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Profit Focused Accounting
November 14th, 2008
I came up with profit focused accounting back in 2004 because I felt business owners and managers needed a methodology that was understandable and easy to use. Typically financial statements include components and disclosures that are understood only by accountants. When it comes to cost accounting and strategic cost management even the accountants are not all that good at utilizing the techniques and applying them.Profit focused accounting is really throughput accounting or direct costing with some modifications. Another link is to lean accounting. These methodologies are all peas out of the same pod. Let me clarify what lean accounting and direct costing really means and how it works. It is a method where profit is measured by subtracting direct variable costs from sales to show contribution to overhead or fixed costs. Standard costing and allocation of overhead isn’t applied so managers can look at an income statement that is in effect a breakeven analysis.
This approach makes it much easier to determine profitability by product/service line and by customer. It is easier to pin point where your profit is derived and the rate of variable margin. Pricing decisions become much easier to understand and track. When business is slow you have extra capacity and you can reduce prices and still make a contribution to overhead. In these difficult times this becomes a strategy for survival.
Lean accounting and profit focused accounting both utilize actual average costs so cost improvement resulting from lean workflow efforts show up on the income statement. This is not the case with standard costing. Many businesses still want to use standard costing but the future is with profit focused accounting and lean accounting.
The conflict between lean accounting and GAAP accounting is with allocation of overhead for inventory valuation. In reality this doesn’t become a big problem after companies reduce inventory levels and hold them constant. Based on static levels of inventory, the amount of overhead contained in the valuation of inventory will remain steady and not be an issue.
In recessionary times I believe this is the only way companies can effectively cope and manage with a chance of survival.