Management accounting performance management techniques

In this blog I will be dealing with some common issues in management accounting and some widely adopted management accounting performance techniques

The discipline is undergoing major developments in the commercial world. The changes that have emerged in the 20th century have impact on management accounting and some of the new principles gaining wider acceptance.

The business environment

Over the years, there were number of new methodologies delivered across the world to improve operations. These include:

* Advanced Manufacturing Technology - it incorporates highly automated and highly computerised methods of design and operation. Machines are easily adapted for short production runs, thereby specific requirements of individuals can be met.

Advance manufacturing is the use of innovative technologies to improve the competitiveness in manufacturing sector. Its aim is to enhance output, increase added value, increase quality, responsiveness to market and flexibility. It allows reduction of the time to market, unit quantities, material content, material inventory and under utilised material plant.

Traditional manufacturing is based on the use of plant with little or no flexibility. These are generally applicable for long production runs, but the advance manufacturing has a capacity to adjust to different requirements without the need for the excess capital investment. It incorporates all aspects of the value chain in the life cycle of a product and utilises information communication technology to integrate the business activities to efficient operations.

The technologies are divided into 3 main groups: efficient production, intelligent production and effective organisation.

Efficient production involves design, simulation, physical and computer modelling, advanced production technologies and control techniques. It includes rapid prototyping ad precision casting.

Intelligent production involves using information technology in production and relating to logistic systems. Production oriented machines, cells and production lines and optimal use of production facilities is considered.

Effective organisation involves effective coordination of company resources of the manufacturing process. It both includes the physical resources and knowledge. It includes advanced tendering activities, sharing resources, knowledge management and trading as well as electronic commerce.

* JIT (Just-in-time) production. Traditional machines were time consuming for switching from one production run to another, this means that items were often produced for stock resulting in heavy storage and financial costs. In JIT goods are only manufactured when ordered, raw materials are purchased when they are required. Stock pricing and stock control here is not an issue.

The concept underpinning JIT is based on making only what is needed, when is needed and at the amount needed. The goal is to achieve the continuous flow and fill a customer order in a shortest possible time by doing only what is needed to perform the next process. When an order is received, instructions to start production are issued to the assembly line as soon as possible. The assembly line must have a minimal inventory of the parts to enable the production. Once an order is filled, the assembly line orders the replenishment parts from the parts-producing process. The parts producing process must keep a small inventory of all types of parts and produce only the quantities needed to replace what is pulled for the next process.

JIT aims to ensure efficient production of quality products with a short lead time. This is possible through elimination of waste, lack of uniformity and unreasonable requirements. Waste does not adds customer value but absorbs resources. When customer demands fluctuates, production cannot be carried out at a constant rate and uneven production generates waste. Levelled production is more efficient. Levelling is achieved through mixing small batches on the assembly line. Each model has a different production lead time. Unreasonable requirements ( beyond once's power) is another source of waste which creates safety and quality problems.

* Total quality management - there are two basic objectives: getting it right first time and the quality of output should reflect the specification. Whatever task is being undertaken, it should be done correctly for the first time it is attempted. There should be no waste, re-work or re-inspection or discounting prices. But there are additional preventive costs such as planning, training and operating the system. "Quality" should not be used with a feeling of 'luxury". Quality product means that the performance meets its specification.

A Total Quality Management Program can streamline a company's processes and dramatically increase profits. It facilitates the quality control, compliance management, risk assessment and document control that contributes to quality management and validity of products and services.

Total quality management is the continuous process of detecting and reducing and eliminating errors in manufacturing, streamlining supply chain management, improving the customer experience and ensuring that employees are up to speed with training. It aims to hold all parties involved in the production process accountable for the overall quality of the final product. The focus is to improve the quality of outputs, including goods and services through continual improvement and internal practices.

It is a structured approach to overall organisations management and it address the internal priorities and external standards priorities. Industry standards can be defined at multiple levels and can be involving adherence to laws and regulations governing the operations.

