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Five Ways to Align Your Sales Forecasting and Budgeting Processes

Five Ways to Align Your Sales Forecasting and Budgeting Processes

Five Ways to Align Your Sales Forecasting and Budgeting Processes

Sales forecasting is a critical discipline that business owners and sales leaders use to create operating plans and make informed management decisions. Sales forecasts estimate future sales volumes over a specified period of time, and they are essential to tracking and managing performance.

Over time, as forecast estimates and actual results are compared, surpluses and deficits are recorded. If this data is tracked in short, frequent increments, which are often determined by the length of the sales cycle and the deal size, then the sales, mar eting, and product-service teams can make necessary adjustments to their activities to stay on plan.

Despite a sales leader’s natural instinct to out-perform his or her forecast, staying on plan is critical. This is because your sales forecast is the starting point for the operating budget that drives capacity planning, production, direct materials investments, labor investments, capital budgets, and more. Keeping your internal “supply and demand” in balance ensures a healthy growth trajectory with minimum risk to short and long-term revenue, profitability, and brand equity. This does not, however, mean that the plan should not be adjusted. Plans as well as budgets should be continuously evaluated and adapted so that the company can achieve its maximum growth potential, but this must be done in a carefully structured manner.

One of the least enjoyable responsibilities of any sales leader is attaching their name and reputation to a sales forecast. However, we can minimize the risk associated with placing a bet on future revenue by following an informed discipline. Let’s take a look at some of the most important questions to answer when developing your sales forecast.

1. What will be your future customer profile?

As Stephen Covey wrote in The 7 Habits of Highly Effective People, “Begin with the end in mind.” Start your forecast by evaluating your best customers. Using key revenue metrics for your business, you should be able to create a definition of your ideal customer based on acquisition and maintenance costs, longevity, growth potential, overall profitability, or other factors. Consider the trends that are occurring in the accounts of your current ideal customers, and the potential for finding and closing more customers like them. Create a profile that describes their characteristics.

In order to locate and acquire customers that fit that profile, the sales leader must engage the marketing team to evaluate the market size of the customer segment, your company’s competitive differentiation for those customers, and the most effective ways to access the market and create brand awareness. Both the sales and marketing teams must be prepared to execute a plan to acquire customers based on a shared vision, and the vision must be based on realistic expectations. The marketing team may find, however, that the number of ideal customers that can be reached is less than the sales team desires, but that other similar groups of potential customers are larger and more accessible. The plan and your forecasts must be altered to reflect the divergence between the customers you want, and the customers you will be able to win.

2. What products and services will you sell?

After defining the customers that you will seek, analyze the mix of products and services that these customers are buying and demanding from you and your competitors. Every 3-12 months, depending on your industry, you will re-evaluate these buying patterns, and the changes that you observe will shape the product-service mix that your forecasts will be based upon.

You will also need to consider seasonal factors that influence buying patterns in addition to the general buying behavior of your customers. What seasonal trends have you observed, and what is the likely impact on sales growth if your product-services team is able to make the necessary adjustments? What if they cannot make the adjustments? Today, as customers become better buyers, buying cycles can shift or completely change multiple times during a selling year. Asking these questions at the start of the year and predicting your ability to capitalize on those changes as they occur will enable you to make appropriate adjustments in your plans, resources, and forecasts.

3. What does your pricing architecture look like?

Effective pricing and price management requires more than simply setting one fixed price per product or service, and using a standard discounting formula. Effective pricing architectures must consider the hundreds of millions of possible price variation options that can exist between your markets, customers, produ ts, and services – if you are going to optimize your deal values without hurting sales conversion rates.

Pricing plays a critical role in a competitive market and in your profitability, and utilizing a thoughtful pricing architecture will make the pricing process more rational. It will minimize potential emotional influences that often result in unsustainable pricing decisions – and ultimately, you are in business to make money, not just to make sales. A detailed pricing architecture will help you find and forecast a balance between the two.

4. How will these products and services be sold?

Despite the popular focus on perfecting the management of “new sales” funnels, there are up to five funnels that must be analyzed when building your sales forecast. Consider how many funnels you actually manage today, how many you should manage, and which ones you incorporate into your annual sales forecast and daily sales leadership plan. The five funnels that must be analyzed are defined as follows:

  1. New Business Funnel: Identifying and closing net-new customers.
  2. Up-Sell Funnel: Net-new customer sales are almost always smaller than they could be. Immediately after closing that first deal, how well do you manage the process of engaging and expanding buying center commitments?
  3. Retention Funnel: What is your customer turnover rate during a project or contract period? How many customers do you lose to competitors, mergers, and other events within a typical customer life-cycle? What measures can you take to proactively secure these customers?
  4. Cross-Sell Funnel: How much success do you have identifying and winning relationships among secondary and tertiary buying centers within your existing customers? It is easier to sell to an existing customer than a new customer.
  5. Renewals: What is your success rate when renewing customer relationships at the end of a typical contract or customer life-cycle? Why do you lose or win? What can you do to improve results?

