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Most Common Problems with Product Costs

I find that one of the most common problems with clients is that they are not confident in the product costs for their products or services.

If the products costs are wrong then their product prices may be incorrect.  They could be too expensive,  losing them business, or possibly they could be losing profits by undercharging.

My first work as an accountant was in manufacturing plants where we used the best product costing methodologies.

Since starting to work as an independent accountant offering part time controller services, I have helped clients in construction, engineering, manufacturing and service develop and improve their costing approaches.

Over the years, I have seen 5 common problems.

The client doesn’t prepare an annual budget

When we are preparing product costs, what we are trying to do is to allocate the total business costs across the product range.

To do that, we need to know what the total product costs for the business will be for whatever period we are working with.

When we finish our costing exercise, the total of all of the product costs that we plan on making should tie back to the total costs we expect to incur.

That is our key check – our key control.

We need to start of with a reliable budget for the year.

To see how I recommend you prepare a budget, you can look at this article on Predicting Business Costs.

How to fix this problem

Best practice for all clients is to prepare an annual budget.

If your business is small, then this will be a fairly easy task.

If your business is larger or more complex, then it’s slightly more difficult but also more important and you really need to do it.   The greater the complexity, the greater the benefits you will get from doing it.

It should be possible to develop a spreadsheet that can be updated from year to year.

The client doesn’t know what is actually being used to make the product

Many clients are not using their accounts for management purposes.   Their accounts exist solely to comply with requirements.

They have a figure for the materials purchased but they don’t always know how much material is used for each different product.

They may have a document which tells what should be used in making the product in a perfect world.   They don’t always have easily accessible information about what is actually happening in the real world.

They need information showing how much of each of the various raw materials are used to make each of their different products.

If they have a controlled product, say a food product, they must keep data for traceability but it may not available to help with management support.

how to fix this problem

Every product should have a bill of materials.  This is essentially a recipe.

What a bill of materials is telling you is not what is in the product but what gets used to make one of the products.

The bill of material should reflect normal waste and normal working practices.  What you want is to identify the average quantities needed for a good production item.

Client ignores waste or scrap

In some cases, the production process is generating waste or scrap but the client was ignoring this.

Let’s say, the client buys in timber to make chairs but the moisture content of some of the timber is too high.  That timber has to be discarded.

However, it may not be possible to send the timber back to get credit.  Maybe the supplier is overseas or maybe the supplier is arguing that the timber was not stored as recommended so the supplier is passing on the responsibility.

In any event, the cost of the unusable timber is a real cost to the manufacturer.

He/she may not be able to pass any or all of that cost on to the customer.  But he/she has a timber cost that they need to be aware of.    At a minimum, they should have an improvement project to try to reduce the losses due to substandard raw material.

Another example could be where the manufacturer has to trim a raw material, let’s say meat, of fat or bone.  The raw material is natural so the amount of trimmings can vary from batch to batch.

We understand that there will always be some trimmings.  What we need to do is identify a reasonable average and use that in our costings.

We should be saying something like “for every 100kg of meat we buy, we use 95kg in the process”.  The cost that we have to bear and pass on to customers is the cost of the 100kg.

how to fix this.

Ideally, you would have a system where raw materials are issued to a batch and at the end of the production period (day, week, month) you can identify the normal usage for each completed item.

If you don’t have that detail, you should still be able to quantify how much  raw materials were used and compare that to what you think should have been used.

The difference will quantify your scrap or waste and you should have programmes in place to reduce this.

Client using inaccurate input costs

When you are preparing costs, you need to have a good handle on what the inputs are costing.

Ideally, you will track the costs of each input and know if they are going up or down and how they compare to historical costs.

In some cases, clients though they know what the inputs were costing but they had not kept up to date with recent changes.

how to fix this

You should either have a product code for each raw material and should track the costs for each order or invoice.

You should have a list of current prices for each of your raw material items.

Client charging for unused production capacity

At the top of this article, we said that we are trying to spread our actual production costs over all of the products that we are producing.

However, if we are a start up and the business is not fully loaded then it may not be sensible to try to pass the costs of our unused manufacturing resources on to our existing customers.

Let’s say, our plant can do 1800 production hours in the year.  But we are only selling 50% of our capacity.

If we are competing with other factories who are working to full capacity, then our costs for our output should be higher than theirs.  However, if we have higher costs and there is no difference in the products, then a sensible customer would buy off the competitor as its cheaper.

We may have to bear the cost of the unused capacity until such time as we can get the sales up to a point where we are using the full capacity.

However, if we have a unique product that has benefits that the competing product does not have, then we may be able to charge more.

That’s an issue we should be aware of and have a proper discussion about internally.

How to fix this

When preparing your budget, you need to be able to express your production output as a percentage of your capacity.  Where there is significant unused capacity, you should be aware of that.

Then you can have the conversation about whether or not you can pass that cost on, or not, to your customers.

Conclusion

These five are the most common costing problems that I have come across.

You should review your own situation and see if any of these are relevant to you.

