Supply Chain and Cost Control

There is a common belief that Supply Chain professionals need not have costing knowledge.  That is a misleading thought process.  Cost savings takes lion share of Supply Chain optimisation.  Ideally supply chain professionals should have intermediate knowledge of cost behaviour analysis and interpretation capabilities.

The most often reported reason for Business Failures amongst small to medium sized companies is a lack of financial management. Budgets, Financial Planning and proper FINANCIAL CONTROL MECHANISMS are often seen as an unnecessary non revenue earning administrative burden. As long as times are good, businesses tend to survive quite easily. But when business conditions change, a lack of financial planning and control makes it difficult to assess the potential damage or exposure the business is subject to.

Thus, BUDGETS, FINANCIAL PLANNING AND CONTROL are issues which have to be solved when Business is good, in order to survive the lean times.  Having created the budgets for the Warehouse operations and with an assumption that the Volume budget will be same as last year’s actual, we get on with the job of creating Financial Control Mechanisms.

Comparing actual performance with budget is the traditional device used by senior management to measure managerial and business performance.  A good business management system asks questions such as, “Do I have the correct plans in place?” and “How is each part of the business contributing?”  A budget management properly and taken seriously becomes a more forward-looking document that can assist senior management to identify trends, predict year-end results, and avoid any unpleasant financial surprises.

To operate effectively management must keep a balance between two extremes; too much control and not enough control.  Too much control will affect the co-operative spirit and the efficiency of the individual involved and not enough control will prevent management from detecting the need for action before a chaotic situation has been created.  Effective control should be based on adequate frequency and acceptance of variance.

One hundred percent accuracy in budgeting should not be expected.  Otherwise the people involved will provide for a cushion in preparing their budget and spend more money than needed at the end of the period in order to conceal the fact that they provided for the cushion.  The best approach is to indicate which variance is considered as acceptable.

In order to properly monitor the budget, one has to work through the four actions of this feedback loop.  This will ensure you have reliable control activity built into your budgeting process.

Cost Control Process:

As suggested above the best method to understand the progress is by comparing the actual performance with that of budgeted performance.  It is also suggested that the Budget may be prepared on monthly basis to generate this variance analysis periodically. The financial accounting will provide the actual amount spent on each head of account and through the Variance analysis, one has to work on the number and understand the reason for any variance.  Mostly, the variance will occur due to three reasons and they are:

1.  Volume,
2. Norm,
3. Mix.

Volume Variance:

 The variance is due to Volume change is always well defended.  If the demand volume and resources are properly matched at the time of budget preparation, a change of volume will result in two ways:

1.  Increased costs due to increased volume,
2. Increased unit input cost due to decreased volume.

Norm Variance:

While creating the budget, we created norm for every variable activity.  This would be the bench mark to monitor the actual performance of the Variable cost.   Any variance in the norms will once again be highlighted in either the actual cost incurred or the level of the unit cost.

Mix Variance:

Changes in the product/customer mix will also have an impact on the cost.  For instance, in case of MR Ltd. if the New Castle customer buying power goes up to 40% and Cardiff customer reduces his purchases to 60%, this would result in reduced transportation costs.

Inputs for Variance Analysis:

1.  Revenue Budget,
2. Volume Budget,
3. Actual expenses,
4. Norms Budget.

Format of Variance Analysis:

Unexpected Variance:

One of the main problems with variance analysis is that often a scapegoat is sought when results fall short of plans.  A meaningful way of looking at unexpected variances is by considering the variance as planning variance or as an operational one.  A typical budget contains information that was thought to be correct at the time of preparation.  Any changes in the marketplace can result in variance.  Hence, there is a necessity to review the budget at least once in 6 months and come out with the revised budget.  Let us assume that at the end of 6 month period we have noticed that there were changes in prices/volumes/mix, and then it is advisable to change the budget and start comparing actual with the revised budget.

One has to very clearly understand that Variance analysis is a management tool to find out the reason for bad or good performance.  It is not a blame game tool.  Hence, while providing the information or data for analysis, at most care has to be taken to feed the accurate information and data to work out meaningful information for the management.

Cartoon Source: http://www.scdigest.com