OPINION – Accounting for the strategy

Jose Álvares

Lawyer and CEIBS Executive MBA candidate

It is common to associate accounting solely with that time-consuming year-end exercise of summarising the financial situation of the business, mostly directed to outsiders. Even if that represents a misjudgment of the importance of financial reporting, as comparability is required for businesses to access funding (be that borrowing or going to the capital markets), accounting is not limited to showing the past situation of a business, rather helping internal decision-making going forward.

Take a simple example of the benefit of managerial accounting – would it be worth keeping a restaurant open for another hour? One major cost in such an operation would be the rental, but in this case, what one actually needs to look at is the contribution margin, meaning sales after deducting direct costs required to keep the shop running beyond the normal time (such as labour). The rental cost will be there irrespective of whether the shop is open or closed, so the aim should be to maximise opening hours, provided those additional hours still generate an income (after deducting the added variable costs from the extra revenue).

That leads us to the concept of unused capacity. No employee will likely tell you that they are not busy, as no one wants to be deemed redundant and precipitate their own termination. While in manufacturing it might be easy to account for the maximum performance of a machine, in the service sector it is also possible to fairly accurately estimate how long completed assignments would actually take and stack them against total working hours, giving management a better picture when making long-term decisions.

And where should this cost of unused capacity be allocated? In the case above, is it attributable to the line manager, the HR department that vetted it, or the ultimate decision maker? Those are relevant considerations, as they help understand the accurate bottom line of different offerings and best support a decision to focus on or shelve that line of business.

Similarly, dividing overhead costs across the board by one single metric might be the easiest way to deal with the matter, but is it really accurate? Say a given manager directs his team to train customers to resort to the online channels when faced with issues, thus being able to keep a much smaller team when compared to others, while maintaining the same level of sales. In such a scenario, would it be fair to allocate headquarters’ payroll administration and performance evaluation costs based on the level of revenues? It probably would not properly incentivize managers to keep a lean team as opposed to making an allocation based on the number of employees.

Traditionally, we would see the cost of a given product by looking at the product itself rather than at the customer. However, what about the cost of servicing that client? A customer profitability analysis can be surprisingly handy considering that, statistically, 80% of the profits normally come from 20% of the clients. The same product might actually have different costs to the company if we factor in, say, the payment time (e.g., is it on the spot or requires engaging in selling receivables?  ), the customer support required (e.g., is it an easy client or a difficult one?  ), the turnaround requirement (because urgency likely always entails additional costs to service), etc.

Such information can be crucial to identifying the type of desirable client or even how to segment the market to more efficiently cater to the different clients depending on their profiles. Also, ascertaining the target client can also help in developing the most cost effective marketing strategy.

In fact, customers carry an acquisition cost, and while many might be extremely appreciative of your service / product, within those, some will switch to a competitor in the blink of an eye if, say, the price is lower. It could thus prove wiser to invest in more loyal customers even if they could be less profitable in the short run, or seek to, if possible, drive loyalty in those “pay-for-hire” kind of clients. After all, it is only a few of us that can hold clients captive with low quality service, a situation characteristic of less competitive markets.

Seeing clients as an asset, especially in recent years, may be more profitable in the long run than trying to squeeze every buck out of every corner.

 A shout-out to David Erkens, our professor for this subject, who shared his real-life experience consulting for companies. This piece represents the authors’ own views on the matter.