WHERE DOES ACTIVITY-BASED RESOURCE
plan—the resource requirements. That is, at this stage organizations usually dis- cover they have too much of what they do not need and not enough of what they do need to meet the customers’ expected service levels (e.g., to deliver on time).
The consequence of having too much implies a cost of unused capacity. The con- sequence of having too little is a limiting constraint that, if not addressed, im- plies an erosion in customer service levels.
Therefore capacity must be analyzed. One option is for the budgeters, plan- ners, or management accountants to evaluate how much to adjust the shortage and excess of actual resources to respond to the future demand load. Senior man- agement may or may not allow the changes. There is a maximum expense im- pact that near-term financial targets (and executive compensation plan bonuses) will tolerate. These capacity adjustments represent real resources with real changes in cash outlay expenses if they are to be enacted.
Assume that management agrees to the new level of resources without further analysis or debate. In the downward flow in Figure 15.1, the new level of re- source expenditures can be determined and then translated into the costs of the work centers and eventually into the costs of the products, service lines, chan- nels, and customers. This is classic activity-based management (ABM)—but for a future period. Some call this a pro formaABM calculation. The quantities of PREDICTIVE COSTING, PREDICTIVE ACCOUNTING, AND BUDGETING 137
Products & Services Activities Resources
Forecasted Demand
Operational Adjustments Financial Adjustments
Meets Target Capacity Matches Requirements
Plan or Budget Strategic
Plan Rate Required Total Required Rate Required Total Required
#
#
#
#
$
$
$
$
Predicted Financial Results (1) Adjust
Physical Capacity (2) Adjust Consumption Rates (3) Adjust Demand
Start Do It!
(5) Adjust Resource expense
(4) Adjust Price
Figure 15.1 Activity-Based Budgeting and Activity-Based Planning Require Making Adjustments
Source:www.CAM-I.org
ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 137
the projected drivers are applied, and new budgeted or planned costs can be cal- culated for products, service lines, outputs, customers, and service recipients. At this point, however, the financial impact may not be acceptable. It may show too small a financial return.
When the financial result is unacceptable, management has several options other than to continue to keep readjusting resource capacity levels. These other options may not have much impact on expenses. Figure 15.1 reveals five num- bered types of adjustments that planners and budgeters can consider to align their expected demand with resource expenditures to achieve desired financial results. Management can physicallytake the first three steps:
1. Adjust capacity. Additional manpower, supplies, overtime, equipment, and the like can be purchased for shortages. There can be scale-backs and removals of people and machines for excesses.
2. Adjust consumption rates. If possible, the speed and efficiency of the existing resources can be cranked up or down. If, for example, the in- crease in manpower makes a decision uneconomical, fewer people can be hired, with an assumed productivity rate increase.
3. Adjust demand. If resources remain constrained, demand can be gov- erned or rationed.
The latter two options are operational but also affect the level of resource ex- penses required. After this cycle of adjustments balances capacity of supply with demand, if the financial results are still unsatisfactory, management can make two incremental financial changes:
4. Adjust pricing.In commercial for-profit enterprises or full cost recov- ery operations, pricing can be raised or lowered. This directly affects the top-line revenues. Of course, care is required because the price elasticity could cause changes in volume that more than offset the price changes.
5. Adjust resource cost.If possible, wage levels or purchase prices of mate- rials can be renegotiated.
This approach has been called a closed loop activity-based planning and bud- getingframework.
Absorption costing is descriptive; the only essentialeconomic property cost- ing you need to deal with is traceabilityof cost objects back to the resources they consume. However, the descriptive ABM data is used for predictive pur- 138 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 138
monitor the impact of decisions or plans in terms of the external cash funds flow of an organization.
In the predictive view, determining the level of resource expenses gets trickier because it requires consideration of an additional economic property: variability.
The variability of resources is affected by two factors: (1) the step-fixed func- tion, because resources come in discontinuous amounts; and (2) reversibilityof resources, because the time delay to add or remove resource capacity can range from short to long.
Financial analysts simplistically classify costs as being either fixed or vari- able within the so-called relevant rangeof volume. In reality, the classification of expenses as fixed, semi-fixed, semi-variable, or variable depends on the deci- sion being made. In the short term, many expenses will not and cannot be changed. In the long term, many of the expenses (i.e., capacity) can be adjusted.
