Advanced Management Accounting & CPA - University of Birmingham PDF

Advanced Management Accounting Customer Profitability Analysis Dr Mohamed Fadzly Accounting & strategy (recap)  The emergence of modern business enterprises (MBEs) in mid 19th century US:  New structure + New process  Managed ‘via’ accounting where managers & employees are held accountable...

Advanced Management Accounting Customer Profitability Analysis Dr Mohamed Fadzly Accounting & strategy (recap)  The emergence of modern business enterprises (MBEs) in mid 19th century US:  New structure + New process  Managed ‘via’ accounting where managers & employees are held accountable through:  Grammatocentrism + Calculability principles  Accounting calculation and accountability relations as a central element to modern business strategy:  So natural that they are often”invisible”  “Genetic symbiosis” (Hoskin et al 2006; p.169) 2 What to look for in N&B (2012)  Critical evaluation of SMA literature/practice vs. ‘Strategic Management’ and other related areas:  SMA has not “stood the test of time”  “A worrying lack of knowledge”  “The paradox of SMA”  Multiple perspectives on strategy in a rapidly changing world – classical vs. others:  Not fully embraced in SMA literature  3 Various ‘strategic’ uses of accounting information in practice – not necessarily branded as SMA or done by accountants. 4 The ‘paradox’ Most useful it is when least needed! Hoskin et al. (2006; 186-7) – temporal & spatial paradoxes: “… strategy will (like accounting – e.g. Yamey 1964) be most successful where the future is like the past… but that is when it is most unnecessary; meanwhile, it will be most necessary when the future is different from the past, which is when it will be most useless.” “… {strategy} will always be… most apt at dealing with the space in here’; and it is therefore not surprising that strategy as practice (military or business) devotes most of its real time effort to controlling that space… However, strategic success actually needs control of the ‘space out there’, where the enemy and/or competition lies… but that is where strategy proves so easily disproven and overturned, whether by counterstrategy or simply by events.” 4 How to ‘read’ the articles?  First reading ‘before’ class (if possible):  Abstract + Intro + Conclusion only?  Second reading in class – read with a purpose:  In what way was the article mentioned during lectures?  Group reading tasks will guide you on what to focus on  Annotate as you go   5 Discuss and complete group tasks Third reading if needed – things should make more sense by then! Learning objectives    6 Discuss the use of ABC for customer-focussed accounting Undertake and interpret the results of customer profitability analysis (CPA) Evaluate the use of CPA for strategic decisions 7 SMA techniques (Pitcher, 2015: p10) Competitive position monitoring Strategic pricing Competitor performance appraisal Capital budgeting Competitor cost assessment Benchmarking Brand value budgeting & monitoring Integrated performance measurement (e.g., BSC) Strategic cost management Customer profitability analysis Quality costing Attribute costing Target costing Life-cycle costing Value-chain costing 7 Recap on ABC    8 Costing systems help companies determine the cost of a product related to the revenue it generates. Two common costing systems are: traditional costing and activity-based costing (ABC). Traditional costing assigns manufacturing overhead based on the volume of a cost driver, such as the amount of direct labour hours needed to produce an item. Activity-based Costing (ABC)  Traces costs to activities:  refine costing systems by focusing on individual activities as the fundamental cost object  Useful for products costing where:  Production overheads are high in relation to direct costs  There is great diversity of product range  Products use different amounts of overhead resources  Consumption of overhead resources is NOT primarily driven by volume 9 ABC steps 10 Illustration 11 ABC helps in terms of:   12 Accurate costing Thinking about activities – i.e., the “value chain” Illustration Kraft corporation is considering the use of activity-based costing. The following information is provided for the production of two products lines: Activity Setup Machine maintenance Direct labour hours Number of setups Number of machine hours Cost £107,000 £50,000 £157,000 Product A 7,000 30 1,200 Cost Driver Number of setups Machine hours Product B 3,000 70 3,800 Total 10,000 100 5,000 Kraft plans to produce 350 units of product A and 225 units of product B. Compute the ABC indirect manufacturing cost per unit of each product. 13 Solution Step 1: Calculate the allocation rate for each activity Setups Machine maintenance £107,000/100 setups = £1,070/setup £ 50,000/5000MH = £10/MH Step 2: Allocation of cost Setups Machine maintenance 14 Product A £1,070 x 30 =£32100 £10 x 1,200 = £12000 £44,100 / 350 = £126 per unit Product B £1,070 x 70 = 74900 £10 x 3,800 = 38000 £112900 / 225 = £501 per unit Customer profitability analysis (CPA) “Analysis of the revenue streams and service costs associated with specific customers or customer groups.” CIMA official terminology   Extends the use of ABC to determine the costs (vs. revenue) attributable to a customer segment. Strategic implications:  Know our profitable vs. non-profitable segments – hence the appropriate strategy to use;  Potentially inform inter-organisational discussions – between the organization and its customers. 