Start by documenting successes in each of these selling processes. Document the steps that were taken with each buyer to create the sale, and then transform those steps into a formal sales funnel.

Once you know how these five funnels operate, you can engage your sales, marketing, and product- service teams to remove any barriers and to proactively foster higher performance by managing each of the steps within the sales funnel. Over time, your forecast accuracy will grow as you collect and process data on the number of opportunities, the average deal value, your win rate, and the cycle time for each funnel.

5. How will you build your budget?

Before setting your budget, it is important to express your forecast in three realistic scenarios: worst, best, and likely. For these forecasts to be of value, each scenario should be based on assumptions that are based on evidence collected from your analyses, not simply adjusted up or down by an arbitrary factor.

When your three forecast scenarios are complete, the next step is to build relevant budgets for each one. In a manufacturing environment, for example, you can begin with a production budget based on projected unit sales. The production budget can then be used to plan manufacturing costs including direct materials, direct labor, and overhead. When combined with selling and administrative expenses (which include marketing), a cash budget can then be created.

During the course of any sales year, forecast and budget variations are to be expected. For this reason, high-performing management teams also create action and contingency plans to help them manage the effects that deficit and surplus situations can have on capacity. Your year should begin with a budget for a mid-range or likely forecast scenario, but it must be continuously reviewed so that operational or other necessary changes can be implemented. All too many companies create concrete operating processes that, when circumstances dictate, can be hard to modify quickly.

If you do not have flexibility built into your budgets and processes, consider what would happen if the company’s actual results matched your worst-case forecast. If sales volumes are lower than expected, firm-wide fixed cost reductions will be required to shrink capacity. If your best-case scenario happens and sales volumes are greater than expected, then you must grow capacity to deliver your orders. In this case, you should invest in finding greater operating efficiencies while holding the line on fixed costs. This will help to control your capacity growth and minimize your risk.

Often, budget contingency planning is thought of as downside planning only, but worst- and best-case scenarios both have capacity consequences that must be anticipated. Action and contingency plans for both should involve creating processes that outline how the organization will respond to variations in sales and operating metrics (these metrics must also be identified by the team). Investing time in creating these plans will allow you to address critical issues early, vet the details of the plan, and ensure that you are able to sustain key value-drivers such as profitability and cash flow over time.

As we have discussed, an effective sales forecast provides key leadership insights that will drive management decisions throughout the year. Take your time and create it by meticulously analyzing all relevant factors, and strongly consider utilizing the services of a professional CFO. The more that you invest in planning and preparation today, the more value you will create tomorrow.

Founded in 2001, FocusCFO® is a leading fractional CFO services provider, with more than 100 CFOs and Area Presidents throughout the Midwest and Southeast. For more information, visit www.focuscfo.com or follow us on LinkedIn.

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Hands on Guide to Cost Modeling

Hands on Guide to Cost Modeling

Hands on Guide to Cost Modeling

Article 5 in a Series of 5

By Todd Peter

In prior articles the key concepts and structures of developing a Cost Model were discussed. Important ideas to review are:

Granularity: Where in your portfolio of products/customers do you want to be able to calculate cost. The finest granularity is for an individual line item on an individual invoice. Higher granularity can be product groupings, or even at the level of a single plant or office. There is no right answer. The decision rule is your measurement granularity should be the same as your required decision making.

Processes: All products (and services) have a cost related to the business processes used in delivering them. Process cost plus material gives total cost. Determining the processes you want to include is a balancing act between accurate detail and practical data measurement and collection. 

Level: This idea refers to how you desire to carve the total cost into different groups. The groups typically are considered incrementally variable, variable, semi variable, semi fixed, and fixed. Selecting the groups properly will give you the best information about cost / volume relationships. The tradeoff is again complexity versus improved insights. 

Special Process Cases: we discussed several that can add some twists and turns to the calculation of cost, review article #4 to check if these may impact your situation.

