SHOW & CHAPTER 13: ACTIVITY BASED COSTING OR HOW MUCH DOES IT REALLY COST? - WILLIAM EASTMAN

This is by far the powerful tool in your financial tool box. Using conventional accounting methods will provide you with gross margins, which leads to profitability, but without the ability to identify the highest margin products and/or services or customers. Also it calibrates your break even point with far greater accuracy.

Show Objective
Given a contracting economy with diminishing business opportunities and inflation devaluing the currency, create a new "TO BE" process and use it to establish best practices for each process and achieve Lowest Cost Producer in your market.

EPISODE 61: ​Summary
In order for a process to generate a good margin and contribute to profitability, all costs need to be identified and assigned to the correct step. This is required to identify a product or service's full cost, variable and fixed, and embed into each step of the process. There is no other way except guessing to answer the most fundamental question - does the output of this process, whether it is a product or service, have sufficient margin to make it profitable? 

Topics:

• Every major process must have a visual map - both internal and external.
• Economies, improvements, reduction in steps in every process has been identified and the map updated.
• Understand all costs - fixed costs (like power, rent, office staff etc) and variable costs (materials, labor, equipment maintenance).
• Working forward each step has a margin assigned. When completed does the final number compare to the price?  Hint: the best companies in the service sector are operating at 40+ margins.
• Determine whether you need more process improvements to alter the price?

EPISODE 62: Value Mapping - Improve First
This starts with creating value maps for each major process that produces something to sell. As we discussed in previous shows, once you have reviewed and improved the process to take all unnecessary steps of the process, now is to time fully burden each step with all of its costs. 

Topics:

• Show/Chapter 6 Review
  • Select the Target Process: Project Manager selects a target process.
  • ​Assemble Process Teams: Simple Projects – Project Manager creates an Action Team to handle the design, building, testing, and finalizing of the new process. Complex Projects – Executive creates a Design Team for research, design, and project management; and an Action Team for building and testing the new process.
  • Create “As Is” Process: Project Manager or Design Team works with employees in the targeted process to determine what they “actually do” and why those steps/methods were chosen.
  • Conduct Market Research: Based upon the output produced from the targeted process  Project Manager conducts research to establish a Benchmark (Should Be) as a starting point.
  • Compare “As Is” to “Should Be” Process: Project Manager or Design Team compares what should be done against what actually occurs to determine the reasons for the difference. This information is critical for designing the “To Be” process.
  • Perform a Value Check: Check 1 - does this step provide value to the customer is willing to pay for? Check 2 - is the step required for technical or quality demands? Check 3: is the step required for legal or regulatory demands?
  • Complete a QSFD: A structured process for creating design specifications based upon user needs and technological requirements. Should include project manager, functional management, subject matter experts, and front line employees.
  • Create “To Be” Process Map: Starting from the As Is, Design and/or Action Team build a process that establishes the company as the LCP (Lowest Cost Producer) or as close as possible.

EPISODE 63: Create Cost Pools
This usually involves three areas for variable costs - materials, labor, and margin. Next, determine how much fixed cost to assign to each step. The simplest is to use time - how long will the step take and what percentage of overheads costs should be assigned. You will never get it exact but will be amazed when you compute all the costs and look at the price - how much margin are you really making?

Topics:

• Start with your new "TO BE" process as part of becoming the Lowest Cost Producer
• Divide the activities into cost pools, which includes all the individual costs related to an activity—such as manufacturing. Calculate the total overhead of each cost pool;
• Assign each cost pool activity cost drivers, such as hours or units; 
• Calculate the cost driver rate by dividing the total overhead in each cost pool by the total cost drivers;
• Divide the total overhead of each cost pool by the total cost drivers to get the cost driver rate; 
• Multiply the cost driver rate by the number of cost drivers. 

EPISODE 64: ABC and Break Even
You have now reached the magic of this method and your ROI. The first cut of BE (break even) was in the aggregate - looking at everything. This will work as long as you sell one product or service but if you have several offers or lines (products and/or services). If your offer is more complicated you need to look at each line starting with individual products and/or services. This analysis will provide you with an accurate picture of how to sell in each area or abandon it.

Topics:

• You have increased production but margins are trending downward
• Product or Service mix has changed due to customer demands and margins are trending downward
• The factors used for drivers has changed and margins are trending downward

Next Show/Chapter 17: Cash Flow Cycle

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