Total quality management considers the customer focused process and continuously improving the business operations, through improving procedures and internal activities. There is a primary focus on the customer and customer inputs are highly valued which allow the company to better understand their needs. Another focus is the commitment of the employees which includes clear communication across departments and leaders setting up the goals and expectations. They will train employees and give them sufficient resources to complete tasks successfully. As the company learns more about its customers, processes and competitors it should aim for continuous small improvements. It helps the company to adapt to changing market and allow for greater adaptability. It drives the competitive advantage. Total quality management relies heavily on the process management and flowcharts. Diagrams, visual action plans and documented workflows are used. Every member must be aware and educated on their parts to ensure process steps are taken correctly. These processes are then analysed for improvements. The company processes and procedures should be the reflection of the overall business goals, vision and mission and the long-term plans. It calls for a system approach in a decision making and making financial investments into quality products. The management must continuously rely on metrics, turnover, efficacy to correlate the outcomes to the actual results. It relies heavily on the documentation and planning. One way to utilise data is to integrate systems. Systems should talk to each other, convey information across departments and make smart decisions. It allows everyone to be on the same page at the same time through 'on-time' data available in the ERP. Data must transfer between departments freely. There is a human element to coordinate processes.

When implemented correctly, it allows the company to make product for less. Through emphasising quality and eliminating waste companies can provide consistent products and get stronger customer loyalty. It touches every department across the organisation and companies who implement Quality management react to changes quicker. It requires substantial buy-in from every department and this level of commitment is difficult to achieve, requires substantial financial resources. It often requires the conversion of practices and managing change that may not be welcomed and easy to adopt.

Changes are pursued in large international companies rather then in small domestic ones. Traditional heavy manufacturing industries declined, such as coal mining, iron and steel, ship building and car manufacturing. They are much less labour intensive as they used to be.

On another side, there has been a growth in the service industry, such as finance, entertainment or tourism. In fact is the major driver in the UK economy. Many profit and non-profit organisations move to outsourcing or privatisation so that entities can focus on their core activities and everything else is bought from suppliers. Production processes and administration is not highly automated and computerised.

Management accounting changes

Since 1980s many organisations also adopted changes in their management accounting procedures. Changes are slow, but we can expect the management of data (collections, recording, extraction) to be performed electronically as opposed to managed by management accountants. As Just-in-time becomes more wide spread, the stock holding costs, materials pricing and stock valuations would become less significant. Product costing and absorption costs will become more sophisticated and data will be processed by a computer. Budgetary procedures will become much more computerised and they will be subject to variety of outcomes. Standard costing may become less significant with the Total Quality principles. Management accountants will become more likely the business analysts specialising in financial decision making from both internal and external data. They will continuously develop and apply new techniques to come with the industrial and commercial world. The progress will be likely to be evolutionary rather then revolutionary.

The peace of change is beginning to quicken in recent years, possibly through the rapid changes in information technology.

There are number of methods used and those will be explained below.

Activity-based management

Activity-based management is a management control technique involving the identification of activities, establishing costs of those activities and managing them. It is used in all types of entities and not just those which manufacture products, but encompasses all costs. We:

1. Determine all activities;

2. Collect costs attached to activity;

3. Charge them to appropriate cost pools;

4. Select a cost driver;

5. Calculate cost driver for each cost pool;

It is also possible to calculate the ABM contribution. The activity cost pools include all costs to make a product, providing services and delivering goods to customers.

Using the ABM we can expect the budgets to become more reliable, diversionary activities can be more closely recognised and costs reduced accordingly. Because accurate costs are established the profitability increases. Performance is measured more closely so it leads to performance improvements.

ABM means to analysing company' profitability at looking at each aspect of business to determine its strengths and weaknesses. It helps managers to find out which areas of the business are loosing money so that they can be improved or cut altogether. It seeks to highlight the areas where business is loosing money and it analyses the cost of employees, equipment, facilities, distribution, overhead and other factors in the business to determine and allocate activity costs.

It can be applied to different types of companies and it provides the costs associated with each area of the business. It allows the company to produce more accurate budgets and long-term financial forecasts. It can be used, for example, in assessing the profitability of a new product, through looking at marketing and production costs, sales, warranty claims, costs of repair and returns. If a company relies on research and development it also looks at those costs including testing.

Activity based management focuses on business activities that drive the organisational business goals through optimising resources.

However, it is difficult to reduce activities to acceptable level and the boundary between activities is often difficult to determine. It can often cause jealousy among the managers and it might not be always clear to the workforce who is in charge of specific activity.

