Management Program Based on Comparative Cost Analysis1

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M A N A G E M E N T P R O G R A M B A S E D ON C O M P A R A T I V E C O S T ANALYSIS 1 FRED m. H. CALHOUN Dairy Service, Incorporated Lexington, North Carolina

I n order for management to cope with the present accelerated pace of business, it must be properly informed. The heart of any management program based on a comparative cost analysis is a good cost accounting system. While it is true that the number of office workers has increased in this century five times faster than the labor force, it is not necessarily true that management is receiving five times as much information. Most of the increase in the labor cost of administration is due to the many reports that are required by the regulatory agencies and the complications of the payroll and tax reports. The comptroller is usually more occupied with meeting report deadlines than furnishing management with the necessary cost infm~iation. REQUIREMENTS

OF A COST A C C O U N T I N G SYSTE)~

The cost accounting system must he capable of rendering accurate information with a minimum of expense. It must be adaptable to the complex dairy industry, be flexible enough to fit machine as well as hand accounting systems, and should be projectable into future operations and conditions. Every function of a dairy plant nmst be separated into an operation, with a separate profit and loss statement made for each department. An example would be the ice cream manufacturing department or the fluid milk department. Then each operation should be subdivided into comparable functions or cost centers, such as raw materials, labor, transportation, etc.

I f the necessary comparisons are to be made comparable, the costs can be based on the sales dollar or the hundredweight processed. These are good measures but each have their weaknesses. For example, hundredweight sold and hundredweight processed are seldom the same. The number of week ends in a month mean little to a manufacturer, but a lot to a distributor, whereas the cost of a container means little to sales but a lot to a manufacturer. We can add a third dimension which will compensate for the shortcomings of per cent of sales and hundredweight by expressing product manufacturing and product distributing in a ratio of actual cost to a group standard. I n Table 1 it can be seen that this new dimension adds depth to the comparison. Operation A has a manufacturing cost of $1.82 per hundredweight and an efficiency of 105%, whereas Operation B has a manufacturing cost of $1.26 per hundredweight and an efficiency of 104%. The relatively high distribution cost of 27% of the sale~ dollar in Operation D is just as efficient as the second lowest distribution cost of 15% of the sales dollar in Operation B. There are many other interesting aspects of this added dimension, but it does not tell us if the operation is at full capacity or if there is a good reason why one segment is lagging. S T A N D A R D S FOR M E A S U R I N G O P E R A T I O N E F F I C I E N C Y A N D COSTS

Standards for group comparison need to be fixed. However, an operation's ability to meet a fixed standard varies with volume and change in facilities. I f the volume processed drops, U S I N G T H E COST A C C O U N T I N G SYSTE~t[ FOR total cost will also drop, but the cost per hunFULL BENEFIT dredweight will rise and the ability to meet a fixed standard will become impossible. ThereTo fully utilize a cost accounting system, a progressive management should join a cost fore, individual standards for a given operacomparison group. This would enable the man- tion need to be flexible in order to measure agement to make cost comparisons with others, the obtainable efficiency of an operation. This can be accomplished by installing a flexible and generally locate those areas where the most improvement is needed. Improvement is budget based on fixed and variable expenses, a never-ending process and by comparison we because it lets all department heads know what is expected and gives them obtainable can constantly measure it and thereby keep pace with others. A good accounting system goals. Another important product of a good gives a cost for each operation and function. comparative cost accounting system is the platform cost of each item manufactured. ~Presented to the Dairy Manufacturing ExWith the total direct cost of the function contension Section at the 57th Annual Meeting of the American Dairy Science Association, Univer- cerned and the allocations from other functions such as the service group, it is a relasity of Maryland, College Park, June, 1962. 750

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DISTRIBUTION DISTRIBUTION

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tively tively simple simple matter matter to to distribute distribute the the cost cost of of the the function function to to the the units units concerned. concerned. Two Two very very important important parts parts of of platform platform costs costs are are return return on on investment investment and and administration. administration. A A 6% 6% rereturn turn on on investment investment for for manufacturing manufacturing equipequipment ment is is not not excessive excessive and and is is generally generally reqUired required in in order order to to keep keep the the equipment equipment up up to to date. date• The The unit unit cost cost should should receive receive an an administrative administrative charge charge to to cover cover office office staff staff payroll payroll and and managemanagement ment supervision. supervision. During During some some months months plant plant problems problems may may require require little little time; time; during during other other months months they they may may require require the the major major portion portion of of management's management's time. time. Where Where branch branch operations operations are are involved, involved, the the cost cost of of transportation transportation of of products to the branch should should be charged charged to all all products. The The true platform cost cost is is the total of of all all functions functions concerned, concerned, return on on ininvestment, administrative administrative expense, expense, and and branch delivery delivery cost. It I t is this cost, with the added profit desired, that is the true tDae platform cost.