The Universal Cost Modeling FORMULA

At the risk of insulting every reader, the cost formula is simple:

Cost = Sum for each material and process required (qty-each * cost – each). The more difficult part is defining all the materials and processes and defining the numbers qty-each and cost- each. In some cases, qty-each is pretty easy if the engineering department has specified by design the quantity each required and the purchasing department can get vendor quotes clearly defining the cost-each. The amount of data however can be very large with material list running 100’s or 1000’s of parts per product and the number of products in the 1000’s. The Cost-each is usually harder for processes.

The Process Cost, Cost-each Calculation

Here is where the cost modeler earns their keep. Again, the formula is not hard.

Process Cost Each = Total cost for that Process / Total quantity produced.

Your first challenge is to define a process where you can collect from readily available data and data you can get periodic updates the total cost of a process. Your accounting system may not collect cost by process and you must prepare a pre-analysis to collect total cost by process. You may find that your process has a mixed bag of costs at various levels – from incrementally variable to fixed – and this cost must be broken into several pieces to analyze. For example, you have collected the total cost for the “smushing department” for each of the last 3 years. The company ran that department for 1000, 800, and 2200 hours respectively, or in other words the volumes were greatly different. You would need to break out variable and fixed costs to get good measures of total cost for your model.

The second challenge is the denominator – quantity. In some businesses with a single product quantity is a simple sum of the units produced. Once product complexity increases and the required-qty-each begins to vary, then a common basis for quantity must be developed. Often this common metric is hours. But it can be any number of quantifiable numbers such as pounds of finished product, cubic feet of product, square feet of space utilized, pounds of a component product, man-hours, machine hours, cell operation hours, plant operation hours, or some more clever and unique numbers as we discuss below.

The challenge for the cost modeler is finding common units for the denominator that best reflect the nature of the cost/volume relationship. Ideally if the relationship between the quantity in the denominator is 100% linear with incremental costs, pretty linear with variable and semi variable costs, and seems “rational” as a way to split fixed costs. What does the term “rational” mean; an example helps. If you were dividing up the cost of your maintenance expense, using square feet for the process department times quantity produced as the denominator that is more rational than quantity as the denominator. (Now, the perceptive reader should recognize that the term square-ft * quantity is an odd idea. But recall that when we do this for all parts and are dividing the total cost for ALL spreading it by this metric, that while non-tangible, is rational). The process of spreading costs is called in the profession, allocating costs; it is an art not a science.

Choosing good denominators requires skill and experience. The CPA profession prefers the time honored “direct labor hours” as a familiar and defensible GAAP compliant method. And this made more sense in the days of high labor intensity, and a high mix of variable to fixed costs. In today’s world where automation has driven direct labor to relatively very low levels of total cost this can be a very misleading denominator. Just think of a $2M machine run by one operator versus a $100,000 machine by 2 operators. Allocating overheads by labor hours could be very, very, misleading.

Keeping Track of Incremental, Semi-variable, and Fixed Costs is Important

Many business decisions require an understanding of the (up or down) impact on the business from a change in sales volume. We have discussed these costs in earlier article #3. To improve the quality of your cost model you should group and maintain all the costs in these buckets.

So practically what does that mean? A single cost element = qty-required * cost-each. So, as you develop the cost-each for incremental costs it should include all the costs that are tied to the element. Take labor as a familiar cost element. You pay your workers $16/hour. You also pay their payroll taxes (10%), some health care costs (8000/year). Overtime is not allowed (for simplicity). Their labor cost each hour is $16 + $1.6 + $4. While health care seems a “fixed cost” and many firms include it in SGA overhead unrelated to direct labor rates, the discerning analyst will understand that changes in employee counts are going to drive health care costs. This simple example must be repeated for every process in your cost model. Maybe you have one labor rate? Maybe you have some employees at $16 and some at $28.

A well-founded knowledge of incremental, variable and fixed costs components of a “product” is critical to understanding margins and impact the quality of all 10 of the reasons costing is important (article #2).

Costing is hard; it has taken 30,000 words to just scratch the surface! Unlike financial accounting, there are no GAAP rules that dictate right and wrong ways to cost. The goal of the cost modeler is to provide costs and margin estimates, that are close enough to allow prudent tactical and strategic decision making. In many small businesses, owners “know” deep in their bones what makes them money and what does not. At some point in the maturation and growth of a business and especially should an owner desire to sell the business to third party, costing and margins become critical.

I would argue that margin % is likely the single most important guide to the health and future success of a business, and understanding cost and how they impact margins a critical skill for business success and survival. Thanks for reading. Call us if you need any help.