Even though the method has been widely adopted and more forward-thinking companies are developing it.

Backflush costing

This is a product costing technique where costs are tracked back to a product after the production has been completed. Traditional methods involves a considerable amount of cost-book keeping and this technique cuts all the efforts. This has been widely encouraged by implementing of JIT. Because there is no stock costs it reduces waste.

There are three possible stages when the backflash costing has a cost attached to a product:

1. On completion. This is the simplest form as no entries are made until the goods enter the stock room.

2. On purchase and completion. The entry would be made at a purchase and then the completion of an order would make a conversion cost and the cost of goods sold.

3. On purchase and sale. It triggers entry at the point of purchase of materials and then when sale has actually taken.

There is much less bookkeeping with this method and it is ideally suited for JIT methodology.

Better and beyond budgeting

Generally, 'incremental' budgeting involves taking last years budget, adjusting it for expected changes and then increasing the costs and revenues by the expected rate of inflation during the budget period. But this method is highly criticised, mainly because it is not always connected to the overall strategy of the business, the system is prepared in departmental basis, the focus is on the financial outcomes and not the operational ones as well as budgeting is a costly exercise in terms of time and resources.

Now, there is demand for something better, that is the 'better and beyond budgeting' that incorporate other then financial factors.

Budgeting should be adopted to the organisational strategy, cover shorter period of time, forecasts are to be adopted as opposed to cost centres, there should be focus on activities and processes rather then costs. Any marketing, research and training costs are to be excluded, both financial and non-financial data shall be included including data on company's competitors. Managers should be allowed greater autonomy in preparing their forecasts and staff should be given a bonus to meeting targets.

Beyond budgeting is the idea beyond abolishing traditional budgeting to improve the management control over an organisation. Company adopting it aims to established a highly decentralised organisational system and processes. Development of traditional budgets is time consuming, costly and these rarely focus on company's strategy. They generally do not stimulate value creation, may create obstacles for changes and increase the centralisation of power. 'Beyond budgeting; allows to move towards more agile business structure and is based on the idea of business agility. This allows for quickly adjusting to changing customer demands in an extremely competitive environment. New agile techniques adapt to globalisation, digitalisation and mobility.

The beyond budgeting is based on 12 main principles. These are presented in the figure below.

Source: Schmidt L., 2023, "Beyond budgeting" accessed from https://corporatefinanceinstitute.com/resources/fpa/beyond-budgeting/ accessed on 30/04/2023

Complete abolishment of old budgeting techniques requires adoption of new techniques, for example rolling monthly and quarterly forecasts rather then annual forecasts. Company targets are being based on Key performance indicators, performance is often compared to external sources rather then internal performance and operational managers are encouraged to react to changes in the business environment to effectively coordinate their actions.

The business environment today requires fast and better adaptability and budgeting is one of the most critical components of managerial control. Traditional budgeting prepares budgets with the last years budget and adjusting the expenses based on the inflation rates, customer demand and market situation.

Better budgeting should be considered a better version of the traditional budgeting to fixed some current problems i.e activity-based costing, value-based management and profit planning. We have to re-think on how we manage organisations so that the business is more empowered and adaptive that brings sustainable competitive advantage. It is shifting people from paperwork and giving them time to think, reflect, share, learn and improve. Budgets often encourage command and control

Some of the requirements are already being incorporated in organisations.

Environmental accounting

Environmental accounting is a form of accounting that captures, records, extracts and report information on financial and non-financial nature specifically related to environment. Its aim is to provide information to management so actions can be taken to reduce the organisation's impact on the environment and report on the performance.

Many companies started collecting data on environmental matters and publish corporate responsibility reports. Organisations evaluate their environmental impacts and try to convert the environmental projects into financial terms. Accountants are getting involved to identify the costs of projects as well as their benefits, prepare financial and non-financial performance measures and so on.

Some environmental costs are tangible such as direct materials and direct labour. Other costs are intangible such as costs of dealing with opposition to a proposed addition to a factory. Generally these are sectioned into:

* Conventional company costs: capital, materials;

* Upfront: site installation, R&D, installation;

* Regulatory: training, monitoring, pollution control;

* Voluntary: community outreach, reports;

* Back-end: closure, disposal of inventory, site surveys;

* Contingent: penalties and fines, personal injury, natural resource damage;

* Image and relationship costs: corporate image, relationship with workers.

