Top Trends in Management Accounting and Enterprise Performance Management (EPM) Methods

Top Trends in Management Accounting and Enterprise Performance Management (EPM) Methods Gary Cokins, CPIM Cary, North Carolina USA www.garycokins.com 919 720 2718 gcokins@garycokins.com SAP Switzerland March 18, 2014 Geneva, Switzerland 1

About Gary Cokins Founder, B.S. Industrial Engineering & Operations Research; Cornell University, 1971 M.B.A. Finance & Accounting; Northwestern University, Kellogg Graduate School of Management, 1974 Previous Associations: - FMC Corporation - Consultant with: Deloitte, KPMG Peat Marwick, Electronic Data Systems [EDS, now HP] - SAS Copyright 2012 www.garycokins.com 2

Who will benefit from this presentation? Managers who have previously struggled at promoting FP&A, enterprise performance management (EPM) and integrating business analytics (BA) into their decision support systems. Managers who intend to champion any or all EPM and BA improvement techniques and need a compelling call to action. Copyright 2012 www.garycokins.com 3

Key questions What? So what? Then what? 4

AGENDA Eras of management accounting and cost model stages of maturity Top Trends: 1. The expansion from product to channel and customer profitability analysis. 2. Integration of mgmt. accounting with EPM / CPM. 3. The shift from historic to predictive accounting. 4. Imbedding analytics into mgmt. accounting and EPM 5. Debates over costing methods (e.g., lean, TDABC) 6. Managing IT as a business (chargebacks, SLAs). 7. Recognition that change management is critical. #7 Why is the adoption rate for EPM so slow? 6

Six Eras of Managerial Accounting Era Of Costing Maturity Rocks and stone piles. Stone Age precious metal and paper money piles, ultimately leading to double-entry bookkeeping (Luca Pacioli, 1496). Medieval standard cost accounting (to reflect Frederick Winslow Taylor s manufacturing scientific methods, 1910) Industrial The USA s Great Depression resulted in regulatory reforms to protect investors (1930s). Regulatory Compliance Causal cost tracing of increasingly diverse types of products, services, channels and customers Consumer Predictive Analytics A shift of emphasis from a historical to a predictive view of strategy and operations 20,000 BC 1492 1910 1930 1980 2015 7

AGENDA Eras of management accounting and cost model stages of maturity Top Trends: 1. The expansion from product to channel and customer profitability analysis. 2. Integration of MA with EPM / CPM. 3. The shift from historic to predictive accounting. 4. Imbedding analytics into MA and EPM 5. Debates over costing methods (e.g., lean, TDABC) 6. Managing IT as a business (chargebacks, SLAs). 7. Recognition that change management is critical. Why is the adoption rate for EPM so slow? 8

BIG TREND #1: The shift from product-centric to customercentric profitability analysis. Products and standard service-lines are not the only thing for which accountants should compute costs. What about costs that have nothing to do with products and standard service-lines? The problem with traditional accounting s gross margin reporting is you don t see the bottom half of the picture. 9

A simple explanation of ABC. Mistrust of the managerial accounting system for accuracy and transparency lead to applying activity-based costing (ABC). 10

The General Ledger View is Structurally Deficient for Decision Analysis. Chart-of-Accounts View Insurance Claims Processing Department Actual Salaries $621,400 Equipment 161,200 Travel expense 58,000 Supplies 43,900 Plan $600,000 150,000 60,000 40,000 Favorable/ (unfavorable) $(21,400) (11,200) 2,000 (3,900) Use and occupancy 30,000 30,000 Total $914,500 $880,000 $(34,500) When managers get this kind of report, they are either happy or sad, but they are rarely any smarter! Copyright 2012 www.garycokins.com 11

Each Activity Has Its Own Cost Driver From: General Ledger Salaries Equipment Travel expense Supplies Use and occupancy Total Chart-of-Accounts View Claims Processing Department Actual $621,400 161,200 58,000 43,900 30,000 $914,500 Plan $600,000 150,000 60,000 40,000 30,000 $880,000 Favorable/ (unfavorable) $(21,400) (11,200) 2,000 (3,900) $(34,500) To: ABC Data Base Activity-Based View Claims Processing Dept Key/scan claims $ 31,500 Analyze claims 121,000 Suspend claims 32,500 Receive provider inquiries 101,500 Resolve member problems 83,400 Process batches 45,000 Determine eligibility 119,000 Make copies 145,500 Write correspondence 77,100 Attend training 158,000 Total $914,500 Activity cost drivers #of #of #of #of #of #of #of #of #of #of $914,500 Copyright 2012 www.garycokins.com 12

