CategoryCost Management Archives — C. Lynn Northrup, CPA, CPIM
Ask and Listen
A key tool in assessing a business is diagnostic interviewing. This is a process of asking questions and then carefully listening to the answers. W. Edwards Deming, the man who helped the Japanese recover from World War II, always said, “Ask the people who are closest to the action to find out what was really happening.” This advice has never failed me.
Diagnostic interviewing provides indications and clues as to problems. It is a technique I have used to conduct assessments in countless organizations. Getting business owners and management to open the lines of communication can be difficult, but it’s worth the effort. Employees might be reluctant to open up and provide the “unvarnished truth.” It is essential for management to make it clear that they want the truth and the facts. Tell me like it is.
The real key to success is listening and hearing what people are telling you. Frequently, what people say with body language is more revealing than the words that are spoken.
A business assessment involves more than just looking at financial data. Take time to step back and thoroughly evaluate the business. Find out what hurts and locate the source of the pain.
Assessments should encompass the entire state of the business from every aspect and all points of view. Get an effective understanding of what is happening in the industry and in the business. Get the big picture as fast as possible.
Analysis is performed in order to prioritize problems. Examine problems and then break them into their component parts. Conclusions then can be developed to fit the problem. This is when symptoms are distinguished from problems.
Analysis depends on the specific problems under consideration. Here is my three phase approach:
1. Sort out the facts,
2. Applying analytical techniques, and
3. Use judgment to draw conclusions from the analytical process.
Sorting out the facts is a process of categorizing all the information collected during the assessment. The facts should be sorted based on the assessment parameters. There will be a lot of data to match up including the information gathered from the interviews. Take time with this process and avoid jumping to premature conclusions.
Once the facts are sorted, then start applying analytical techniques. There is both qualitative and quantitative analysis. Qualitative techniques are used to analyze factors which can’t be measured in numerical terms. Examples of qualitative techniques include the development of matrices, asking fundamental questions, and searching for patterns. Additional examples include comparison of events for the purpose of identifying both differences and similarities. Qualitative techniques also include development of flowcharts and fish bone diagrams. Applying analytical techniques is very important so think carefully about the potential range of possibilities.
I developed a Self-Assessment Toolkit for use in my consulting work. You don’t need to use it but the checklists and questionnaires it offers provides a good roadmap. Another component of the toolkit is a team survey to gain feedback regarding employee opinions about the organization.
The 10 Step Process
To get things on a profitable footing I created the 10 Step Process to Building Business Value:
1. Identify and locate the pain.
2. Establish the parameters on what needs to be done.
3. Evaluate your market, products, and services – are they right for your business?
4. Right size the business.
5. Financing the business.
6. Maximize asset utilization and returns.
7. Improve employee productivity.
8. Conduct product and customer analysis.
9. Improve business processes.
10. Measure and monitor performance.
These 10 steps represent the essential components of what every business needs to do to maximize profitability and build the value of their organization. These steps represent a long-term no nonsense approach to value based management that produces results.
This methodology works because I have used it to produce results in a number of businesses. When businesses apply the tools and employ them consistently over a period of time, the benefits are record growth in sales and profitability.
These concepts are not silver bullet fixes. They represent a common sense application of tried and true methodologies that can make the difference between survival and failure.
Health care costs are outrageous and continue to climb. A Business Week article reported that over 700 hundred billion dollars is wasted on countless wasted procedures, fraud, and unnecessary treatments. After thinking about the current state of the economy, this revelation struck home. With all the effort being placed on health care reform, it is shocking that this legislation will have no impact on the rising level of health care costs.
Because the health care system operates on a fee-for-service basis, there is no incentive for doctors and medical care facilities to eliminate waste and do a better job of cost control. While there is no incentive for doctors there seems to be plenty for those who are interested in using the system to fraudulently rip off the system for an estimated $150 billion dollars or more.
In thinking about this mess, I tried to consider some potential solutions. CPAs have lots of tools to assist in fraud investigation. The talent is there to get the job done. Why not engage some of the best resources available to stem the tide of leakage from fraud?
The health care system is a process, just like internal control and business processes. Again, wouldn’t it make sense to tap into the lean experts that are streamlining our supply chain and provide focus on the health care system?
When considering cost containment and control, health care represents one of our biggest challenges. I realize the political sensitivity and polarization that surrounds these issues, but government could wake up and pay attention to the talent pool available and make some real progress in contrast to pushing legislation that isn’t going to get the job done. The answer doesn’t lie with Congress; it requires executive action to take the steps that could really make a difference.