There are also some environmental benefits, for example, capital costs savings resulting from better project design resulting in less wastage. Revenue savings can also be expected through more efficient use of resources such as energy, water etc. Companies can also benefit from better image and employee relations. However, many of the environmental benefits are difficult to identify and allocate financial metrics to it.

Businesses have been increasingly aware of the environmental implications of their operations, products and services. Environmental risks cannot be ignored and these are now part of managing a business within the product design, marketing and financial management. Nearly all aspects of business are affected by environmental pressures, including accounting and production of separate environmental management accounts.

In the ideal world companies could address environmental performance in financial metrics but many of the current accounting systems cannot deal with environmental costs. Consequently, the managers are unaware of those costs leading managers to make decisions that are bad for the business and bad for the environment. The most obvious example relates to energy use. Inefficient practices allow for 30% waste in the UK according to recent statistics. If companies do not incorporate the environmental costs in their profits and loss statements, they are missing on identifying cost reductions and other improvement opportunities: employing incorrect product pricing, mix and development decisions. This leads to loss in enhancing customer value while increasing risk profile and long-term consequences. Environmental management accounting contributes to improving the environmental management of an organisation and integrates best management accounting thinking with the best environmental management thinking.

It analyses both financial and non-financial information to support the internal environmental management process. It allows for identification of environmental-related costs within the product pricing, budgeting, investment appraisal, calculating costs and savings on environmental projects or setting quantified performance targets. The technique is defined as 'using monetary and physical information for internal management use'.

There are various approaches for the identification of the environmental costs:

* Conventional costs - raw materials and energy having environmental relevance,

* Potentially hidden costs which may loose their identity in 'overheads',

* Contingent costs that may be acquired in the future such us cleaning up,

* Image and relationship costs, for example costs of producing environmental reports.

Input and output analysis can also provide information on the environmental costs. The technique records the material flows. Materials incur energy and water and at the end of the process these can be measured in units. For example if 100kg of materials has been bought and 80kg have been produced, 20kg may be scrap and be presented in monetary terms. Process flow charts can help trace inputs and outputs, in particular waste.

Performance management

This technique involves collecting both financial and non-financial data to monitor the business's performance in achieving its objectives. Ratios are being calculated from the organisation's financial statements. Recently, the performance management techniques and practices change as organisations want to include non-financial data, comparisons with the competitors and greater use of statistical information.

Benchmarking could be used by including comparative data into performance management. Benchmarking can be internal (where data is compared between internal units within the same industry), functional (comparisons are made with the best external practitioner), and strategic (with a purpose to make changes).

Benchmarking is defined as a process of measuring products, services and processes against those known to be leaders in one or more aspects of their operations. It allows insights to determine how the organisation compares with similar organisations or competitors. It allows businesses to recognise areas for improvements wither continuous or dramatic improvements.

Technical benchmarking is performed by design staff to determine the capabilities of the products and services with the competitors products. Competitive benchmarking compares how well an organisation is doing with respect to leading competition, for example ranking of products in comparison to competitors through customer surveys.

Before an organisation can achieve a bull benefit of benchmarking, its own processes must be clearly understood and under control. Benchmarking studies require significant investment of money and time so managers must be willing to make changes as they learn. Too broad scope and inefficient resources involved in the process may lead to failure of the benchmarking exercise.

We must therefore define the subject of the study and choose a subject critical to the organisational objectives. Generally a cross-functional team is formed. A thorough study of internal processes shall be conducted and we need to know what is the work done as well as what are the outputs. We also identify partner organisation which may have the best practice. We need to collect information directly from the partner organisation and then compare the data both numeric and descriptive. This way we can determine gaps in our own performance and potentially differences in practices that cause the gaps. We then develop goals for the organisational process, develop plans and monitor those plans.

Balance scorecards could also be used, which aim to link the performance with business objectives. It has four perspectives which are related to the business activity and each perspective has a question linked to it:

* Financial. How do we look to shareholders?

* Internal business process. What must we excel at?

* Innovation and learning. How we continue to improve value?

* Customer. How do customers see us?

