Cost-System Redesign at a Medium-Sized Company: Getting the Right Numbers to Drive Improvements in Business Performance: Activity-Based Costing Allowed a Manufacturer to Make Business Process Changes That Helped Improve Cash Flow, Product and Channel Profitability, and the Company's Competitive Position

By Stout, David E.; Bedenis, Gregory P. | Management Accounting Quarterly, Summer 2007 | Go to article overview

Cost-System Redesign at a Medium-Sized Company: Getting the Right Numbers to Drive Improvements in Business Performance: Activity-Based Costing Allowed a Manufacturer to Make Business Process Changes That Helped Improve Cash Flow, Product and Channel Profitability, and the Company's Competitive Position


Stout, David E., Bedenis, Gregory P., Management Accounting Quarterly


Many businesses today are pursuing a growth strategy. Typically, small- to medium-sized enterprises must fund growth internally, which, in turn, is a function of the company's ability to generate positive cash flows. A domestic electronic consumer products manufacturer, referred to in this article as XYZ, was experiencing cash-flow difficulties and unprofitable growth, so it responded by implementing a simple activity-based costing (ABC) system. This cost system redesign allowed XYZ to estimate return on sales (ROS) and return on investment (ROI) results for both product lines and customers. In short, the ABC system provided the owners with strategies for pursuing profitable growth.

We will look at how ABC improved XYZ's pricing and product decisions and spurred business process improvements, all of which allowed the company to become more competitive. To help accountants and managers who otherwise might hesitate to engage in a cost-system redesign project, we also discuss ABC implementation issues likely faced by small- to medium-sized manufacturers.

BACKGROUND

Founded in 1999, XYZ Corporation caught the Internet wave squarely by offering domestically produced, value-based consumer electronics products directly to the end user through the company's website. The company separates its products into six families:

* Product family A consists of purchased accessories.

* Product family T items have textured finishes and can be purchased locally in small-lot quantities. All other finish types must be purchased in ocean-container quantities.

* Product family V comprises items with a vinyl finish.

* Product family W includes premium wood-finished items.

* Product family U is uniquely designed and exclusively manufactured items.

* Product family S items represent complete assemblies, which XYZ purchases from foreign manufacturers.

Annual sales for all products amount to approximately $9 million. Currently, the company ships all orders from a single U.S. manufacturing facility. XYZ sells products directly to domestic customers, but foreign customers purchase items through an exclusive dealer network. The company has three owners and 16 employees, most of whom work at home in various parts of the country.

Since XYZ's founding, the company's competitive advantage has been low overhead costs and high customer service--a combination that equates to high value in the customer's mind. XYZ's primary competitors include low-cost Internet direct distributors that purchase complete products from foreign manufacturers and high-end product manufacturers that distribute merchandise via specialty retail shops. Technical innovations and new product offerings principally fuel growth in the industry in which XYZ competes.

During each of its first five years, the company experienced significant sales growth. The first three years saw 40% sales volume and revenue growth per year followed by 20% growth in each of the next two years. Sales volume and total revenues are still increasing, although cash flow is becoming a problem for the company. Shrinking dividend payouts and slowing payment cycles to suppliers suggested that the proverbial "edge of the cliff" for this company was fast approaching! (1)

Growth in sales revenues is a desired outcome for most businesses, as it is with XYZ, but growth in sales without sufficient cash to fuel expansion may actually be counterproductive. This could occur, for example, when growth is fueled by new product offerings that do not recover their full costs. In short, cash flow and working capital, not sales revenue or sales volume, are the lifeblood of a business. (2)

Continued success for XYZ was therefore being jeopardized by the lack of sufficient cash flow. Understandably, the owners wanted to know the causes of the deteriorating situation, so they put together a cross-functional team consisting of the chief financial officer, plant manager, (3) and director of engineering to investigate the situation. …

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