allocation
Most people know the issues with the traditional allocation of the cost of board members, staff departments, indirect costs to direct departments, and eventually products. The issues our clients face go beyond the discussions of finding the appropriate allocation keys or determining the estimated time spent per department. Issues include, but are not limited to:
- Discussion on the role of centralized versus decentralized budgets. Should a direct department have an IT budget to buy products and services from the IT department, or should the IT costs be allocated based upon a generic key? In other words: do you create a buyer-and-supplier relationship within the company where the buyer controls the budget instead of the supplier? And does this hold up for all products and services? The CostPerform TBM models help with answering these questions about IT financial management.
- Many large organizations struggle with the determination of the fiscal implications of setting certain transfer prices between business units or departments. To calculate these implications with multiple scenarios can save millions of dollars.
- Different reporting standards or regulators require different cost allocations with the same data. For example, international insurance companies that have to report according to their local accounting standards (US GAAP, IFRS 17, etcetera) can find it complicated to do so with one set of figures. We try to enable clients to use the same starting point (usually a general ledger and operational data) and represent them using the different standards in a combined and transparent way.
- Fairly complicated overhead allocations are those where reciprocal allocations play a role. Suppose the IT department allocates to the HR department, but the HR department provides services to the IT department. In that case, you could be caught in a loop. Whereas some tools and companies decide to go with an approximate solution, CostPerform will provide a solution for this loop with 100% mathematical accuracy.
2. Cost prices and cost structures
The basic concept of calculating cost prices is to make sure all the costs that reside in the general ledger for a certain period end up in all your products. Usually, this calculation takes place by identifying all resources and activities that are part of creating your product and services. Unfortunately, this concept comes with its own challenges and issues as well. We’ve listed a few of them below.
- Nowadays, costing is a multi-dimensional, rather than a single-dimensional exercise. The cost drivers in a company are not only the products that you sell but also the channels you use (such as the countries you sell in or the client groups you sell to). Consider the following situations:
*Product X is sold through an online shop to a client that comes to pick the product up at the factory.
*Product X is sold through a retail outlet in a foreign country to a client that buys the product through its company account and wants the product to be delivered to their company.
Although both are the same product X, the costs associated with each sale are completely different. The selling price will not differ that much, but the cost price should. Without taking the dimensions (channel, country, client group, etcetera) into consideration, you won’t get an accurate insight into the build-up of your profits. You can read more about this on our Multi-dimensional Costing page.
- Companies and regulators have an increasing demand for the tracking and tracing of the costs within a company. Whether they are the costs for a certain product or any other dimension, transparency is key. At any place in a cost model, one should be able to see what the complete build-up is of those costs. Similarly, one should be able to follow any cost element to check where these costs will land within the model. Read more about this subject on our Cost Transparency page.
3. Operational and financial management
Having cost prices and acting upon them by adjusting your prices and processes accordingly is an excellent step in improving your companies bottom-line. To further enhance the continuous improvement cycle, many of our clients use CostPerform within the financial and operational management cycle. Read the examples below and consider how this would work for your company:
- Variance analysis: where a result in a given period is split down into various consequences. All (cost) results can be characterized as a sum of:
– Volume effects – have I sold and produced more or less than anticipated?
– Price effects – did I pay more or less for my resources?
– Efficiency effects – did I produce according to my anticipated standards?
– Capacity effects – did I manage to scale my capacity to the volume?
– Unknown effects.
Using a driver based cost-model and using the comparison between a budget model and an actual model can help visualize different impacts of changes.
- Scenario analysis: choosing between different improvement projects, checking the effect of different macro-economic outlooks or just checking sensitivity of certain input parameters. Clients have asked us to help in running quick multi-period scenarios to provide insights. Whether it is changing the average wage to see the effect on profit or wanting to load a 40 parameter economic outlook for multiple periods, CostPerform has done it.
For more info on the subject, read this blog about how CostPerform lets you analyze multiple scenarios at the same time.