Each perspective then has a number of objectives, and each objective has a measure and a target set for it. This model is rather flexible and can be adjusted to individual circumstances and there could be any number allocated to each perspective, but it may result in information overload.

Senior management understand that what is measured highly affects the behaviour and attitude of their employees. Recent studies urge to forget the financial measures but improve the operational measures, such as cycle time and defect rates and the financial benefits will follow. Therefore managers want a clear indication of financial and operational measures. Balance scorecard compliments the financial measures on the customer satisfaction, internal processes, and the organisations innovation and improvement activities which drive future financial performance. Managers need to see performance in many areas simultaneously. The balance scorecard allows managers to look at the business from important perspective. It provides information to the four important questions on how customers see us, what must we excel at, can we continue to improve and create value and how do we look to shareholders.

New measures are added when an employee gives a worthwhile suggestion so the balance scorecards meet several managerial needs. It brings together all management reports, becoming customer oriented, shortening response time, improving quality, emphasizing teamwork, reducing new product development time and managing for the long-term. It forces managers to consider all operational measures and companies can reduce time to market.

Product life cycle costing

This is a costing technique that captures, records and reports on the cost of making the product from the time someone has an idea to when we forget it ever existed. There are 3 main stages of product 'life cycle':

1. Development. Initial idea to design, prototype and test. This can account for approx. 80% of the product costs.

2. Manufacturing. The product is manufactured and goes onto the market. Some products are manufactured within few days and some may take decades. Each product takes some time before its being taken off in the market, then the sales growth begin, then there is a period of maturity and then period of decline.

3. Disposal. The product is taken off the market and no longer manufactured.

All of the 3 stages incur costs. In a traditional costing system the R&D costs would be written off, and the disposal costs would be treated similarly, thus the profits are generally being overstated. Product life cycle costing provides more accuracy of the product profitability in both development and disposal costs. Emphasis is placed on costs in every stage of the life cycle and greater emphasis is given to the disposal and waste costs.

Product life cycle costing has still not been widely adopted.

Life-cycle costing means considering all the costs that will be incurred during the lifetime of a product, work or service: Purchase price and all associated costs (delivery installation, insurance), Operating costs, including energy, fuel and water use, spares and maintenance. Life cycle costing is being applied by an increasing number of public authorities. Under their rules a contract must be awarded based on the most economically advantageous tender, cost and price is part of any assessment and it is usually one of the most influential factors.

When we purchase a product, service or work, we always pay a price. Life cycle costing is considering all the costs incurred during the lifetime of the product, including purchase price and all associated costs ( delivery, insurance, installation etc), operating costs (including energy, fuel, water, spares and maintenance), as well as the end of life costs (such as decomposition and disposal). Specific rules also apply regarding costs for environmental externalities. This often leads to 'win-win' situations whereby a greener product the work or service is cheaper on overall. There are potential savings on use of energy, water and fuel, maintenance and disposal.

The European Commission has developed a series of sector specific LCC calculation tools which aim to facilitate the use of LCC amongst public procurers.

A comprehensive overview of LCC approaches, tools and good practices can be found in the EU website here https://ec.europa.eu/environment/gpp/lcc.htm#:~:text=Life%2Dcycle%20costing%20(LCC)%20means%20considering%20all%20the%20costs,water%20use%2C%20spares%2C%20and%20maintenance.

Strategic management accounting

This is an advanced form of management accounting that includes the internally generated financial and non-financial data as well as comparable data concerning company's competitors. It places a greater emphasis on related management accounting information to a strategics of the business. It also includes much more non-financial data on the performance of business activities. It also incorporates data from the business direct competitors.

Businesses set their targets and objectives, then figure out on how to achieve the aim and the management accounting provides information that compares the set results with the objectives. The strategic management accounting is not easy to put into practice. Setting aims and objectives is easy, but it might be difficult to obtaining comparable information about the competitors. But we can still a try to implement the technique in order to make better decisions.

Strategic management accounting is the management accounting in support of strategic management process. It encounters the provision and analysis of management accounting data about the business and its competitors for use in developing and monitoring business strategy. It is about supporting managers and placing a definition on specific activities with a focus of supporting the business. The skill set of an accountant is important in that it is not just accounting skills that are required, but a wider skillset, including business acumen, interpersonal skills and the ability to build relationship with senior management that enables accountant to add value to the process.