If you have any comments, you can leave them below.  If you have any questions, please feel free to email me.

 

Reducing the cost of preparing your Annual Accounts

Reducing the cost of preparing your Annual Accounts

Are you conscious of your business costs and do you want to reduce the cost of getting your annual accounts and tax done.  It’s a common issue and one I will address in this article.

As you may know, I am a qualified accountant with many years of experience.  When I worked in management positions in industry, we always used external accountants for the audit and tax work.  In that role, I was very focussed on keeping costs down.

Now, in practice, I work with a wide range of clients.  In a surprising number of cases, these clients were paying more for accounts than they need have.  This not because they were being overcharged. It’s because of what they were asking the accountant to do.

Are you asking your accountant to do work you could do cheaper?

When you send you accounting records to your accountant, are they well organised? Are you asking your accountant to organise the information he/she is receiving?

Like you, your accountant is running a business and will have to charge you for that work.  Why not either do it yourself or have one of your staff do it.  If you have no staff, investigate if can you outsource it to someone who will charge less than your accountant.

Do you send in information that is incomplete?

Your accountant starts working, then realises he/she doesn’t have all they need.  They request that from you and then wait to receive it.   This is just inefficient.

You know that when you stop and start a job, you lose time because you have to have to get back up to speed every time you get back to the job.

It’s the same for accountants.  If a job is broken up and I don’t look at it for a couple of weeks, I have to invest an extra bit of time refreshing myself on where I was.

Do you send in information in piecemeal fashion?

Maybe you think think that I have some of the information so I’ll send that in and I will send in the rest when its ready.

This is the same as sending in incomplete records and is inefficient.

Do you send in information that contains errors?

If you send in errors the accountant must find and fix them.  If you find and fix them before you send the information in, the job will take the accountant less time.

Do you check your accounting records?

When I get information from a client, I have to check it first, before I start working on the accounts, to make sure that its right ie complete and accurate.

Accounts call this type of work reconciling, but basically its just proving that the numbers are reliable.

With accounting software now, it’s easy for the client to do some, if not all, of these checks.  You can do bank reconciliations and you can do checks on the customer and the supplier balances.

Do you use accounting software?

For an accountant, getting information that is already entered into a reasonable system is much better than getting the raw data.  The accountant will be just have to review and analyse it, making some corrections.

It doesn’t take as much time and I know that I prefer that sort of work.

Do you use cloud accounting?

Cloud accounting can be a big help.  The accountant can review the records during the year and maybe give your feedback on the quality of the records earlier in the year.

The software will make you organise the information and you can do many of the reconciliaations yourself.

Cloud Accounting Software lets the accountant work remotely.  I have clients using Xero and Kashflow and we can have Skype calls to review accounts and discuss issues.  This saves me from having to travel to the clients premises which reduces the cost.

Are you making your accountant do data entry work?

Data Entry can be done cheaper in most cases by an entry level admin person.   Even if your accountant puts a junior staff member on the job, they will still want to recover the wage cost and overhead cost of that staff member and they will want to make a margin on it.

You must have access to someone who can do data entry cheaper.

Do you leave it to the last minute to send in your information?

If this is the case, the accountant may have to work overtime – evenings or weekends. That’s going to cost more money.  Staff have to be paid overtime.  It’s also more difficult to do a good job as there may not be time to find full answers to any questions the accountant raises.

Does your accountant do an audit even though you are below the audit exemption threshold?

Some clients like getting an audit done because it gives them more comfort about the numbers.  However, auditing is very regulated and the auditor will have to compile lots forms to satisfy the auditing regulations.   You could ask your accountant to review the accounts without going through a full audit.

Are you using an expensive firm for all your accounting work?

Larger firms tend to have high overheads and therefore have to charge more.  I know some clients who split up the work into different areas and use different firms for different elements.

For example, if your accounting records are good and you are just getting the accounts done for compliance purpose, you could get a smaller, possibly cheaper firm to do the accounts.  If you need more sophisticated tax or maybe corporate finance advice, you could have a different firm advising you on that.

Conclusion

For many client’s there are a number of things that they could to reduce the cost.  However, depending on your circumstances, you may not want to take on some of this extra work.  However, you need to think it through.  There may be other cheaper ways of getting it done through using part-time admin or book-keeping staff.

Don’t think your accountant will resent this.

I prefer working with clients to help them use their accounts to improve and grow the business.  I feel that I can be much more effective if I am working on analysis and advice than if I am doing data entry or filing/organising.  I also find it much more enjoyable working on providing analysis and advice.

Next time, you notice yourself resisting or resenting the accountants fee, use my checklist to see if you could do anything to reduce the fee.

Your Turn

This article is based on my own experience working with clients.  If you have any comments or feedback, I would love to hear it.  Feel free to leave a comment or send me an email.

Cost of Part-time or Virtual Financial Controller

Cost of a Part-time or Virtual Financial Controller

Are you running your own business and struggling with the finances?  You would love to have your own financial controller but you can’t afford a full time one.