Gaining an understanding of strategy and its objectives is essential not only for business, but in everyday life. I teach this topic to my accounting and finance students and thought it would make a good blog post.
Competitive strategy is really about being different and selecting a different set of activities capable of delivering a unique mix of value to customers. In the process of selecting a different set of activities it boils down to the choices you make to change the rules in your favor so you create a competitive position that eliminates the competition.
Choices to change the rules should include setting the right goals. A sound strategy might be to achieve superior profitability by not becoming too big or growing too fast. It might involve becoming a technology leader. Strategy needs to have continuity and is something that can’t be constantly reinvented. It boils down the basic value you are trying to deliver to customers. It is important to maintain a strategy that is consistent in the face of a multitude of changes.
A good strategy will ensure that its components will drives competitive advantage and sustainability. There should be a simple consistency between each functional activity and the overall strategy. This will occur when activities are reinforcing and there is an optimization of effort. A good competitive strategy will grow out of the entire system of activities.
Essentially there are five steps in developing strategy which are presented as follows:
1. Formulating a strategic vision of the organization’s future business composition and the direction on where the entity is headed.
2. Setting objectives.
3. Crafting a strategy to achieve the desired outcomes.
4. Implementing and executing the selected strategy efficiently and effectively.
5. Evaluating organizational performance and making appropriate corrective adjustments wherever necessary.
These five primary tasks become a continuous loop whereby you are observing, orienting, deciding, and acting on necessary adjustments as needed. In the current economic environment, organizations need to be agile and quick in making these decisions.
Good strategy can involve a variety of approaches. This might include a variety of cost approaches ranging from low cost/low price, differentiation, to a specific market niche. Other approaches include responses to changing market conditions, moves to secure a competitive advantage, geographic market coverage, and vertical integration. In addition strategic approaches include financial approaches, human resources, R. & D., marketing, manufacturing, and collaborative partnerships and alliances. The development of the strategy will certainly consider some of these options.
In addition to various approaches, there are some fundamental components of strategy. Foremost, it will be essential to decide what product or service attributes offer the best chance to win a competitive edge. The next step is to develop the skills, expertise, and competitive capabilities that will set the business apart from rivals. Your choice of strategic components should insulate the business as much as possible from the effects of competition.
Attempt to evaluate your firm or company as to whether it is either conventional or reactive. Another way of looking at the evaluation is to determine whether your firm is distinctive and far-sighted. One way of assessing this is evaluating which issues absorb management’s time and attention. How does management’s point of view regarding the future measure up against the competition? Are you better at improving operational efficiency or at creating new businesses? Is the company’s agenda determined by actions of competitors or is it set based on your own unique vision of the future? Within the organization, what is the balance between anxiety and hope?
Finally, it is essential to assess the quality of your strategic market leadership in terms of the customers being serviced today in contrast to those you expect to service in the future. This same question can be directed to your current competitors and who you expect to compete against in the future. Where are your profits earned today and versus where they will be earned in the future? Effective strategy is dependent on resolving the key questions of what drives your business today in contrast to what will provide the competitive advantage in the future. In too many instances, organizations fail to address these issues and follow the course of plodding from day to day with not real thought of the future.
In the current economic environment there are lots of business owners struggling to deal with issues and problems and no idea on where and how to get help. Likewise there are CPAs who are asked by their clients for assistance in areas where they lack the knowledge and experience to provide support. It is a perception that help has to be geographically accessible. The reality in many situations is that there are virtual means of accessing the necessary experience and assistance.Many services, including training, can be provided virtually using the telephone, e-mail, and conferencing tools. I selected the areas of my expertise that could be delivered virtually. It is possible to review strategy and operational situations by using my questionnaires and experience in effective ways. Another situation faced by many companies is that they lack the financial expertise to provide the financial and controllership skills required to survive the current difficult economic environment. Virtual tools are available to share financial information and in many instances an experienced financial manager can provide the needed suggestions that can make the difference between success and failure.
Internal controls represent an area where CPAs need some assistance so they can avoid reinventing the wheel. In many instances I can provide instant answers to questions and provide suggested solutions that could otherwise take hours to solve. Based on working with the COSO internal control framework and assessing audit risk, I can provide direction and advice to practitioners and even help them review their work papers to minimize their risk.
My dealings with family-owned businesses have provided me with firsthand experience in working with succession and planning issues including estate and trust planning tools. It is like having someone working in your CPA practice where you can discuss and review a problem for potential solutions.