Multiple-Stage Cost Assignment Tracing Resources Resources Activities Activities Objects Objects Simple ABM Expanded ABM 13

Costs Measure the Effects (1) Demands On Work Costs (2) ABC/M Cost Assignment Network Resources (general ledger view) Salary, Fringe Benefits Direct Material Phone, Travel Supplies Depreciation Rent, Interest, Tax Work Activities (verb-noun) Support Activities Equipment Activities People Activities cost-to-serve paths Final Cost Objects Suppliers Products, Services Customers Business Sustaining 14

Why Do Customer-related Costs Matter? # 1- Customer retention versus acquisition costs. # 2 Sources of Competitive Advantage Commoditization leading to service-differentiation. # 3 From mass selling to one-to-one customer relationships. # 4 The internet s irreversible shift of power from sellers to buyers. Copyright 2012 www.garycokins.com 15

A Customer Profit & Loss Statement CUSTOMER: XYZ CORPORATION (CUSTOMER #1270) Sales $$$ Margin $ Margin (Sales - Costs) % of Sales Product-Related Supplier-Related costs (TCO) $ xxx $ xxx 98% Direct Material xxx xxx 50% Brand Sustaining xxx xxx 48% Product Sustaining xxx xxx 46% Unit, Batch* xxx xxx 30% Distribution-Related Outbound Freight Type* xxx xxx 28% Order Type* xxx xxx 26% Channel Type* xxx xxx 24% Customer-Related Customer-Sustaining xxx xxx 22% Unit-Batch* xxx xxx 10% Productrelated costs Channel & Customerrelated costs Business Sustaining xxx xxx 8% Operating Profit xxx 8% * Activity Cost Driver Assignments use measurable quantity volume of Activity Output (Other ActvityAssignments traced based on informed (subjective) %s) 17

Migrating Customers to Higher Profitability Very Profitable High (Creamy) Product Mix Margin Low (Low Fat) Types of Customers Low Cost-to-Serve High Very unprofitable 18

A Shift in the CFO s Emphasis The CFO must now help Sales and Marketing to better target customers. Segmentation, predictability, churn, offers, deals, risk and uncertainty must be understood in the language of money. 19

BIG TREND #2: Integration of management accounting with enterprise performance management (EPM) Vision & Mission A Vision statement answers where do we want to go? Strategy Mapping Balanced Scorecard Strategy maps and scorecards answer, How will we get there? The strategy map and scorecard are mechanical. They help realize the vision and mission. Copyright 2012 www.garycokins.com 20

Vision & Mission Exceed shareholder expectations Financial Diversify income stream Increase sales volume Improve profit margins Customer Diversify customer base Increase sales to existing customers Test new products Internal Process Target profitable market segments develop new products Optimize internal processes Attract new customers Learning & Growth Develop employee skills Integrate systems Copyright 2012 www.garycokins.com 21

Financial Diversify income stream Vision & Mission Financial value Exceed shareholder expectations creating Increase sales volume Improve profit margins Customer Diversify Increase sales to customer base Customer existing customers intimacy Test new products leads to Internal Process Target profitable develop new market segments Process products excellence Attract new customers stimulates Optimize internal processes Learning & Growth employee Develop skills Integrate A learning environment systems Copyright 2012 www.garycokins.com 22

What is the difference between KPIs and PIs? Strategy Diagram Measurements Frequency of reporting Scorecard (inter-related measures with cause-and-effect correlations) Project-based KPIs Must have targets KPIs (strategic context) Process-based KPIs Without targets - drill-down analysis - alert messages quarterly monthly weekly daily hourly Dashboard (measures in isolation) $ $ Budget & Resource Planning With targets PIs (operational) Without targets - Trends - Upper / lower thresholds real-time Copyright 2012 www.garycokins.com 23

