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CHAPTER THIRTY-ONE

Analysis, Evaluation, and Control of Revenue and Costs

A COMPANY CAN IMPROVE its bottom line and overall operations by analyzing, planning, monitoring, and controlling revenue and costs. Control reports help in this process. This chapter provides some benchmarks in this evaluation and control process.

CONTROL REPORTS

Control reports are issued to highlight poor performance so that timely corrective action can be taken. The reports should be frequent and detailed, and should look at each important operational level.

Summary reports should present performance over a long time period (e.g., monthly) and provide an overview of performance.

The form and content of the control report varies depending on the functions and responsibilities of the executives receiving it. The reports may be narrative, tabular, or graphic. A lower-level manager is more concerned with details. A higher-level manager is more interested in summaries, trends, and relationships. The reports may be in both financial and nonfinancial terms.

How can revenue be controlled?

Important questions needing answering in sales analysis are: What was sold? Where was it sold? Who sold it? What was the profit?

Sales and profitability analysis involves these considerations:

• Customer: Industry or retail, corporate or governmental, domestic or foreign
• Product: Type of commodity, size, price, quality, and color
• Distribution channel: Wholesaler, retailer, agent, broker
• Sales effort: Personal visit, direct mail, coupon, ad (e.g., newspaper, magazine), media (television, radio)
• Territory: Country, state, city, suburb
• Order size: Normal purchase, volume purchase
• Organization: Department, branch
• Salesperson: Group, individual
• Terms of sale: Cash purchase, cash on delivery, charge account, installment purchase

Profitability can be determined by territory, product, customer, channel of distribution, salespeople, method of sale, organization, and operating division. In deciding on a product line, economies of production have to be considered.

The CFO should watch out for significant changes in sales trends in terms of profit margin and distribution channels. How do actual sales conform to sales goals and budgets? In analyzing the trend in sales, the CFO may see the need to redirect sales effort and/or change the product. The types and sizes of desirable accounts and orders should be determined. Volume selling price breaks may be given for different order sizes.

In appraising sales volume and prices, the CFO should not ignore the possibility that unfavorable variances have arisen from salespeople having excessive authority in establishing selling prices.

Pricing should be reviewed periodically after considering relevant factors, such as increasing costs. All types of costs must be considered including total costs, marginal costs, and out-of-pocket costs.

The CFO should compare the profit margins on alternative products in deciding which ones to emphasize. He or she should also consider the probable effect of volume on the profit margin and the importance of changes in composition, manufacturing processes, and quality on the costs to produce and distribute the product.

The CFO should determine:

• The least cost geographic location for warehouses
• The minimum acceptable order
• How best to serve particular accounts, such as by mail order, telephone, jobber, and so on

The CFO may find that most sales are concentrated in a few products. In fact, a few customers may represent a significant portion of company sales. The CFO may be able to reduce selling costs by concentrating sales effort on major customers and products. Perhaps salesperson assignments should be modified, such as concentrating on only a few territories. Perhaps a simplification of the product line is needed.

The CFO should provide the alternative costs for the varying methods of sale. For example, how should samples be distributed to result in the best effect on sales at minimum cost?

In evaluating sales effort, the CFO should consider the success of business development expense (e.g., promotion and entertainment) by customer, territory, or salesperson.

How can customers be analyzed?

Customer analysis should indicate the number of accounts and dollar sales by customer volume bracket and average order size. A small order size may result in unprofitable sales because of such factors as high distribution costs and high order costs. In this case, the CFO should analyze distribution costs by size of order in order to bring the problem under control and take appropriate corrective action.

It may cost more to sell to certain types of customers than to others among different classes as well as within a particular class. For example, a particular customer may require greater services than typical, such as delivery and warehousing. A particular customer may demand a different price, such as for volume purchases. Profitability analysis by customer should be made so as to see where to place salespeople’s time, what selling price to establish, where to control distribution costs, and what customer classes to discontinue. A determination should also be made as to which customers have increasing or decreasing sales volume. Sales effort may be curtailed on large-volume accounts that only buy low-profit margin items and on low-volume accounts that are at best marginally profitable.

From a sales and profitability perspective, it may not pay to carry all varieties, sizes, and colors. The company should emphasize the profitable products, which may not be the odd items (e.g., unusual colors, odd sizes).

What analysis can be made of sales?

Sales that have not been realized should be listed and analyzed, particularly with regard to any problems that may have been experienced. Such analysis considers:

• Orders received
• Unfilled orders
• Lost sales
• Cancellations

Sales deductions should be analyzed to indicate problems that could lead to deficient profits. Problems may be indicated when excessive discounts, allowances, and freight costs exist. What are the extent of and reasons for returns, price adjustments, freight allowances, and so on? A determination should be made of who is responsible. A defective product is the responsibility of manufacturing. An excessive freight cost or wrong delay is the responsibility of traffic.