Some other areas where virtual assistance is available are cost management, operations and supply chain management. Why struggle with these areas when help is a phone call away. I can also provide assistance with strategic planning and share checklist and questionnaires that will allow you to facilitate development of strategic thinking with your clients. If you are a business looking for assistance, I can provide virtual support and training in these and other specialized areas.
You may not have given thought to using virtual support or training, but it available and utilized all the time. It is a cost effective way to receive the assistance you need. Give me a call to discuss ways that I might be of assistance.
Why not virtual consulting and business support? Since I have always performed consulting services at client’s sites, this represents an interesting question. In the current economic environment when every dollar counts it occurred to me that I could provide companies with excellent support and advice they might not be able to access in their geographic region. I teach on-line courses for Villanova University in conjunction with Bisk Education where I facilitate live discussion session with students every week. If I could teach on line then why not consult on line?After pondering the topic and the question, the answer seems pretty straight forward. Clients could really benefit from such an approach. In one of my recent live discussion sessions we had an extensive dialogue on the transformation of communication. Virtual communication is what has evolved in today’s world. Since we communicate virtually, then consulting and business advisory support represents a logical approach.
Telephone and e-mail are logical tools that most clients understand. The part which is a mystery to them is realizing that we can conduct an on-line dialog over the internet utilizing voice in addition to sharing of presentations and other analytical tools. It isn’t quite the same as face to face communication, but it works pretty well and is a lot cheaper and more time effective. It is an approach that works well enough to help a large number of clients. Virtual consulting can save time and reduce costs so traveling to client sites is limited only to the bare essentials.
In addition to reducing costs and improving efficiency, this approach saves a lot of wear and tear and allows me to reach out to a greater audience and expand my market reach. I can now help more people access my knowledge and expertise. I think this is a good way to work especially in a tough economic environment.
Lean accounting is a mystery to most business people and accountants. They have heard of lean manufacturing but not lean accounting. Lean accounting evolved in the manufacturing environment and hasn’t made much progress into lean thinking applications. There are a number of ways lean accounting can be applied in a variety of situations. It is perfect for managing and measuring results in tough economic times.Initially lean accounting got traction because it had the capability of overcoming the problems associated with standard costing. Standard costing is driven by labor efficiency, machine utilization, and absorption of overhead. These standard cost techniques were traditionally used by managers to build excessive inventories and generate positive variances to improve GAAP profitability leading to higher management incentive bonuses.
The economic recession has created a need for lean accounting. However, since most accountants haven’t use lean tools, the application goes unused. Lean accounting deals with tracking throughput or revenue and the associated variable costs required to generate those sales. Understanding that lean contribution from sales directly improves the bottom line is critical. You don’t spend funds unless it is associated with generating revenue. Since lean accounting provides better information for decision-making it has the impact of increasing sales. In a slower economy, companies need tools like value stream costing and similar lean-decision making applications.
Lean accounting financial statements are easier to understand. Since the focus is on the value stream linked to the voice of the customer, lean encourages measurement of drivers that produce value that customers want. Based on lean thinking, we are only incurring costs to produce customer value. We know the cost of the form and features demanded by customer. Costing techniques include target costing and analysis of the life-cycle of products. These approaches utilize continuous improvement techniques focused on improving our profit margins.
Since most managers relate lean accounting to manufacturing, the tendency is to ignore the concepts of lean and lean accounting for non-manufacturing applications. These areas represent the most lucrative opportunities for lean thinking and lean measurement. There are significant opportunities to lean our administrative and other overhead areas of organizations. Service, health care, and other industry sectors are leaving money on the table by not using lean thinking and lean accounting.
There are plenty of ways to apply lean thinking to accounting and financial operations. The use of simplified financial presentation and measurement can represent significant improvement in time savings and better decision-making. One of the concepts I advocate is sales and operational planning linked to rolling forecasts that virtually eliminates the need for annual budgets. This is a process of getting the entire organization to commit to a regular process of monitoring and communicating the most up to date information available and converting it to meaningful and actionable information. Rolling forecasts provide a simplified lean measurement of the organization and where it is going on a timely basis. It becomes a real-time basis decision making tool.
These concepts are discussed and explained in my book, Dynamics of Profit Focused Accounting. A lean front office is no different than a lean shop floor manufacturing operation. It is all about process flow and eliminating the waste from the value stream. The problem lies in the lack of education and inability to shift paradigms to a new lean way of thinking.