BIG TREND #3: Predictive Accounting Trends (1) Traditional budgeting --> EPM-based budgeting --> Rolling financial forecasts (2) Customer Lifetime Value (CLV) (for business-to-consumer, B2C) 24

BIG TREND #3: Predictive Accounting Trends (1) Traditional budgeting -> EPM-base budgeting -> Rolling financial forecasts (2) Customer Lifetime Value (CLV) (for business-to-consumer, B2C) 25

Why is the budgeting process broken? The budget is typically a fiscal exercise by the accountants that is: -- disconnected from the executive team s strategy. -- not based on future driver volumes. 26

Spreadsheet Budgeting It is Incremental!! 1 2 3 4 5 6 7 8 a b c Current Year Budget Year Wages $ 400,000.00 Formula = Column B * 1.05 Supplies $ 50,000.00 Rent $ 20,000.00 Copy down Computer $ 40,000.00 Travel $ 30,000.00 Phone $ 20,000.00 Total $ 560,000.00 Sheet 1 Copyright 2012 www.garycokins.com 27

Recurring Expenses // Future Volume & Mix inputs Resources Process Costs Output & Outcome Costs Resource expenses can be calculated with backwards ABC/M Customers and Service-recipients Start Here. Copyright 2012 www.garycokins.com 29

Predictive Accounting Accounting Treatments and Behavior of Capacity (expenses) Descriptive Predictive Past Now Future unused sunk unused Traceable to products, channels, customers, sustaining used fixed (unavoidable) variable (adjustable capacity; avoidable) Copyright 2012 www.garycokins.com 30

Enterprise Risk Management (ERM) Assessment Grid High 7 2 8 Severity of impact on event occurrence and achievement of objectives 6 10 3 4 Low 5 9 1 Budget Low probability of an event occurring High Do not budget Copyright 2012 www.garycokins.com 31

Match the Budget Method to its Category Budget method Demanddriven Recurring expenses volume & mix of drivers production and ABP/B Integrated Budget (rolling financial forecasts) Projectdriven Non-recurring expenses Strategic & risk mitigation projects strategy map and risk grid Copyright 2012 www.garycokins.com 32

Linking Strategy and Risk to the Budget Strategy Modeling (by executives) Strategy methods (e.g., SWOT) Strategic objectives Define and adjust strategy and risk, and create strategy map Identify and manage strategic initiatives KPI targets = financial information (e.g. $) knowledge Create balanced scorecard Managerial Accounting (e.g., Activity-based Costing) priority projects and processes Forecast drivers (e.g. sales) ; develop production plan KPI dashboard feedback Driver volumes and mix Approve strategy risk and capital budget (2) capital budget (3) strategy budget (4) risk budget e.g., hours, Pounds, # employees Traditional and driver-based budgeting (e.g. PBB) (1) Operational budget Financial Modeling Driver consumption rates Capacity resource plan Changes and responses Derived budget (and rolling financial forecasts) Operational Modeling (by employee teams) Manage and improve core processes Revise plan Acceptable? Results and outcomes No Yes OK Copyright 2012 www.garycokins.com 33

Marginal / Incremental Expense Analysis Most savvy managers know that some expenses are fixed short-term and variable long term. They want to know the financial impact of a decision. Decision examples: Adding / dropping products, channels, or customers Make versus buy Outsourcing or not Capital investment justification Budgeting / rolling financial forecasts 35

BIG TREND #3: Predictive Accounting Trends (1) Traditional budgeting -> EPM-base budgeting -> Rolling financial forecasts (2) Customer Lifetime Value (CLV) (for business-to-consumer, B2C) 36

Customer Value Management Who is more important to pursue with the scarce resources of our marketing spend budget? Our most profitable customers? Or our most valuable customers? What is the difference? The customer lifetime value is intended to answer this question. 37

Imagine you are pharmaceutical supplier. Which Customer is more Important? Dentist A Sales = $750,000 profits = $100,000 Age 61 Dentist B Sales = $375,000 profits = $40,000 Age 25 Which is more profitable? Which is more valuable? 38

