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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.

 

Common Problems when working with accountants

If you are a business owner, you probably have an accountant.

The relationship you have with your accountant is very important.  Your accountant prepares and helps you to interpret the accounts for your business and ensures that you  comply with various regulations re reporting and taxation.

If this relationship is not providing you with the advice and inputs that you need, then you need to think about changing.  However, if you change you don’t want to end up back in the same situation – just with a different accountant.

I have been working as an accountant in practice for many years and, in that time, I have taken on several clients who left their previous accountant because of problems they encountered.

Let me explain to you what are the most common problems that have been reported to me and let me tell you how you could avoid or at least minimise these.

Little or no explanations for your results

You may have been expecting to see a certain profit but when your accounts are complete the results are different – usually not as good as you expected.

You look for an explanation.   You want to understand your business and to know what you can do to improve your results.

Your accountant can’t provide the explanation.  They just tell you that this is the answer we got and they can’t provide any other insights.

How to avoid this

Speak to existing clients of the accountant you are considering moving to and ask how the accountant has responded in similar situations in the past.

Give the accountant a couple of scenarios that you have had and ask what may have caused those.  You will learn a lot from how they approach answering these questions.

Little or no advice is given

Some accountants are reluctant to give advice.  I had one client who asked his previous client if he should renovate his offices. The accountant simply replied “That’s up to you.”

Technically, that answer is correct but what the client is really asking is “how do I make the decision.”

You need to be able to ask your accountant for help with major decisions.  Additionally, your accountant has access to all of your financial data and if he/she spots something that could help, you want them to tell you.

How to avoid this

When you meet with the accountant that you are considering moving to, have one or two questions that you can ask so that you can get a sense of how the accountant will reply.

You can also speak with other clients to see if they are provided with relevant and useful advice.

Too much contact is with junior staff

In many firms, the principal can be very busy and often delegates the interaction with a client to employees.

While its normal, and more cost efficient, for junior staff to do the number crunching work, you want your accountant to share his/her expertise and experience with you.

At a minimum, the principal should review the file, should become familiar with your situation and should provide analysis and advice.

Junior staff are unlikely to have the experience or the confidence to deputise adequately for the principal.

How to avoid this

When engaging with the accountant, ask with whom you will have interactions and clarify the purpose of the interactions.

Again, find out what happens with existing clients of the same accountant – not clients of his/her partners.

When the accountant is issuing the letter of engagement, you could consider asking that this letter be used to specify the type and nature of interactions that you will have with the accountant and his/her office.

Too much jargon

Many clients report that their accountant is no good at explaining things to them.  The clients give up asking because they don’t get the answers that they need.

Typically, what is happening is that the accountant is so familiar with the material that they unconsciously use jargon which is not readily understandable by most clients.

How to avoid this.

Test the accountant by asking him/her to explain something to you.  Bring a situation that you had previously or something topical for you now and discuss this with the accountant.

Ask existing clients how they rate the explanations of the accountants.

Hidden commissions or biased advice

Many accountants earn commissions on sales of life and pension products or tax based investment products.  They can also earn extra income by acting as resellers for software products.  These practices are more common with larger firms.

These accounting firms may have associated companies that sell software or financial services.  They may appear to be independent but the shareholders could well be partners in the accounting firm.

If your accountant is recommending something to you, they should disclose any fees or commissions earned that could bias the advice they give.

If they are a tied agent for a particular life and pension company, that should be disclosed as this relationship likely means that they will not have researched the whole market when selecting the product offered to you.

If they are connected to a company selling a product of service that they recommend, then they should disclose that.

How to avoid this

Don’t be afraid  to ask the accountant if they are earning any fees or commissions on any product they are recommending.

Consider asking them to operate on a fee rather than commission basis.

Consider asking them to include a statement in their letter of engagement relating to transparency around fees and commissions.

Recommending systems that suit only them

Some accountants want their clients to use accounting or payroll software that they already use themselves.

On one level this is fine, as it delivers efficiencies to the accounting firm.