You have heard someone mention part-time financial controllers and that sounds interesting.  But you are still wondering how much a part time or virtual financial controller service would cost.

As with many of these questions, there is no simple answer.  It all depends on what you want from the service.

I have been working as a financial control for many years now.  I was a full time financial controller when I worked with the multinationals.  Since I went freelance, I have worked as a part-time financial controller for a large number of clients in a variety of businesses.

Providing financial controller services is a professional service and these are usually  priced based on the time input.  However, there are a number of different factors that influence the amount of time input.

When I meet with a potential client I will be trying to understand and evaluate their circumstances so that I can give them a proposal which is tailored to their situation.

The factors that I will be looking at will include the following

Existing Accounting Capability

How is your accounting function staffed and what level of skills are available to you?   Will we be recruiting new staff, developing existing staff or supervising existing staff?  How much can be delegated to in-house staff and how much will be left to the part time controller.

Accounting Systems

What sort of systems do you have?  Are these well implemented or do they need to be enhanced.  Are there standard routines or do we have to develop and install those routines?

Reporting/Analysis Requirements

What sort of reporting or analysis in required?  Is the infrastructure in place to provide this or does it have to be developed?  Has the potential client got a good handle on their revenues and costs?  Are they confident in their product or service costs?  Do they understand the reported profits or do they express surprise that the profits are not as expected?

Type of Stakeholders

What sort of stakeholder are in the business?  What requirements have they specified for reporting and analysis both in terms of frequency and detail?

Stage of the Business

At what point in the development cycle is the business. Is it a startup with external funding or plans to bring in external funding?  Is it a mature business with fairly steady sales and costs?

Challenges facing the business

What are the challenges facing the business?  Are profitability levels acceptable?   Are they undertaking any significant projects – new markets, new products, new processes, new facilities?

Once I have a good understanding to the current situation for the company, I will then start to work on defining what the desired situation should be.  As part of that we will set some goals – a mix of development goals and some maintenance goals.

Agreed Workplan for Outsourced FC Services

From that analysis, I will create a workplan which will determine the cost of the service.  This workplan will be presented to the potential client and discussed to come up with an agree workplan.

The level of work needed varies from company to company.  I have one company where I did a lot of work early on developing the staff and the systems and I now attend them about one half- day per quarter with additional time as they require for specific, clearly identified issues.

I have other clients where I am with them for two days per month.  These clients with a higher time requirement tend to be either dealing with some major issues or are still in the development stages of the business.

With good broadband, I can also work remotely.  This can be be very helpful if something crops up and it will only take a short time to resolve.  So a skype-type call will avoid travel time and can give the client the answer much more quickly.

Service Cost per month

In terms of cost, it can range from € 400-500 per quarter to maybe € 1500 per month but if the client requires greater inputs the cost will be greater.

From the client’s point of view, what they want to get from the service is the elimination of surprises, much improved understanding of their profitability, greater confidence when pricing for their customers and improved profitability.

To get a better understanding of how we work, feel free to browse through our blog articles.   I suggest this article,  “Understanding the nuts and bolts of accounting”, as a good starting place.

As always, if you have any comment or questions on this article, feel free to contact me by phone(086 2323525)  or by email at jim(at)accountsplus (dot) ie.

Unit Price v Total Cost

Today’s blog update comes from Mindshop founder, Chris Mason.

“In today’s ever increasingly competitive global market the question on how to compete on price always comes up.

People believe that the only way to compete is to be the lowest price supplier of their goods or services. Unit price is only one factor in deciding who to deal with. The more compelling factor is what I call the Total Cost.

For example, I want to get my car repaired, do I go to the person with the lowest quotation if they are located in a city four hours away; of course not. Do I go to someone locally just because they have the lowest cost; probably not.

So what is causing my concern? I know from experience that I need to check the total cost, will the unknown supplier use quality parts, will they do it when I want, do they take my preferred credit card, and can I trust them to do the repair well? I cannot always put a financial price on each of these factors but they do impact on my perception of the total price. The bottom line is that not always is the lowest unit price the lowest total cost.

This concept works in any sales situation. A lot of manufactures were tempted to source their components from emerging nations such as China and India, only to find that there was a sting in the tail of the total cost. In this case factors such as communication, quality, on time delivery, minimum order quantities, and freight, added to the unit price. Many have subsequently brought their business back on-shore because of these extra costs.

Think about your own business, what are the unit costs and what extra costs can you manage for your customer.

You should be able to work on making the total cost of buying from you lower than the total cost of buying from your competitor even when your unit cost is higher. If you find you really cannot create a lower total cost perhaps you need to change the way you price and pull waste out of your processes.

The worst case scenario is that you withdraw from that market, but the need to do that is rare. Start with the price that you need to be competitive and work backwards to determine your target material, labour, and overhead costs. When talking to your customers, talk total cost rather than unit price and you are less likely to have to compete poor quality and unreliable competitors.”

As always, if you have any comments or questions on the above blog post, contact jim(at)accountsplus(dot)ie.