The main areas in which the management accounting information are utilised to support strategic direction making is the information gathering and analysis stage, mostly in connection with current performance, strategy formulation, and monitoring and evaluation stage which is presented in figure below.

Source: AICPA &CIMA, 2015 "Strategic management accounting", accessed from https://www.aicpa-cima.com/resources/download/strategic-management-accounting#:~:text=The%20term%20'strategic%20management%20accounting,developing%20and%20monitoring%20business%20strategy'. accessed on 01/05/2023

The use of simple re-forecasting techniques is also contributing to the strategic management process as it helps to shape future strategy to indicate the need for strategic action. Accountants working with managers to assist analysis, formulation and monitoring and evaluation of the strategy. It can make a significant contribution in validation of managerial decisions for example pricing, business/market development, new product development, merges or acquisitions. Analysis of markings, variance analysis and exception reporting is found useful for the monitoring and evaluation of the strategy and contributed to the identification of need for strategic action. Techniques such as benchmarking, customer profitability analysis and investment appraisal techniques are most commonly used.

Adapting a proactive approach and positively offering the skill may achieve a higher degree of adding value in strategy development. Those organisations who build robust information systems are capable of producing key performance data and support managers with strategic issues.

Target costing

This technique establishes the cost of the product by determining the selling price and deducting the profits from the selling price. By deducting 'desired profits' from the 'selling price' we are left with the 'target cost'. The traditional 'absorption costing' here works the other way round. But in reality the selling price cannot always be determined this way because the competitors price has to be taken into account.

This costing techniques includes suppliers, employees and customers. Potentially a market research is being carried out for the best price and then profit is set from the price. Rigorous cost assessments need to be carried out and in many cases cost reductions. Organisations often need to work on reducing the costs down. Originally its main objective was to reduce costs, improve product quality, provide what customer wanted and bring new products into the market when the time was right. Here, the emphasis is placed on the customer that is the key factor in the business survival, cooperation among staff is enhanced, a culture of research and continuous improvement is created and new ideas are brought into development.

Problems arise in forecasting changes in the market and the technological advancements. It is also difficult to determine many factors, for example, exact customer needs, competitors activities and drive an accurate target price.

Target costing is a system under which a company plans in advance for the price points, products costs and margins that it wants to achieve for a new product. It it cannot manufacture a product at these planned levels, then it cancels the design project entirely. It is a powerful tool for monitoring product from the moment they enter the design phase and through the life cycle. It is considered one of the best tools for achieving profitability. It is opposite of the approach when product is designed based on the engineering department's view of what product should be like and then struggling with price to meet the market price. The design team need to research specific product features that customer will want and the amount that they will pay for the feature. The features will need to be learned and what effect they have on the price. The company then provides the design team with mandated gross margin that the product must earn. This will allow to determine the target cost that must be achieved before allowing into production. The engineers and procurement teams then create the product. The components must be determined based on required quality, delivery and quantity levels. The engineers must design the product so that it meets the cost target. The team now focuses on reducing production costs, for example through waste reduction. This further reductions allow to decrease the price of the product over time. The design team focuses on cost reduction methods which may be allocated to various products components. This approach is widely used when company wants to upgrade an existing product and maintain low costs.

Throughput accounting

This is a costing technique which enables the throughput of a process to be calculated which is the sales revenue and direct materials costs. It is very similar to 'marginal costing' where all variable costs are deducted from the sales revenue and the balance is referred as the 'contribution'.

But in the modern world it is unrealistic to calculate labour costs that are regarded as direct expenses. This technique is based on assumption that all business activities are restricted by a 'constraint'. For example, a company may be able to sell and produce but it does not have a skilled labour. It also relates to removing of 'bottlenecks" that waste time.

This method is easy to understand and implement and the direct materials costs can be easily identified. The emphasis is placed on the value added from selling and not from continuing to increase output and the attention is placed on removing the constraints and bottlenecks. Products can also be easy ranked on the basis of their profitability.

However, for many organisations it is difficult to accept that sometimes we must stop production and coping with staff layoffs is a major problem.