Sales should be analyzed in terms of both price and volume to identify unfavorable trends, weaknesses, and positive directions.

CONTROL OF COSTS

Cost control must be exercised over manufacturing and nonmanufacturing costs. Costs should be incurred only for necessary business expenditures that will provide revenue benefit to the firm.

How can manufacturing costs be controlled?

The purpose of cost control is to obtain an optimum product consistent with quality standards from the various input factors, including material, labor, and facilities. The input–output relationship is crucial. In other words, the best result should be forthcoming at the least cost. The office should be shut down when the factory is not in operation. Since most costs are controllable by someone within the organization, responsibility should be assigned.

Changes in standard prices for material, labor, and overhead should be noted along with their effects on the unit standard cost of the product. Perhaps there is a need for material substitutions or modifications in specifications or processes.

Labor control should be jointly developed between staff and management. Line supervisors have prime responsibility to control labor costs. Actual performance of labor should be compared against a realistic yardstick. Unfavorable discrepancies should be followed up.

The CFO may assist in controlling labor costs in these ways:

• Prepare an analysis of overtime hours and cost. Make sure overtime is approved in advance.
• Prepare a report on labor turnover, training cost, and years of service.
• Determine the standard work hours for the production program.
• Establish procedures to limit the number of employees placed on the payroll to that called for by the production plan.
• Make sure that an employee is performing services per his or her job description. Are high-paid employees doing menial work?
• Consider overtime hours and cost, turnover rate, output per worker, and relationship between indirect labor and direct labor.
• Improve working conditions to enhance productivity.
• Analyze machinery to ensure it is up-to-date.

Because most overhead items are small in amount, proper control may be neglected. Of course, in the aggregate, overhead may be substantial. Areas to look at include the personal use of supplies and photocopying, and the use of customized forms when standardized ones would suffice.

In order to control overhead, standards must be established and compared against actual performance. Periodic reports of budget and actual overhead costs should be prepared to identify problem areas. Overhead costs can be preplanned, such as planning indirect labor staff (e.g., maintenance), to avoid excessive hours. The preplanning approach may be beneficial when significant dollar cost is involved, such as in the purchase of repair materials and supplies. A record of purchases by responsibility unit may be helpful. Purchase requirements should be properly approved.

The cost of idle equipment should be determined to gauge whether facilities are being utilized properly. What is the degree of plant utilization relative to what is normal?

What can be done to minimize manufacturing costs?

The control of distribution costs is a much more difficult problem than the control of manufacturing costs. In distribution, we have to consider the varying nature of the personality of seller and buyer. Competitive factors must be taken into account. In production, however, the worker is the only human element. In marketing, there are more methods and greater flexibility relative to production. Several distribution channels may be used. Because of the greater possibility for variability, distribution processes are more difficult to standardize than production activities. If distribution costs are excessive, who and where does the responsibility lie? Is it a problem territory? Is the salesperson doing a poor job?

Distribution costs and effort must be planned, controlled, and monitored. Distribution costs can be analyzed by functional operation, nature of expense, and application of distribution effort.

In functional operation, distribution costs are analyzed in terms of individual responsibility. This is a particularly useful approach in large companies. Functional operations requiring measurement are identified. Examples of such operations might be circular mailing, warehouse shipments, and salesperson calls on customers.

In looking at the nature of the expense, costs are segregated by month, and trends in distribution costs are examined. The ratio of distribution costs to sales over time should be enlightening. A comparison to industry norms is recommended.

In looking at the manner of application, distribution costs must be segregated into direct costs, indirect costs, and semidirect costs.

Direct costs are specifically identifiable to a particular segment. Examples of direct costs assignable to a salesperson are salary, commission, and travel and entertainment expense. But these same costs may be indirect or semidirect if attributable to product analysis. An expense that is direct in one application may not be in another.

Indirect costs are general corporate costs and must be allocated to segments (e.g., territory, product) on a rational basis. Examples are corporate advertising and salaries of general sales executives. Advertising may be allocated based on sales. General sales executives’ salaries may be allocated based on time spent by territory or product. Here a time log may be kept.

Semidirect costs are related in some measurable way to particular segments. Such costs may be distributed in accordance with the services required. For example, the variable factor for warehousing may be weight handled. Order handling costs may be in terms of the number of orders. The allocation base is considerably less arbitrary than with indirect costs.

A comparison should be made between actual and budgeted figures for salesperson salaries, bonuses, and expenses. The salary structure in the industry may serve as a good reference point.

An examination should be made as to the effect of advertising on sales. Perhaps a change in media is needed.

Telephone expense may be controlled in these ways:

• Requiring prior approval for long-distance calls
• Using controls to restrict personal use of the telephone, such as a key lock
• Discarding or returning unnecessary equipment

The trend in warehouse expense to sales should be analyzed. Increasing trends may have to be investigated.

