Cost Management

learning objectives cost/volume/profit (CVP) relationships and break-even analysis break-even chart – low fixed costs, high variable costs break-even chart – high fixed costs, low variable costs contribution break-even chart profit volume (PV) chart Session Summary (1)

CVP and break-even analysis limitations of CVP and break-even analysis multiple product break-even analysis estimated UK labour costs % of manufacturing costs activity based costing (ABC) framework of activity based costing (ABC) throughput accounting (TA) Session Summary (2)

throughput report life cycle costing target costing benchmarking kaizen cost of quality (COQ) non financial indicators balanced scorecard Session Summary (3)

explain cost/volume/profit (CVP) relationships and break-even analysis identify the limitations of CVP analysis outline the more recently developed techniques of activity based costing (ABC), and throughput accounting (TA) identify the conditions appropriate to the use of life cycle costing Learning Objectives (1)

apply the principles of target costing consider benchmarking as a technique to identify best practice and enable the introduction of appropriate performance improvement targets outline kaizen as technique for continuous improvement of all aspects of business performance explain the types of information and measurements used in lean accounting Learning Objectives (2)

use cost of quality (COQ) to identify areas for improvement and cost reduction within each of the processes throughout the business appreciate the importance of, and consider the use of both financial and non-financial indicators in the evaluation of business performance consider the use of both financial and non-financial measures incorporated into performance measurement systems such as the balanced scorecard Learning Objectives (3)

Economist’s Cost and Revenue Curves

Cost/volume/profit (CVP) analysis may be used to determine the break-even position of a business to provide sensitivity analyses on the impact on the business of changes to any of the variables used to calculate break-even the break-even point is the level of activity at which there is neither profit nor loss Cost/Volume/Profit (CVP) Relationships and Break-Even Analysis (1)

There are three fundamental cost/revenue relationships that form the basis of CVP analysis total costs = variable costs + fixed costs contribution = total revenue - variable costs profit (or operating income) = total revenue - total costs the slopes of the total cost lines in the following two charts represent the unit variable costs Cost/Volume/Profit (CVP) Relationships and Break-Even Analysis (2)

Break-Even Chart – Low Fixed Costs, High Variable Costs

Break-Even Chart – High Fixed Costs, Low Variable Costs

Contribution Break-Even Chart

Profit Volume (PV) Chart

profit = contribution – fixed costs and at the break-even point profit is zero and so profit = contribution – fixed costs = zero or contribution = fixed costs it follows therefore that the number of units at the break-even point x contribution per unit = fixed costs or number of units at break-even = fixed costs contribution per unit The Break-Even Point (1)

The number of units at the break-even point x selling price per unit is the break-even £ sales value, so £ sales value at break-even point = fixed costs x selling price per unit contribution per unit selling price per unit = total sales revenue contribution per unit total contribution which is the reciprocal of the contribution to sales ratio %, so £ sales value at break-even point = fixed costs contribution to sales ratio % The Break-Even Point (2)

the term ‘margin of safety’ is used to define the difference between the break-even point and an anticipated or existing level of activity above that point the margin of safety measures the extent to which anticipated or existing activity can fall before a profitable operation turns into a loss-making one The Break-Even Point (3)

the many limitations to CVP analysis are related to the assumptions on which it is based to consider break-even, decision-making, or sales pricing the main assumptions are: output is the only factor affecting costs cost and revenue behaviour is linear there is a single product costs are easily split into variable and fixed, which are constant within a given range Limitations of CVP Analysis

where a business offers a range of products or services, the weighted average contribution may be used to calculate the selling prices required to achieve targeted profit levels, and revised break-even volumes and sales values resulting from changes to variable costs and fixed costs Multiple Product Break- Even Analysis

Estimated UK Labour Costs % of Manufacturing Costs Estimated UK Labour Costs % of Manufacturing Costs

the more recently-developed techniques of activity based costing (ABC) and throughput accounting (TA) are approaches that attempt to overcome the problem of allocation and apportionment of overheads Activity Based Costing (ABC)

Framework of Activity Based Costing (ABC)

Unit Costs for the Rouge and the Rose

TA is similar to the approach of contribution per unit of scarce resource, but whereas contribution = sales revenue - total variable costs throughput is defined as throughput = sales revenue - direct materials cost Throughput Accounting (TA)

Throughput Report

life cycle costing uses maintenance of cost records over entire asset lives so that decisions regarding acquisition or disposal may be made in a way that optimises asset usage at the lowest cost to the business Life Cycle Costing

a target cost is a product cost estimate that may be less than the planned initial product cost the target cost will be expected to be achieved by the time the product reaches the mature production stage through continuous improvement, and replacement of technologies and processes Target Costing (1)

a target cost is derived by subtracting a desired profit margin from a competitive market price, determined through customer analysis market research Target Costing (2)

benchmarking processes of the best performing organisations within the industry, or within any other industry, can identify best practice, the adoption of which may improve performance Benchmarking

kaizen, an “umbrella” concept covering most of the “uniquely Japanese” practices, is a technique used for continuous improvement of all aspects of business performance Kaizen

Lean Accounting lean accounting provides the relevant information and measurements to support an organisation’s use of less resources to provide more output and in greater variety, and to encourage lean thinking throughout the organisation lean accounting includes the use of target costing and value stream cost analysis the strategic emphasis of lean accounting is on performance measurement that focuses on the elimination of waste and creation of capacity

cost of quality (COQ) is used to identify areas for improvement and cost reduction within each of the processes throughout the business Cost of Quality (COQ)

The Traditional View of Quality Costs

The Total Quality View of Quality Costs

quality % of repeat orders customer waiting time number of on time deliveries % customer satisfaction index number of cut orders Non-Financial Performance Indicators (1)

manufacturing performance % waste number of rejects set up times output per employee material yield % adherence to production schedules % of rework manufacturing lead times Non-Financial Performance Indicators (2)

purchasing/ logistics number of suppliers number of days stock held purchase price index Non-Financial Performance Indicators (3)

customer development number of new accounts number of new orders % annual sales increase % level of promotional activity % level of product awareness within company Non-Financial Performance Indicators (4)

marketing market share trends growth in sales volume number of customer visits per salesman client contact hours per salesman sales volume actual v forecast number of customers customer survey response information Non-Financial Performance Indicators (5)

new product development number of new products developed number of on time new product launches % new product order fulfilment Non-Financial Performance Indicators (6)

human resources/communications/employee involvement staff turnover absenteeism days and % accident/sickness days lost training days per employee training spend % to sales % of employees having multi-competence % of employees attending daily team briefings Non-Financial Performance Indicators (7)

information technology number of PC breakdowns number of IT training days per employee % system availability number of hours lead time for problem solving Non-Financial Performance Indicators (8)

the use of non-financial indicators is important in the evaluation of business performance both financial and non-financial measures are now incorporated into performance measurement systems such as the balanced scorecard Non-Financial Performance Indicators (9)

An Example of the Balanced Scorecard