Making Money Work

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MAKING MONEY WORK – Assign Costs According to the Resources Consumed

Your listening to Money To Wealth with Maxine Kneubuhler on 997 Bridge FM.

“Gut feel’ is anathema [uh–nath–uh-muh] to finance. That is it is something hated. It is far better to make business decisions based on sound analysis.

Cost-benefit analysis is essential in making calculated business decisions.

Accounting information is a historical record of every commercial transaction that the company has entered into for the period under review.

To have information available to make business decisions, all relevant data needs to be processed.  If we are making forecasts about the future there are a lot of assumptions we have to make. We often rely on what has happened in the past because that information is readily available through your accounting software system.

Financial tools help management to make business decisions. Through research and analysis you can determine exactly how much the investment is going to cost in dollars. It is more difficult to determine exactly what the benefits will be: how many customers you are going to acquire (or avoid losing) and exactly how much each customer is worth.

It is however, far better to make business decisions based on sound analysis and have your assumptions documented so that you can learn from your mistakes and/or incorrect assumptions and continually improve your business decision-making process.

Much work has been done on how to forecast the future. The truth is none of us knows; however, there are ways we can better understand how the future is likely to turn out, and so manage our risks better.

Historical information is often the most reliable point of reference – it factual. We discussed historical information in terms of accounting information last week Cash is King, that is positive cash flow is king.

Today I will discuss how to Assign costs according to the resources consumed. I am talking Costs and Efficiency relating to Activity-based costing, it is other management tool that help in making calculated business decisions.

Although costs are easy to determine, the benefits must be based on assumptions about the unknown future. Assumptions should be clearly documented so they may be referred to in the future when analysing the difference between expectations and what actually did happen. Learn from these differences – it will help in making more accurate forecasts in the future. Your with Maxine Kneubuhler Money To Wealth 997 Bridge FM .

Answers – Joe Kong

MAKING MONEY WORK – Assign Costs According to the Resources Consumed

Q

Joe – In the intro I mentioned “Gut feel’ is anathema [uh–nath–uh-muh]  to finance. It is far better to make business decisions based on sound analysis. It is all about Costs and Efficiency – Part of the decision making process is Cost-benefit analysis because it is essential in making calculated business decisions.

Activity-based costing – how do we assign costs according to the resources consumed?

A

• Cost accounting aims to determine a company’s costs of production by measuring direct costs (such as raw materials) and adding an estimate of overhead or fixed costs (such as utilities).

Q

According to a UK Professor at Cranfield School of Management David Myddelton he stated the inherent inaccuracy of this method Cost Accounting often means that companies know far less than they should about their costs?

A.

• What David is trying to explain is that companies may be relatively clear about direct costs, but vague about the overhead costs that should be attributed to specific products.
• The commercial consequence of this is that a business may allocate marketing spending to a product that is not very profitable.
• In the long run, a business that makes wrong decisions like this will struggle to keep up with its rivals.

Q

Let’s discuss why Activity-base accounting helps to make better decisions related to a particular product or service?

A

• Ideally, an accounting system measures every aspect of every transaction and decision related to a particular product or service.
• The most effective way of achieving this is through activity-based costing.
• Whereas traditional accounting systems estimate the overheads (perhaps by assuming that every unit produced at a factory should bear the same share of the total overhead bill), activity-based costing is much more precise.
• It breaks down the overhead costs to find out which activities create which costs.

Q

By employing activity-based costing into a company’s activities what does it achieve?

A

• Activity-based costing allows the organisation to realise that the cost of manufacturing as an example a chocolate product – it is not about [an estimate] $1.20, but exactly $1.55.

Q

This level of accuracy tends to be especially important when considering non-standard products such as a completion of a special order?

A

• If a company was to receive a special unusual large order of merchandise as an example for an event or festival –
• Activity-based costing might show that the costs associated with this special order are higher than they would be for standard products.
• This would help the business to set the right prices for the special event or festival items.

Q

To carry out effective activity-based costing what does a company need to do?

A

• First identify all the direct and indirect activities and resources
• Second determine the costs per indirect activity.
• Third identify the ‘cost drivers’ for each activity.