To reduce dues and subscription expenses, a control is necessary, such as having a card record of each publication by subscribed to, by whom, and why. If another employee must use that publication, he or she knows where to go.

There should be centralized control over contributions, perhaps in the hands of a committee of senior management. A general policy must be established as to amount and for what purposes.

PERFORMANCE MEASURES

Performance appraisal must take into account the trend in a measure over time within the company, compared to competition, and compared to industry benchmarks. Performance measures may be appraised by customer, sales territory, contract, job, service, product, division, department, and manager.

What performance measures may be used?

Performance measures include the:

• Number of skills per worker
• Output per labor-hour
• Lead time
• Setup time compared to total manufacturing time
• Backup of orders
• Non–value-added cost to total cost
• Rework costs on manufactured goods
• Number and duration of production delays
• Time per business process
• Repeat sales to customers
• Production costs to total costs
• Production costs to total sales
• Number of complaints and warranty services required
• Time between order placement and receipt
• Time between receipt of an order and delivery
• Number and length of breakdowns in machinery

The CFO should formulate with manufacturing managers optimum production volume that minimizes carrying and setup costs.

Quality

The cost of quality (COQ) is the cost to correct poor quality or to improve good quality. It considers the costs to guard against product defects (e.g., proper machine maintenance, employee training), appraisal costs (e.g., inspecting, training), and cost of the failure to have quality (e.g., rework, warranties). Problems must be identified and corrected in a timely way. Compute the trend in the following ratios: COQ to sales, and COQ to total operating costs. The CFO’s objective is to minimize COQ subject to the restraints of production limitations, customer requirements, and company policy.

Productivity

Productivity is enhanced by minimizing direct labor cost. An attempt should be made to reduce indirect labor costs relative to direct labor costs. Greater and more efficient productivity may be derived by consolidating facilities and equipment. A productivity measure is the relationship of the time, cost, and quality of an “input” to the quality and units generated for the output. There should be a proper input-output balance. Resource utilization should be optimized.

Personnel Performance

In looking at personnel performance, consider sales dollars and volume relative to the number of employees. Compute the following ratios:

• Labor costs to sales, profit, and total costs
• Revenue to number of workers
• Sales volume to number of workers
• Revenue to wages
• Employee turnover rate

Sales Efforts

Salesperson effectiveness should be evaluated, such as by reviewing salesperson incentives, call frequency, dollar value of orders obtained per hour spent, cost per salesperson, and revenue generated by salesperson.

An appraisal of promotional and advertising effectiveness can be made by analyzing the profit prior to and after promotion, dollar expenditure by media compared to sales generated, marketing costs to sales, and media measures. A test market analysis should also be undertaken comparing the industry versus the consumer markets. An activity analysis may also be performed looking at sales and marketing, order management, and customer support.

Space Utilization

In analyzing space utilization, consider:

• Production per square foot = Units manufactured/Square feet of space for equipment
• Customer space = Number of customers/Square feet of space
• Expense per square foot for owned property = Expenses of owning property/Square feet of space
• Revenue per square foot = Net sales/Square feet of space
• Sales per square foot of equipment = Net sales/Square feet of space for equipment
• Rent per square foot = Rent expense/Square feet of space
• Profit per square foot = Net income/Square feet of space
• Employee space = Square feet of space/Number of employees

BUSINESS PROCESSES

A business process is an activity, function, or operation that crosses departments and divisions of a company to produce the good or perform the service. By emphasizing a process, it is easier to comprehend the complexities and interrelationships among organizational units, and assist in improved communication as to where each responsibility unit fits in. Emphasizing and improving the business process results in improved effectiveness and efficiency.

When evaluating business processes, take into account:

• The quality of the process
• Whether all steps in the process are necessary
• Work flow
• What the process costs and how long it takes
• Problems or bottlenecks in the process

Are there redundant steps? Are the steps too costly, time consuming, or complex? Can the steps be simplified and more time efficient? The CFO should look into what processes can be dropped, curtailed, added, or expanded. A modification of a process may be needed periodically depending on changing circumstances.

How can processes be improved?

The following actions can be taken to improve a business process:

• Prioritize strategies.
• Reduce cycle time.
• Use up-to-date technology.
• Improve operational sequence.
• Reorganize procedures.
• Reduce the number of employees or functions in the process.
• Clarify job descriptions and instructions.
• Improve training.
• Upgrade machinery.

A “value-added appraisal” should be performed for each responsibility unit, activity, function, or operation. Is the value added sufficient to justify that activity or business segment? If not, what can be done to improve the situation?

A business process analysis is especially called for when profitability of product lines or services is shrinking, market share is declining significantly, service quality is deteriorating, and customer response time is becoming prohibitive.

Operational audits should be conducted to examine corporate policies and procedures and ensure that they are functioning properly.