Challenges with traditional accounts.
Are your senior management aware of impact that total supply chain and logistics costs have on the business? Do they view sales revenue as more important to the business? What are you and your colleagues worth? Traditional accounts do not provide much help for these questions, for accounts are designed to be used by external investors, banks and tax authorities.
Can the chart of accounts and structure of the Profit & Loss (P&L) statement be changed to provide a better view concerning the value of supply chains to the business? The answer is yes, but few companies do it.
In my last blog post I said that you cannot cut a business to glory – at some point management must think about how the organisation can operate more effectively. How the business is measured is a good point to start. In traditional accounts, the P&L statement gathers together all the sales-side income and expenditure under sales and administration headings; the supply-side expenditure is grouped under the general heading of ‘cost of goods sold’ (COGS).
Using this approach, it is not immediately evident what the cost are to purchase materials, components and products or payments for service contracts with logistics service providers (LSPs). Consequently, sales revenue continues to take pride of place.
In addition to net profit (or net income), metrics used by the financial media to measure performance often consider output – sales per employee or output per hour. These types of measures actually reflect the extent to which a business is buying in their goods and services. The result of more purchases is the same or higher output from fewer employees, but less value being added within the business.
Outsourcing of functions and contracting out tasks is a valid business decision. But do not think the business is ‘better’ because the sales per employee or output per hour have increased.
Outsourcing of functions has been a common approach to reduce costs and removing a particular function ‘off the books’. Of course, the costs have not disappeared, they have just moved from an internal cost to a purchased costs. Moving functions ‘off the books’ has the effect of reducing the Value Added (VA) also called Added Value (AV), that your business makes to the purchased goods and services. But, what is the VA measure and how can it be used in your business?
Using Value Added in your business
VA recognises that the only means of changing the form of materials and services to provide a saleable product or service is through people within the business. Using their imagination, skill, time and energy people utilise the capital resources at their disposal – land, buildings, machines and money. An old saying is ‘only people can add value; using technology just reduces costs’.
VA is applicable in any organisation where value is added through one or a combination of: material conversion, assembly of components, distribution, post-sale services and technical or advisory services.
The difference between the net income from sales of products and services and the purchase cost of material and service inputs is the value that has been added by the people within the organisation. This is available to pay the costs of employing people and operating the business, leaving a surplus from which to pay taxes. to the government, dividends to shareholders and providing money to re-invest in the business.
The table shows an outline of the traditional P&L statement structure and the improved structure that highlights the costs of supply chains.
In the restructured column, the sales revenue is the net revenue after paying royalties, commissions, sales tax, import duties and allowing for bad debts. The supply market spend covers all external purchases on materials, parts, products and services; from this, the specific spend on direct supply chain and logistics purchases can be identified.
The VA is available to pay the time related costs of the business. The first is people costs (the 50 percent of VA in the diagram is only for illustration), which cover the total cost of employing all staff (including senior executives). In addition to salaries and wages, there are annual leave pay, superannuation or provident fund payments and employee benefits. Examples of these are: company cars, baby creche, staff dining or meals subsidy and training. The people costs figure can be broken down into the costs of each group, including supply chain and logistics.
Benefits for your supply chains and the business
Through identifying the supply market spend on goods and services and the total cost of supply chain and logistics employees, the total investment that your business is making across its supply network is more evident, providing senior management with an immediate indication of total supply chain costs. This can help to change the perception of supply chains from a cost to the organisation into it being an investment in external supplier and customer businesses. This is a more strategic view that gets the head of supply chains and logistics into the boardroom to argue the merits of improvements to supply chains against projects of equal merit from other parts of the business.
The company costs are those incurred to legally establish and maintain the business, such as registrations, licences, professional audit fees etc.
An added benefit of implementing the improved structure of P&L statement is that the ratio of VA per full time equivalent employee can be used as an overall performance measure. This provides an ongoing (trend) measure of the capabilities of all employees in the business.
Also, under this scenario, management does not have to use the ‘our wages are too high’ stories (which companies paying $1 per day in developing countries also say). Instead, through the use of VA, employees can see what happens as various shares of the VA ‘cake’ change. When staff wish to increase their share of VA, positive discussions can be held concerning the actions required to either increase the VA (increase prices or reduce total landed costs of goods and services), reduce total people costs, company costs or the tax/finance share.
The challenge is to get the change to happen, as there are multiple challenges. The first is the supply chain group requires a manager with conviction, who can advocate for change (and preferably understands accounting language!). The second is that accountants like the way things are, which is acceptable to the board, so why change?. And finally, software applications may not easily allow the inclusion of VA breakdowns in the P&L (or even in an addendum to the traditional P&L statement).
‘We behave how e are measured’ is an old (but true) saying; getting changes to measurements so that improvements can be better understood by all in the business can be surprisingly difficult.