However, if the software does not have the functionality that you need then it may not be the best fit for your business.  For example if you want to use cloud systems but they only work with desktop systems then their proposed solution is not a good fit for you.

How you can avoid this

Ask upfront, if the accountant has any preferences for which software systems they like clients to use and ask how flexible they are around this.

Do a system evaluation before you buy the software and implement any software to make sure that it’s a good fit for you.   I have an article on selecting accounting software called “How to choose accounting software”.

Mismatched Expertise

A friend or business associate may have recommended a particular accountant to you because they were very happy with the service.  However, you may have different needs from your accountant.

For example, your friend may have PAYE income and a rental income portfolio. You on the other hand have an engineering business.

Your friend will be looking for basic accounts and tax advice.  You could be looking for support with budgets, product costing and maybe business planning.

Your friends accountant may or may not be a good fit for you.  Pretty soon after starting to work with this accountant you will know whether you have made a mistake or not.

How to avoid this

Understand what sort of client base the accountant has.

Does he/she specialise or have sufficient experience in your particular sector?

Consider asking some questions along the lines of how do you handle particular situations unique to your sector. Consider asking if they can outline their experience with your sector.

Lack of contact during the year

Many accountants have little or no contact with their clients other than the few days or weeks when they are working on your accounts.

This may suit some clients but most clients will require some accounting inputs during the year.

Issues arise where it would be helpful to talk to an accountant.  You may have questions that you would like to ask.   There may be legal or technical changes that you should be made aware of.

Not having contact could lead to sub-optimal decisions or non-compliance with certain requirements.

How to avoid this

Talk to existing clients and establish what sort of contact they need and get.

See if this is covered in the engagement letter.  If not, consider including something around this.

Unexpected Fee Notes

Sometimes clients ring up with queries that they think are minor and the accountant should be able to answer off the top of their head.

On the other hand, the accountant sees a more complex issue and undertakes some research and investigation to make sure they are giving the best answer.

The result is that the accountant invests significant time and then bills for this time.

The client may not be aware of the amount of time that has been input and is very surprised when a large bill comes in.

How to avoid this

Its normal that the costs of responding to minor questions would be covered in the annual fee but issues that take more than 15-30 minutes to address may be charged separately.

In the engagement letter, include something to specify that the accountant will flag when something is going to trigger a separate bill.

You can then have a discussion to see if it your request is something that justifies that fee.

Also, check with existing clients of the accountant to see how queries are dealt with.

Why is AccountsPLUS different.

Over the years while working as an accountant, clients have often commented that I am very different to other accountants that they have worked with.  When I try to drill down to understand what they mean a few common responses come up.

They tell me that they can understand me.  They say that I give advice about improving performance and profitability.  They can see that I want them to understand the accounts.   They comment that I have a better understanding of their business because I am more hands on than other accountants they worked with.

I think it comes from my background and experience.  I relate well to non-accountants because  I qualified first as an engineer and I had no experience with accounting before starting to train as an accountant.

Then I went into industry and my role involved supporting management to understand the financial impacts of their decisions.  I could see the difficulty they had in understanding accounting information, but I knew that this was down to the way the information was presented.

I also have significant experience working on projects to improve profitability.  I can see how the accounting data can be used to drive the business and I try to use business software to organise the most relevant data and make it available to management.

Bottom line, my background is very different from most other accountants.

Conclusion

In many ways the accountant-client relationship is a project.  You need to have a good project definition up front.

You need to identify what you expect from your accountant and then have a discussion to ensure that your accountant shares your understanding.

Be very careful to do your homework before you decide to hire an accountant for your business.  You are likely to be working with your new accountant for several years and the relationship needs to be excellent.

If after reading this article, you feel like you need to change accountants but are not sure what to do,  I have an article on changing accountants that might be helpful – How diffcult is changing your accountant.

Over to you

Have you been experienced frustrations when working with your accountant?  What type of problems did you face?

I would love to you hear from you, so please leave a comment below.