7
Resource Management:
1.1 Strategic Funds
A fundamental approach to cost analysis considers the sources, flow, and uses of current organizational resources in an effort to identify discretionary funds that might be used to implement new strategies and processes. A future-oriented perspective regarding fiscal requirements and potential sources to meet those needs is provided through this approach. As such, it can be applied to both private and public organizations.
The first step is to conduct acash flow analysisto determine how current fiscal resources are allocated and to show where potential adjustments might be made to yield discretionary funds. Generally speaking, an organization can generate new funds from three sources:
1. Regular operations and other internal sources (such as profits after taxes, depreciation, disposition of excess inventory or unused facil- ities or in the public sector, increased revenue through adjusted tax levies).
2. Expansion of short-term debt consistent with the fiscal structure of the organization (for example, having banks provide extended lines of credit, leasing rather than buying equipment, factoring accounts receivable).
3. Changes in the fiscal structure of the organization to permit the addition of new long-term debt or equity funds.
Funds accumulated from these sources generally comprise the total funds available for managing the organization’s operations and fall into two categories:
baseline funds and strategic funds.
Baseline fundssupport the current, ongoing operations of the organization.
They are used to pay operating expenses, provide adequate working capital, and maintain the current plant and equipment. Baseline funds are used to (a) maintain the same level of production or services, (b) secure the organization’s “market share,” or (c) achieve a specified, ongoing rate of growth.
Strategic funds are invested in the new initiatives required to meet the organization’s strategic objectives. They are used to purchase new assets, such as equipment, facilities, and inventory; to increase working capital; and to support direct expenses for research and development, marketing, advertising, and program promotions. In the private sector, strategic funds are also used for mergers, acquisitions, and market development. A market penetration strategy, for example, may call for a more intensive investment of funds in the current business. A market expansion strategy usually requires aggressive use of strategic funds for advertising and promotion. An organization must use strategic funds to produce more diverse products or services and to develop new markets for them.
The total amount of strategic funds available to the organization can be determined by subtracting baseline funds from total assets (revenue or appropriations). Once estimates have been made as to the funds required to carry out each strategy, they can be ranked according to their potential contribution to the achievement of the identified objectives. In undertaking this ranking, the kinds of strategic funds available and the level of risk involved must be taken into account.
Available strategic funds should be allocated to each program according to some set of priorities. Key decision points concerning risk and return are encountered (1) when funds available from internal sources have been fully consumed and (2) when readily available credit sources have been exhausted. At this point, proposed strategies must be evaluated in terms of changes required in the financial structure of the organization. The final step is to establish a management control system to monitor the generation and application of funds to achieve the desired results.
1.2 Basic Concepts of Cost
Cost can be defined as a release of value required to accomplish some goal, objective, or purpose. In the private sector, costs are incurred for the purposes of generating revenues in excess of the resources consumed. While this profit motive is not applicable to most public and nonprofit organizations, the test as to whether a cost is appropriate and reasonable is still the same: Did the commitment of resources advance the organization or program toward some agreed-upon objective?
It is important to distinguish between direct and indirect costs. A direct costrepresents a cost incurred for a specific purpose that is uniquely associated with that purpose. Four direct cost components are involved in any process, project, or program: (1) labor or personal services (salaries, wages, and related employee benefits), (2) contractual services (services purchased from outside sources), (3) materials and supplies (consumables), and (4) equipment expenses (sometimes categorized as fixed asset expenses). In analyzing the overall operations of a day care center, for example, the salary of the center’s manager would be considered a direct cost. However, the center might be divided into departments according to different age groups of children and a portion of the manager’s salary may be allocated to each department. Then the manager’s salary would be considered an indirect cost of each department. An indirect cost is generally considered to be any cost associated with more than one activity or program that cannot be traced directly to any of the individual activities. In the public sector, the terms indirect cost and overhead often are used interchangeably.
Costs can also be defined by how they change in relation to fluctuations in the quantity of some selected activity—for example, number of hours of
labor required to complete some task, dollar volume of sales, number of orders processed, or some other index of volume (see Figure 7.1). Variable costs are more or less uniform per unit, but their total fluctuates in direct proportion to the total volume of activity. The cost for medical supplies in a public health clinic will increase in direct relation to the number of patients treated. Fixed costs do not change in total as the volume of activity increases, but become progressively smaller on a per unit basis. Utility costs involved in operating a public health clinic, for example, remain the same regardless of the number of patients treated by the clinic. However, the greater the number of patient visits, the lower the cost per patient for utilities.
Costs may also besemi-variable, whereby both fixed and variable compo- nents are included in the related costs, orsemi-fixed, described as a step-function.
FIGURE 7.1 Graphic illustration of cost concepts. (a) Fixed cost; (b) variable cost; (c) semi-fixed cost; and (d) semi-variable cost.
Maintenance costs often exhibit the characteristics of semi-variable costs. A fixed level of cost is initially required, after which maintenance costs may increase with increases in the level of activity. Salaries of supervisory personnel might be described as semi-fixed costs; at some level of increased activity, additional su- pervisory personnel may be required. Since costs are usually classified as either fixed or variable, the incremental character of these mixed categories often is a determining factor. If the increments are relatively small, the costs are usually defined as variable; if the increments between levels of change are large, the costs may be classified as fixed.
1.3 Factors Influencing Future Costs
Any framework for resource management must include an examination of those factors that influence the future costs of the goods and services provided by an organization to its constituents, clientele, or customers. No program decision is free of cost, whether or not the decision leads to the actual commitment of organizational resources. Choices among alternative strategies for the accomplishment of the objectives of any organization are likely to involve many costs. Such choices include not only the expenditure of money, but also the employment of human resources, the consumption of physical resources, and the use of time—all critical commodities in any organization.
Often the tendency is to consider costs strictly in terms of dollar inputs—
the financial resources required to support personnel, equipment, materials, and so on. Future costs that cannot be easily measured in dollar terms all-too- often are dismissed as noncost considerations. Such costs, however, may have important implications beyond their measurable monetary value.
Strategic managers must be cognizant of the following factors that influ- ence future costs:
1. Scope and quality of the services or products to be delivered.
2. Volume of activity required to deliver these services or products.
3. Processes, methods, facilities, and organizational structure required to perform these activities.
4. Qualities and types of labor, materials, equipment, and other cost elements required by these programs.
5. Price levels of the various cost elements.
In addition, uncertainty in the economic, political, and social arenas—which might include exposure to risk—constitutes a major factor influencing the direction of future costs [2].
1.4 Monetary Costs and Economic Costs
Monetary costs are commonly reflected in financial accounts. They include research and development costs, investment costs, and the costs of operations,