Throughput accounting is the revenues generated by a production process minus all variable expenses and direct materials and sales commissions. It is the number of units that pass through the process during a period of time. For example 800 units can be produced during the 8 hours shift, which means that the production process generates the throughput of 100 units per hour. In production, it can be increased by improving productivity of the bottleneck operation that is constraining production. For example, an additional machine can be purchased or overtime authorised. The key point is to focus attention on the productivity of the bottleneck operation. If other operations are improved, the overall throughput of the operation will not increase since the bottleneck operation has not been enhanced. They key investment is the bottleneck and not the entire operation.

For financial analysis throughput can be increased by altering the mix of products being produced to increase the priority on those products that have the highest throughput per minute of time required of the constraint resource. If a product has a smaller amount of throughput per minute it can increase by routing a third-party for processing. Some positive throughput can be increased by outsourcing

Value chain analysis

Value chain analysis (VCA) is an investigatory technique used to assess the value added to a product through a sequence of activities from the development stage to delivery to the customer. The chain is illustrated in figure below.

Source: Dyson, J. R., Franklin, E. 2017. Accounting for Non-Accounting students, 9th Edition. Pearson Education

It is believed that adding value to the product in each stage of the product process will give competitive advantage among the competitors. There are the main 'primary activities', such as operations, marketing and sales, but also 'support activities', for example procurement and human resources.

A value chain analysis involves six main steps:

1. Divide entity into strategic business units, such as planning, development, production and marketing;

2. Identify those activities within each strategic business unit that add value;

3. Allocate revenue, costs and asset to each value crating activity;

4. Identify the cost driver for each value activity. This is obtained by dividing the value added by the cost driver;

5. Compare results for each value added activity. We can spot here the activities that add little value and make them more efficient or eliminate altogether;

6. Compare the overall results with other similar entity. This will not be easy as the information required may not be available.

This technique is similar to activity based costing. This can be a complicated exercise and generally in a business non-value activities can be quickly spotted.

Value chain analysis is a means of evaluating each of the activities in the company's value chain to understand where the opportunities for improvements lie. Conducting value chain analysis prompts to consider how each step adds or subtracts value from the final product or service.

Successful businesses create value with each transaction - for the customers in form of satisfaction and for themselves and the shareholders in the form of profit. Companies that generate greater value with each sale are better positioned to profit that those which generate less value. Therefore, it is critical for a business to understand its value chain. A value chain can consist of multiple stages of the product lifecycle, including R&D, sales and everything in between. we can determine what goes into each transaction and maximising the value created at each point which enables to develop a greater understanding of its competitive advantage.

Harvard Business School (2020) illustrates all the components of the value chain that contribute to margins (figure below).

Source: Harward Business School, 2022, "What is value chain analysis? 3 Steps", accessed from https://online.hbs.edu/blog/post/what-is-value-chain-analysis#:~:text=What%20Is%20Value%20Chain%20Analysis,your%20final%20product%20or%20service., accessed on 01/05/2023

Primary activities are those which go directly into creating of the product and include Inbound Logistics, Operations, Outbound Logistics, Marketing and Sales and After Sales services.

Secondary activities help primary activities become more efficient and create competitive advantage: Procurement, Technological Development, Human Resource Management and Infrastructure.

Cost reduction can be derived by making each activity more efficient and less expensive. Additionally, by investing into activities such as research and development, design and marketing allows for product differentiation.

In order to perform the value chain analysis we need to identify the value chain activities and understand the primary and secondary activities. If a company produces multiple products and services it is important to conduct this analysis for each one. We then need to determine the cost of the value chain activities. We may try to define on how each activity increases customer satisfaction and understand the costs associated with each process. Sometimes lowering expenses can add value. We then need to identify opportunities for competitive advantage. For example, if the primary goal is to reduce firms costs evaluation through reducing expenses should be performed. We look at what processes can be more efficient, eliminate those which does not create particular value.

Bibliography:

Accounting Tools, 2022, "Target costing definition:, accessed from https://www.accountingtools.com/articles/target-costing#:~:text=Target%20costing%20is%20a%20system,cancels%20the%20design%20project%20entirely. accessed on 01/05/2023

Accounting Tools, 2023, "Throughput definition", accessed from https://www.accountingtools.com/articles/throughput-definition-and-usage.html#:~:text=Throughput%20is%20the%20revenues%20generated,direct%20materials%20and%20sales%20commissions. accessed on 01/05/2023

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