Deciding on what product and or service attributes will provide the best chance to win a competitive edge strikes to the very heart of how to develop an effective strategy. There are a number of approaches that can be used to craft a winning strategy. In this post we will identify some of the more common techniques that can be deployed.One approach many companies use, especially during difficult economic conditions, is a low-cost and low price approach. An alternative approach is one of differentiation and selection of a specific market niche. Differentiation can represent a more profitable option.
During a turbulent economy you will see a number of companies making moves in response to the rapidly changing industry conditions and other factors that develop in the external environment. This is one of the reasons adopting and maintaining a strategic focus is so essential when times are tough and competition heats up. Many of your strategic choices will go beyond just pure survival; they will be to secure a competitive advantage.
Another element of strategy relates to geographic market coverage and the extent of penetration in the market. Companies who got stretched with excessive capacity will have to consider adopting this approach to secure markets and customers to consume this capacity. One approach that some businesses have followed is deciding to pursue vertical integration to enable more sales to existing customers.
There are a number of different financial value propositions that are used by companies as a component of their strategy. Additional choices include the application of human resources, research and development, technology, and a variety of marketing promotions. Linked to these options will be manufacturing and operational approaches that fit with these choices.
A unique approach to strategy as we proceed into the 21st century is collaborative partnerships and strategic alliances. This seems to be a growing trend since it is difficult to be all things to all people making this a choice of necessity.
Strategic choices require developing skills, expertise, and competitive capabilities that set the business apart from rivals. The goal is to insulate your business as much as possible from the effects of competition. From this step you need to perform an analysis of the strategic variables and match them with your capabilities as well as your competitors. Strategic and competitive analysis is a critical component of crafting a winning and sustainable strategy.
You need to carefully think about your point of view relative to the future and assess how it stacks up against your competitors. Are you a risk-taker or just a rule maker? Another question that begs answering is what percentage of your effort is focused on catching up to competitors versus building business advantages that will take your business successfully into the future. It is critical to evaluate your agenda and determine whether you are setting it or if it is being driven by the competition.
While times are tough and success doesn’t come easily, it is imperative to think into the future and set the course for where you plan to be in five to ten years.
My wife and I decided to move to Montrose, Colorado as our final step toward retirement. After realizing that I was flunking retirement, it was important to develop a working life style that would fit and also provide a vehicle to deliver years of experience to individuals, business owners and CPAs. Thus, the new web site became a reality. The web site was built at the same time we were building our new residence.One of my objectives was to provide other CPAs with the benefit of my consulting experience and training. Accordingly, the web site was developed to offer a variety of resources that would enable CPAs to deliver a wider range of business advisory services and support to their clients.
Most Montrose CPAs haven’t realized that I live in their community and that they have access to a wide variety of CPA resources. Since I believe in a team effort, these professionals can directly access my capability without any fear of losing clients. I only wish to provide support and help others in the community. Besides, I need a little time for golf and fly fishing.
Owner managed businesses in Montrose and throughout the western slope of Colorado also have new resources available to them without having to leave the area. My expertise can help these businesses achieve greater bottom-line profitability. Another area where I can help family-owned businesses is with succession planning.
Since my wife and I developed a life plan approach to retirement planning, I decided to offer our methodology to others contemplating and planning for retirement. In addition to pure estate and tax planning, my approach is to provide guidance in a wide range of areas from budgeting, life style decisions, where to live, and how to achieve your retirement goals and objectives.
In this current economic environment, which will last for some time, individuals and businesses will need a different level of service and guidance to help them navigate these difficult times. CPAs are uniquely suited to provide this guidance. CPAs can no longer just prepare tax returns and financial statements. They will need to learn other skills such as strategy and operational management. It is interesting to view the proposed format of the Uniform CPA Exam to see the emphasis that will be placed on these areas. This is all about helping businesses become leaner and do more with less.
I am looking forward to providing my contribution to the re-education process. My wife and I also look forward to working together with our neighbors and contributing to the Montrose, Colorado community.
In these days of uncertainty and tough economic conditions it is critical to take all the necessary steps to keep costs under control. Usually the first step most companies take is to wield a big sharp axe and cut their payroll, often without thought or consideration. I have a better approach. How about work simplification.
Here’s how it works. Gather each supervisor and employee and have them challenge every detail of their jobs. Here are a list of questions they should ask:
- What is its purpose?
- Why is it necessary?
- Where should it be done?
- When should it get done?
- Who should do it?
- How should it be done to get better results?
This is a simple process that can pay big dividends. It will also give you good feedback on which supervisors and which employees are really thinking. Give it a try and my guess is that it will pay dividends.
In the long run it might be a sharper tool than the unwieldly axe.
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.