As a manager, have you ever questioned the validity of the information you receive regarding the costs and profitability of your products and services? Find out how to improve the quality of the information provided by your company’s management control systems and increase the success of your business.
Author: Maria João Major | Reading time: 3 minutes
Receiving inaccurate information occurs more frequently than one might have previously anticipated, which usually leads to poor decision making by those in charge of the marketing mix.
With that said, would you like to increase the entrepreneurial spirit of your management team, while improving the financial performance of your business?
In this short article, I give you four tips to enhance the quality of the information provided by your company’s management control systems and to make your business more successful.
Replace the traditional systems of indirect cost partition for systems based on a “cause and effect” logic
Throughout the last two decades, organizations’ surrounding environment suffered significant changes. This drove indirect costs (those that are common across the various products and services) to represent an increasingly significant share of the cost structure. Parallel to this (in many cases exponential) increase of indirect costs, there is also a noticeable change in their behaviour: the volume of production and sales is no longer due to indirect costs, but due to the complexity of the activities taking place in order to obtain the products and services.
In this context, it becomes crucial to distribute indirect costs based on a partitioning criterion that can measure the degree of complexity of our products and services, appealing to a “cause and effect” logic. Adopting these Activity-Based Costing systems is the best way to assure that indirect costs are properly allocated to the different products and services.
Attribute the costs of financial assets and liabilities to their respective products and services
The costs of products and services are not limited to their direct and indirect costs. They should also bear the corresponding costs of financial decisions from investments in economic assets (clients, inventory, suppliers and tangible fixed assets). Decisions related to the negotiation of average collection and payment periods, the levels of inventory and tangible fixed assets… all involve resources that have to be financed. Frequently these costs are ignored when the products profitability is ascertained and the costs established. Thus, creating a loss for the selling companies and distorted information.
Structuring the company into responsibility centers and identify performance evaluation criterion
Responsibility centers are decentralized units that are responsible for the prosecution of objectives in their respective areas. Creating them means creating a relevant instrument to assure managers are motivated to accomplish the global and strategic objectives of the company. For these responsibility centers to work properly, managers need both to have their objectives established and decision power regarding their means (that can be translated into costs, gains, assets and liabilities) to achieve the proposed objectives.
The managers’ performance must be assessed periodically. With that said, it is crucial that the established evaluation criteria accurately reflect the type of responsibility centers that were created.
Valuation of the services provided between areas of the company based on the internal transfer prices
Lastly, one should consider every transaction of goods and services between the existing responsibility centres, through the definition of internal transfer prices (ITPs). The ITPs are one of the most efficient mechanisms to enhance a company’s internal efficiency, for which it is essential to use market prices.
When properly established, these ITPs induce managers to make decisions that are better aligned with the strategy and contribute to financial improvement.