In order to be able to assess the health of a company operating in the industrial sector and for it to be able to seize new business opportunities, it is essential to know the margins of the characteristic activity, especially with product/customer detail. Within the framework of industrial accounting, for example, as we had already stated in a previous article, the cost of sales assumes considerable importance since it can weigh up to 75 percent of revenues on an annual basis and, therefore, has the potential to significantly influence the company’s performance.
Within this framework, therefore, the CFO of these entities must be able to understand in detail which products and/or customers contribute most to characteristic profitability. Let us see, then, how industrial accounting can support companies in this task.
Evaluating business performance: the tools
Within revenue, as anticipated, each product or customer generates a different margin. One of the main roles of the Office of Finance is precisely to determine what degree of contribution each one has in the overall gross margin. For this to be possible, two basic tools must be used:
- An industrial accounting system, preferably located within the CPM layer, which relies on a cost accounting system found within the ERP layer.
- A reporting system often and frequently to be located within the Business Intelligence area.
Through these, data from cost accounting (ERP layer), together with the accounting balance sheet, are used by industrial accounting (CPM layer) to make margin assessments by product/customer. Thereafter, an efficient reporting system is indispensable to examine and analyze them clearly. To do this, given the large masses of data to be managed, a BI tool becomes almost indispensable.
The tools that support industrial accounting
As anticipated, industrial accounting helps to determine costs with product/customer detail only when properly supported by a cost accounting system. In terms of comparisons and variances, however, it is appropriate to place these results in the forecasting context defined in the budget phase. Industrial accounting, with actual costs, will, in fact, be used on a monthly basis to determine product costs, but the margins thus obtained will have to be included in the budget context in which the company moves. For this very reason, this type of analysis should go hand in hand with variance analysis to understand the causes of deviation and take appropriate corrective action. Considering that this type of analysis requires the management of an even larger amount of data, the use of a BI tool becomes essential for the purpose.
From a systems perspective, typically the budgeting (and forecasting in general) phase is located within the CPM layer and, not, in the ERP layer. In fact, CPM software, as is now well known, was created precisely to fill the inefficiencies of ERP systems on the forecasting phase, some proving to be particularly performant even in the area of industrial accounting. Hence the need to have a CPM system that provides support not only in revenue budgeting by product/customer, but also in cost budgeting, with particular attention to standard costing. This suggests that with a view to maximum support for the Office of Finance, the CPM system should also have an industrial accounting system within it. Without this feature, in fact, it would be difficult to go to budgets by product/customer in terms of cost, losing the opportunity to have a single repository capable not only of accommodating data but also of generating them.
The role of variance analysis in cost analysis
Knowing overall production costs without breaking them down, for example, by channel or customer, does not help much more in making strategic business decisions. Knowing the margins broken down by various products or channels does, in fact, allow you to know which areas you can invest more in and which, on the other hand, you should slow down on. Of course, however, it is necessary to correctly assess whether what is in place is related to contingent or structural situations, otherwise there is a risk of making decisions that could turn out to be wrong.
Costs incurred, in fact, as is now well known, can depend on an endless series of factors, which often cannot be foreseen, such as an international geopolitical event or more simply extraordinary machine maintenance. These, in fact, might force production to be moved to another site/line or energy to be purchased at twice the cost of what was budgeted: in these cases, margin analyses would make little sense unless put in the right context; it is a different matter if the costs are systemic/structural in nature.
Within this scenario comes variance analysis, which allows comparisons to be made between costs incurred at the actual level and those defined at the budget stage (typically standard cost). By comparing the actual cost with the cost that would have been incurred under the market/production conditions anticipated at the budget stage, it is therefore possible to understand the nature of the variances accrued. Through variance analysis, it will then be possible to understand the causes of the accrued effects:
- Has there been a change in the sales price?
- Has there been a change in the exchange rate?
- Was there a change in the sales mix?
- Was there a change in the production process?
- Has there been a change in the purchase cost of raw materials?
- Have there been cyclical or systemic phenomena?
Basically, with variance analysis it will be possible to understand the nature of any deviations. As a result of the above, using the same CPM system for both actual and forecast costing allows for consistency in the subsequent variance analysis and, therefore, allows for timely decisions consistent with the existing economic picture.
Processing the budget within a CPM system and having an ERP system calculate the actual costs makes subsequent comparison difficult, since this information will have to be transferred back into a CPM system if it is to be analyzed more accurately. Not to mention that the logic by which the actual costs were calculated may differ from the logic by which the budget costs were determined, still making the comparison misleading. In fact, therefore, the choice of using different systems for determining the various production costs, in addition to increasing the time required for analysis, also brings with it problems of another nature going to burden the entire company system.
How to improve performance through industrial accounting
To improve the health of a company, it is first essential to know in detail its current situation so that the right corrective/improvement actions can be taken. To this end, in industrial realities, the presence of a process and control tools that enable timely assessment of the state of profitability by product/customer is a prerequisite. It is, then, the comparison with the guidelines defined in the strategic plan and budget, together with the evolution of the economic and market plan, that directs business decisions. In this framework, industrial accounting and variance analysis are decisive tools, along with those supporting the definition of a sound strategic plan and budget/forecasting.
Today in the CPM field there are integrated solutions that make the entire process efficient, going to reduce the analysis timeframe and also reducing costs related to maintenance.