BIG TREND #4 Analytics: Work backwards with the end in mind. Regardless how Business Analytics should be defined, there should be no argument as to its purpose: Better decisions. Better actions. BA s goal should be to gain insights and solve problems, to make better and quicker decisions with more accurate and fact-based data, and to take actions. 39

Improving Performance by Unifying EPM and BA -- BI Reporting consumes stored information. -- Analytics produces new information. -- Enterprise Performance Management deploys Analytics. It is not about monitoring the dials on a dashboard, but rather moving the dials. Copyright 2012 www.garycokins.com 40

Business Analytics automates the shortcuts Queries simply answer questions. Business analytics creates questions. Further, analytics then stimulate more questions, more complex questions, and more interesting questions. Most importantly, business analytics also has the power to answer the questions. 41

BIG TREND #5: Debates about Costing Methods Time-Driven ABC (TDABC) is an alternative method for activity drivers and applies under conditions: highly repetitive activities, less interest in indirect expenses, concerns about unused capacity costs. Lean accounting can co-exist with one or more other costing methods. Be wary of its anti-abc zealots. Resource consumption accounting (RCA) is justified if the higher climb is worth a better view. 42

BIG TREND #6 Managing IT as a business Managing IT as a business is now an imperative. No longer can IT be seen as a technology supplier it must be seen to be adding value to the organization and providing strategic capability. IT performance management enables IT to become service oriented, aligning itself with the organization to provide internal customerdriven solutions to problems. But it is difficult to maximize returns from IT when the products and services appear to be free to internal customers. 43

Costs Measure the Effects (1) Demands On Work Costs (2) IT ABC Cost Assignment Network Resources People (Salary, Fringe Benefits) Hardware Software Network IT charge into other ABC/M models Work Activities Resources equipment Support Activities Activities R&D Develop Replace Support Operate Final cost objects Final Cost Objects New systems (future value) In later years IT cost objects Current systems / facilities (current value) Business cost objects IT Services, Products Business Sustaining Customers 45

AGENDA Eras of management accounting and cost model stages of maturity Top Trends: 1. The expansion from product to channel and customer profitability analysis. 2. Integration of mgmt. accounting with EPM / CPM. 3. The shift from historic to predictive accounting. 4. Imbedding analytics into mgmt. accounting and EPM 5. Debates over costing methods (e.g., lean, TDABC) 6. Managing IT as a business (chargebacks, SLAs). 7. Recognition that change management is critical. #7 Why is the adoption rate so slow? 46

BIG TREND #7 the need for change management Why is the adoption rate so slow? What are the barrier categories? (1) Technical barriers include IT related issues. 47

Remove the wall between IT and Users IT s view of Business - competitor - solve but don t operate - IT resource intensive - risky; low concern for governance and control - a mystery of what they do Business view of IT - obstructionists - controlling - uncooperative - bureaucrats - less skilled than us - just a service center BA provides IT the opportunity to drive value, but IT will need to be more tolerant and flexible. 48

Why is the adoption rate so slow? What are the barrier categories? (1) Technical barriers include IT related issues. (2) Perception barriers are excess complexity and affordability. (3) Design deficiencies include poor measurements or their calculations and weak models and assumptions. (4) Organizational behavior barriers involve resistance to change, culture, and leadership. 49

Overcoming Resistance to Change To create change, you need to create the need for change! How? Change only occurs and continues only when: the product of 3 factors is greater than R (D x V x F) > R esistance to change Dissatisfaction with how things are Vision of what better would look like First practical steps 50

The Complete Vision of Analytics-based Performance Management Make the RPM of the PM and BA gears spin better, faster, cheaper and smarter and safer 51

Podcasts of the 7 Top Trends The Institute of Management Accountants (IMA) at www.imanet.org recorded brief 3 minute podcasts of me introducing these 7 top trends. Here is the overview: http://www.youtube.com/watch?v=gryw2_ay2cw&hq_e=el&hq_m=1655061&hq_l= 12&hq_v=bd6554f22c Here is the first one on trend #1: http://www.youtube.com/watch?v=lcj4-gvh1wq&feature=youtu.be 52

From Theory to Practice Your success depends on how well and how fast the right information and intelligence gets to the right people. 53