PREDICTIVE COSTING, PREDICTIVE ACCOUNTING, AND BUDGETING 139
Framework to Compare and Contrast Expense Estimating Methods
Figure 15B presents a framework that describes various methods of predictive cost estimating. The horizontal axis is the planning horizon, short-term to long-term, right to left. The vertical axis describes the types and magnitudes of change in demands of the future relative to the recent past.
Discrete-event process simulation
ABP/B
Project management
& accounting Job order
costing
Historical cost rate extrapolations
(adjust cost rates)
(apply cost rates) Annual budget
Long-term Planning time Short-term
Horizon Effort level to
adjust capacities
Standard products
Low One-of-a-kind
difficult manageable
easy Engineer-to-order,
make-to-order
Uniqueness of Outputs
Mass production of few products
None (recurring, stable,
static) Changes in Output Mix & Volumes (Future vs. Past)
Very high, volatile (appears random)
Figure 15B Methods of Forecasting Results Copyright 2001 Gary Cokins. All rights reserved.
(Continued) ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 139
A commercial organization ultimately manages itself by understanding where it makes and loses money, or whether the impact of a decision produces incremental revenues superior to incremental expenses. Organizations are in- creasingly achieving a much better understanding of their contribution profit margins using ABM data. By leveraging ABM with ABRP and discrete-event process simulation tools, an organization can plan better. It can be assured that its plan is more feasible, determine the level of resources and expenditures 140 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS
Framework to Compare and Contrast Expense Estimating Methods (Continued)
The lower part of the figure illustrates that the effort level to adjust capacity becomes easier farther out in time. It describes expenses as becoming more variable and less committed as the planning horizon lengthens. On the short- term horizon, an organization would not add or reduce employee manpower levels to match daily workload requirements, so there is a step-fixed cost function. It takes a while to convert in-case resources into as-needed ones.
However, committed expenses (in-case) today can be more easily converted into contractual (as-needed) arrangements in a shorter time period than was possible 10 years ago. Fixed expenses can become variable expenses. The rapid growth in the temporary staffing industry is evidence. Organizations are replacing full-time employees, who are paid regardless of the demand level, with contractors who are staffed and paid at the demand level, which may be measured in hours. In short, historical cost rates can be more easily applied for longer-time-frame decisions; there are fewer step-fixed expense issues.
There are no definitions for the boundary lines between the various zones, and there is overlap as one estimating method gives way to another as being superior. But how much do the various conditions need to change before ad- ditional decision support is needed to validate the feasibility or completely evaluate a decision? That is a good question. I am investigating the question of just where the zones begin to overlap. So far, it appears that ABRP has sub- stantial applicability across a wide set of conditions.
Figure 15B illustrates in the upper-right corner that as the time period to adjust capacity shortens and, simultaneously, the number of changes in con- ditions from the past substantially increase, it becomes risky to rely exclu- sively on extrapolation methods for cost forecasting. Discrete-event process simulation, which can evaluate and validate decisions in any zone, may es- pecially provide superior and more reliable answers in this upper-right zone relative to the other methods.
ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 140
needed to execute that plan, then view and compare the projected results of that plan against its current performance to manage its various profit margins.
All this may seem like revisiting an Economics 101 textbook. In some ways it is, but here is the difference: In the textbooks, marginal cost analysis was some- thing easily described but extremely difficult to compute due to all of the com- plexities. In the past, computing technology was the impediment. Now things have reversed. Technology is no longer the impediment—the thinking is. How one configures the ABRP model and what assumptions one makes become criti- cal to calculating the appropriate required expenses and their pro forma calcu- lated costs.
NOTES
1. The ideas in this chapter on activity-based resource planning (ABRP) are based on excellent research from a professional society, the Activity- Based Budgeting Project Team of the Consortium of Advanced Manufac- turing International’s (CAM-I) Cost Management Systems (CMS) group.
More information is available at www.cam-i.org.
2. More can be learned about RCA at www.rcainfo.com.
PREDICTIVE COSTING, PREDICTIVE ACCOUNTING, AND BUDGETING 141 ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 141