15 The ‘Whale’ Curve 16 In many cases the top 20% = >100% of profit Pfeifer, Phillip E., Mark E. Haskins, and Robert M. Conroy. “Customer Lifetime Value, Customer Profitability, and the Treatment of Acquisition Spending.” Journal of Managerial Issues 17, no. 1 (2005): 11–25. – Page 16. 16 Shapiro, B. P., Rangan, V. K., Moriarty, R. T., & Ross, E. B. (1987). Manage customers for profits (not just sales). Harvard Business Review, 65(5), 101-108. 17 Product is crucial; good supplier match Costly to serve but pays top price Price sensitive; care little for service and quality Leverage their buying power Customer Profitability Matrix 18 Product and Customer contribution Traditional costing Activity Based costing Direct materials Direct materials Direct labour Direct labour Gross margin Product related Overhead Customer related Overhead Overheads Facility Sustaining Overhead Full cost PROFIT 19 PROFIT Gross margin Product contribution Customer contribution Full ABC Cost Illustration  A chocolate manufacturer has three types of customer:  multiples (Tesco, etc.)  wholesalers (cash & carry)  corner shops (newsagents etc).  Costs associated with supplying each type of outlet are provided. Recommend a strategy for profit improvement. 20 Customer Profitability Customer Discounts Ordering Delivery Bad Debts Multiples Wholesaler Corner Shop Very high High Low Large Bulk Electronic Regional warehouse Nil Bulk Electronic Store/ depot Minimal Weekly visits Shop High Recommendation  Conclusion  Multiples: high volume, low margin  Wholesaler (cash & carry) : most profitable  Corner Shops : least profitable Strategy = stop selling to corner shops and get them to buy from wholesalers? What other strategy can you suggest here? 22 The Cola Bottling Company uses customer profitability analysis and the information for two of its customers shows the following: Bottles sold List price per bottle Actual price No of purchase orders No of sales visits No of deliveries No of emergency orders Km per delivery L 70,000 0.60 0.55 15 4 20 2 20 M 60,000 0.60 0.60 10 3 15 0 6 From the company’s ABC system, the following rates are established: Processing purchase orders Sales visits Delivery Product handling Delivery costs of emergency orders £100 per order £80 per visit £2 per km £0.02 per bottle £300 per order The production cost of a bottle of cola is £0.50. a) b) 23 Prepare a Customer Profitability Analysis for each of the two customers Discuss your findings. Revenue at list price Discount Net revenue Less: Cost of goods sold Less: Operating costs Order taking Sales visits Delivery vehicles Product handling Emergency costs Operating profit 24 L 42,000 3,500 38,500 35,000 M 36,000 0 36,000 30,000 1,500 320 800 1,400 600 (1,120) 1,000 240 180 1,200 0 3,380 Cola Bottling The numbers suggest that we should stop selling to L, right?  Or should we be asking more questions before deciding, e.g.,  Is L a new customer?  Does L buy other products from us?  Where does L fit within our strategy?  Could we engage with L to build a strong & profitable relationship?  Problems with L seem to relate to no. of orders, delivery costs & emergency orders:  Need to reduce numbers of orders  Needs to reschedule deliveries  Could threaten L with loss of discount – penalty for emergency orders 25 CPA: Advantages     26 Improved profitability by eliminating non-profitable customers and maximising sales or services to profitable customers. An understanding of the true costs of each customer segment, including taking into account non-production costs when determining profitability. Provides a method of identifying customer groups who are of lifetime value to the company, and who are worth retaining or protecting. Improved strategic decision making by providing useful information for customer related decisions, including pricing, discounting and marketing decisions. CPA: Disadvantages     27 Companies may not have the data capture systems to produce an accurate estimation of customer segmental revenues and costs. Practical difficulties in calculating costs attributable to each segment. Implementing ABC is often challenging for many companies. CPA may overlook the combinations of products or services purchased by customers. Annual profitability may not be representative of lifetime value. Customer lifetime value (CLV)  Considers profitability of the customer over their lifetime.  Recognises that the annual profitability of a customer group will vary from year to year  Judgements to be made on:  the duration of the company’s relationship with the customer;  likelihood, frequency and amount of expected purchases over the lifetime of the customer.  28 Present value of future income streams are then calculated using suitable discount rate. Summary   29 CPA extends the strategic application of ABC to enable customer-focused accounting. CPA facilitates identification of most and least profitable customer segments – to inform appropriate strategy formulation for improved profitability. References 30  Bhimani, Alnoor, et al. (2018). Management and Cost Accounting 7th edition. Harlow: Pearson – Ch. 12  CIMA (2009). Customer profitability analysis. Topic Gateway Series No. 55. Available from: https://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_cu stomer_profitability_analysis_jan09.pdf.pdf  Anderson, J. C., Narus, J. A., & Van Rossum, W. (2006). Customer value propositions in business markets. Harvard Business Review, 84(3), 90.