Q

What is a cost driver?

A.

• A cost driver is a factor that influences or creates costs.
• For example, a bank teller has many activities
  • When measuring the cost driver of an activity such as handling incoming cheques, the bank should work out how long the teller spends on this task alone.
• By dividing these cost by the quantity produced, an accurate unit cost can be obtained.

1. Q.

Companies like Boral Bricks, and Leggo does this very well.

Give an example of what an accurate unit cost can be used to make effective business decisions

A.

• A company can establish break-even points,
• Identify the products with the profit margins that make them worth backing (with possible advertising support), and
• Allow clear comparisons for making sound investment decisions.

Q

The best thing about activity-based costing is that it will predict if you’re going to be in the red … or the black. Even if you loathed maths at school, star gazing your own finances can be quiet fascinating. Because what we have talked about today no longer revolve around how Phil and Kate can divvy up 15 Smarties among three friends, or how the 5 to the power of nothing equals some mysterious amount. No, I can tell you this kind of maths is all about YOUR money, and how little or much you have. No matter how ambitious you are, this conversation has got to rank pretty high on the list of what makes for interesting entertainment. To tie this all together let’s have a quick look at sales?

A.

Let’s not state the obvious and say what a good idea looking at your sales figures each month is – because I am certain you already are. It is always our first go to figure.

• Ask yourself what different types of income you earn, and whether you can split that income into between three and ten different categories.
• For example you may be a builder who earns money from the work you do on new houses, renovations, extensions and landscaping – four income categories.
• A newsagency that doubles as a post office and dry-cleaning agency (three categories)
• As soon as you arrive at some kind of split, modify your bookkeeping to incorporate these different categories.
• You can see, at a glance, which category is the biggest earner and which is the dead weight, as well as how income patterns change from year to year.
• If you sell new and second-hand good and accessories. By splitting up your income to monitor how much money is generated from each source, you will be surprised at the pitiful amount some categories produce.
• Watch the trends for a few months and you will be able to make a decision to keep or axe the second-hand goods, it is a strategy that will work well for everyone.
• The activity-based costing will also be much easier to work with.

Q

Joe, let’s give an overall view of Activity-based accounting

Let’s summarise

Maxine

Whatever kind of business you have, you will have some expenses that directly relate to sales. The idea is that when sales go up, cost of sales goes up and when sales go down, cost of sales goes down.

Think about your business and figure out which expenses are truly cost of sales accounts. Create new cost of sales accounts in your accounts list.

Grab your Profit and Loss reports for the last few months and scan them. Highlight your five highest expenses (usually items such as wages, rent, interest and advertising). Write these expenses down and total them up. My bet is that these five expenses combines probably make up around 75 per cent, or more, of your total outgoings.

Watch your five highest expenses like a hawk for the next few months and have a brainstorming session on ways to reduce them. For example, if wages are skyrocketing, review overtime, penalty rates and how you take advantage of casuals or subcontractors. If interest is a big expense for you, consider ways to reorganise your loans so you pay less.

With Activity-based costing one important thing to ponder over is whether any income or expenses categories are directly related to one another. For example, purchases, commissions and freight usually go up or down in direct proportion to monthly sales, and superannuation goes up and down in tune with wages.

 

A final lesson and a tip: The trick is to tell your spreadsheet about these relationships so that it calculates them for you automatically.

The neat thing about specifying relationships in spreadsheets or your software is that when you change one figure in the spreadsheet, other figures change automatically, too. So, if you raise your sales forecasts, purchases correspondingly go up; if you change wages, superannuation also changes, you can quickly see in real time if you are ahead – in the black or in the red

 

Maxine:

Jump in on the conversation and To get a copy of today’s show notes and answers to these question visit the Money to Wealth with Maxine Kneubuhler Facebook group for 997 Bridge FM.

 

 

END OF SHOW __________________________________________

Next week we will be talking Debt is the worst poverty – leverage and excess risk

THANK YOU FOR YOUR COMPANY YOU HAVE BEEN WITH MAXINE KNEUBUHLER MONEY TO WEALTH ON 997 BRIDGE FM

 

BE UNWAVERING and CONSISENT to get your money to wealth.