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OOST C O S T STATEMENTS STATEN[ENTS

Quarterly route profit and loss statements are the backbone of analyzing distribution costs. The largest route sales volume does not necessarily indicate the highest profit. Driving habits, vehicle abuse, and route returns play an important important part p a r t in the real profit. Once platform costs are established, route profit and loss statements are relatively easy tD to obtain. Units will have to be recapped by routes and individual vehicle costs will have to be kept. and supervisory Administrative, advertising, and expenses will have to be allocated. The results will ffar a r outweigh the cost of obtaining the and loss statements. quarterly route profit and OPERATION PROJECTION PROJEOTION OPERATIO~ of the more more important important uses of of cost acOne of counting is to tD predict predict the the profitability of of a counting change in in operations. IIf the operation operation is is to be change f the merged with with another another similar operation, operation, what what merged the new new costs be ?~ W What the effect of of will the h a t will be the government contract contract bid bid on on costs? costs~ A A managemanagea government ment program program based based on on comparative comparative cost analanalment help solve these these problems• problems. To To explain explain ysis will help the use use of of cost cost accounting accounting in in predicting predicting the the the future, the the following is is assumed: assumed: future, 1. The The plant plant is is operating operating below its its capacity. capacity. 1. 2. The The plant plant is is to to bid bid on on aa government government concon2. tract for for 600,000 600,000 lb Ib per per month month in in halfhalftract gallon cartons• cartons. gallon 3. The The present present volume volume is is 1,250,000 1,250,000 lb Ib per per 3. month. month.

manufacturing functions functions that that are are afafThe manufacturing The fected by by the the projected projected change change are are receiving, receiving, fected half-gallon packaging, packaging, and and case case processing, half-gallon processing, handling. IIn Table 22 itit can can be be seen seen that that in in handling• n Table the combined combined fmletion fmlction of of receiving receiving and and processprocessthe ing the the cost cost per per hundredweight hundredweight will will drop drop just just ing under 111~¢ 11%¢ per per hundredweight. hundredweight. Since Since the the under plant isis processing processing 12,500 12,500 hundredweight hundredweight per per plant month, the the cost cost of of processing processing the the present present volvolmonth,

TABLE 2 C h a n g e in p l a n t cost due to a d d e d volume

Paper Dollars c h a r g e d ½ - G a l l o n homo W i t h new volume Savings

per ~-gallon

S a v i n g s p e r p r e s e n t ewt Total s a v i n g s on p r e s e n t volume

Receiving and processing $5,525 .01900 .01410

Packaging

Container and closure

Case handling

Total

R e t u r n on investment

Adm. and general

$1,330 .01.330 .00732

.......... .0'2450 .02450

$2,590 .00647 .0,0532

.......... .06327 .05124

$3,085 .010.61 .00717

$2,800 .00963 .00651

.00490

.00508

...........

.11400 $1,425

.04784 $598

........... ..........

Product

Total

.................... .2'7735 .36087 .27735 .34227

00114

.01202

.00345

.00312

...........

03,704 $463

.19888 $2,486

.08000 $1,0'00

.07260 $908

........... ..........

01859

3514,8 $4,394

l ) i s t r i b u t i o n cost with a d d e d volume T o t a l cost of a l~-gallon delivered

Labor T y p e of sales Dollars c h a r g e d Wholesale sales " $.47/~-gal. 290,697 u n i t s Contract sales $.36/1~-gal. 140,000 u n i t s Contract dollars

Direct

Indirect

Vehicle

Advertising

$8,198

$2,459

$6,968

$2,732

$2,595

$6,335

$683

$29,970

$136,628

6.0%

1.8%

5.1%

2.0%

1.9%

4.6%

0.5%

$50,400

Direct 1.0% $504

Included in direct 0

3.0% $1,512

0.5% $252

0.5% $252

0.2% $101

Sales

0 0

O p e r a t i n g A d m . and R e t u r n on expense general investment

Cost p e r unit

Pres. vol

New vol

21.9%

.10310

.46397

.44537

5.2% $2,621

.01872

Total

C h a n g e in profit due to n e w volume N e w volume u n i t cost

Bid price

Unit difference

Dollar difference

Volume savings

Increase in present prol~t

.36099 .36099 .36099 .36099

.36099 .35.099 .340,9'9 .3296~

.OlO00 .02000 .03137

$1,4'00 $2;800 $4,392

4,394 4,394 4,394 4,394

4,394 2,994 1,594 2

.36099

OUI~ I N D U S T R Y

ume will be lowered by $1,425. I n the halfgallon packaging function there is a savings of $598. With the increase in volume the platform cost of each half-gallon is lowered by almost 2¢ per unit. The total savings in the manufacturing division is $4,394. The distribution costs of delivering the hMf-gMlon cartons for the contract will be reduced almost 81/2¢ per unit. There is a $4,394 recovery of overhead in the operation if the contract is bid at the delivery cost of $0.36099. I f the bid is above the delivered cost, tl. Jre will be more profit. I t is possible to bid less than the platform cost and still have an increase in total profit. Cost accounting has done its job, and it is up to management to make a decision on the actual bid price. SUM1E[ARY

A management program based on cost analysis will aid any raanagement in reaching a better decision. Five applications of cost accounting as a management tool are: 1. A comparison with other operations, to determine if the operation is just drifting or making reM progress. 2. A comparison of the operation to its own

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flexible standards to determine if the performance is up to capabilities. 3. A platform cost for each item manufactm'ed. 4. An individual route profit and loss statement. 5. An accurate method by which the future costs of an operation under varying conditions can be projected. Information alone will not insure an efficient operation unless it is properly applied. Cost accounting makes no decisions. It may point out that several items are being sold below cost or that a particular route is losing money. I t is up to management to determine why the cost of manufacturing is high and it must analyze the figures to determine why it is losing money. Cost accounting is a tool of management and not a substitute for management. I t is up to the man in management who is responsible for the proper application of this tool to make the right decision. Publication limitations did not allow the printing of a sample budget, unit cost data, route profit and loss statement, or volume cost graphs. These may be obtained on request from the author.