How does your accounting measure your business so that you can manage it, secure in the knowledge that all the parts are doing what optimises the whole?
Finance departments are under increasing pressure to deliver value to the business - not by being mere scorekeepers but by being active players on the field of competition.
Too often we have observed that the Finance department's focus is on low leverage activities that focus on cost recoveries and optimisation of local departments at the expense of the overall organisation. A good finance department must provide timely, useful and accurate information in the following key areas, as a necessary condition of profit maximisation for the business as a whole:
- Group profitability
- Evaluation of profit centres
- Investment decisions
- Make/buy decisions
- Product/service profitability
- Pricing decisions
We consider it axiomatic that in order for a company to profit maximise, it must sell the product or service with the highest contribution per unit of its scarce resource.
Despite this well known fact, most companies continue to pursue cost allocation/absorption methods which do not consider scarce resource, and therefore, cannot profit maximise other than by blind chance.
Furthermore, your people understand that the way that they are measured, implies how they must behave. Thus if your management accounting systems measure individual performance, then the behaviour that this produces is more often than not at the expense of the business as a whole.
To overcome these deep systemic issues, Ensemble will help you develop the management accounting system called Constraint Accounting. It encourages behaviour that maximises profitability through helping people make better sense of operational performance and hence superior decisions for the business as a whole.
Constraint Accounting is the application of Theory of Constraints to management accounting. Using the formulation below, anyone from anywhere within the organisation can determine the highest leverage ideas by including in their consideration the impact of their decisions on Return on Investment (ROI) by considering the change in Throughput (T), Operating Expense (OE) and Investment (I).
ROI = T-OE
Where: T = Sales - Variable Costs (Contribution Margin)
OE = Labour + Overhead
I = Investment
Finance departments will benefit the business when using the constraint accounting system by empowering people to make good judgments in the following key areas:
Evaluating profit centres - Understanding what the constraints are within your profit and cost centres allows better decisions to be made in evaluating their performance.
Investment decisions - By having a clear understanding of the organisations scarce resource, the finance department can readily measure the merit of the business case when requests are made for capital expenditure and whether or not the proposed investment will make a difference to the constraint.
Make or buy decisions - In your outsourcing decisions we show you how to increase Througput, control Operating Expense and minimise Investment by looking at the implications for the constraint and not on the often misleading indicators derived from activity based product and service costings.
Product or service profitability - By understanding the constraint of a product/service line, Finance can engage in a rich dialogue with Marketing and Supply to determine which product or service lines should be promoted and which should be discontinued. Constraint Accounting can give you the added advantage of knowing how any given customer demand on your suite of products and services affects your ability to maximise your profit.
Pricing decisions - Constraint accounting allows Finance to provides the business with a pricing model that is linked to operational capability. By understanding the constraint of a product or service line, it can determine the range of prices for any given product that will allow the business to maximise opportunity whilst conserving known profitable use of capacity.
Through the Ensemble approach to Management Accounting, we help you increase revenues, reduce operating costs and minimise risk, making your invested capital work smarter.
Call us on +61 2 9387 3955 to find out more.