Todd Peter is a FocusCFO Principal based in Cleveland.

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Hands on Guide to Cost Modeling

Practical Costing Situations and Concepts: 4 Cases

Practical Costing Situations and Concepts: 4 Cases

Article 4 in a Series of 5

By Todd Peter

You are ready to begin building your cost model, or perhaps in the process of selecting/upgrading your ERP software and want to plan through how it will support your cost model. As we have discussed, at the core of a cost model are the business processes that make up your cost, plus any materials used of course. Here we discuss 4 concepts to guide your thinking. Especially when considering the platform (e.g., ERP or Excel) where you will build your Cost Model, you must determine if your ERP system will accommodate some of these cases. A skilled Excel modeler can accommodate just about anything!

By and large these concepts apply to manufacturing situations and are most easily understood in that context.

Discrete and Batch Processes

In a discrete manufacturing process product, finished parts are distinct and identifiable. What this means is even though you may make 10 (or 10,000) at a time, they are made individually. The time or effort or resources (costs) to make discrete products are driven by the countable number made. Examples are common household products like a toaster or a PC. Cost models for discrete processes are the easiest to model as most costs follow the formula of Time/each or QTY/each and cost can be calculated multiplying by the cost rate ($/time, or $/qty) to get cost.

Batch process products are made a batch at a time. A common example is a chemical reactor process. Materials are placed in the reactor, heat applied and some fixed time period later (say an hour) a batch of reacted chemicals is ready. The batch size can be 100, 200 or 2000 gallons up to the size of the reactor tank, but it takes an hour to process regardless. Batch costing requires assumptions about the average batch size to be manufactured at any one time. Products with sequential batch process steps can be tricky as efficient operation requires operation not always at the max of all “tanks” but in fitted sets. Well designed and engineered processes will typically be set so that a BIG tank feeds exactly X smaller tanks. In real life this is often not the case as recipes change faster than do hard fixed assets.

Continuous Processes

A continuous process is best thought of as a batch process in interconnected pipes. This is quite different than a highly automated discrete process that seems to flow but each unit is still an individual. An example of continuous processes are oil refineries. Here flow rates per hour and costs per hour and varying yield rates are common elements of costing. Other complexities typically arise in continuous processes as a common feedstock branches into different products undergoing different processes along the way. Other common issues are dealing with and assigning a negative cost to by-products that are generated and (hopefully sold off) to reduce cost. Other challenges often involve items like catalysts which are used in the process, and can be regenerated for a lower cost than buying new and recycled back into the process. Manpower in continuous processes is often quite low and heavily weighted towards fixed costs.

Man vs Machine Processes

Many manufactured products require both manpower and machinery to perform. Sometimes the relationship between man hours and machine hours is 1:1. Sometimes it is less when a single man can tend multiple machines. Sometimes a crew runs a machine. Calculation of cost rates in man/machine environments is usually best attacked with a developing a man cost rate and a machine cost rate and tracking and applying those rates separately.

Some of the challenges in developing these rates are addressed in the final article. But for developing the overall approach to your Cost Model, recognizing that you have both man and machine rates is important. Most sophisticated ERP systems allow both rates, which makes cost modeling much easier at even the most granular level.

Man/machine processes are very common in certain construction projects and the same concepts apply.

Cellular Processes

A close cousin to man/machine processes are cellular processes which will typically involve a number of machines executing sequential process steps manned with 1 to several operators. While similar to the simple man/machine model a cell is costed based on its “tac” time of the time interval to produce a single part. The cost for the collective manpower and machine cost gets spread to an individual part based on the time to complete the entire cycle. This contrasts to calculating the cost at each of the machine steps and summing it. The cellular cost is based on the time of the slowest o bottleneck process in the cell. In a culture of continuous improvement, the pacing process can change and the “tac” time reduced. Careful construction of your model to allow for changes will make you updating process much easier and quicker.

These special processes are the most common in manufacturing costing. Thinking through what kind of processes will speed you path to building a model as you recognize common process type can be duplicated for specific individual cost elements.

The next article provides a hands-on guide to cost modeling.

Todd Peter is a FocusCFO Principal based in Cleveland.

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Hands on Guide to Cost Modeling

Three Core Concepts in Building a Cost Model

Three Core Concepts in Building a Cost Model

Article 3 in a Series of 5

By Todd Peter

In prior articles I have discussed the reasons behind the importance of understanding margins (price minus cost) for the seller of any product or service. Your Cost Model is the framework for calculating costs. A Cost Model has the following objectives that often require trade-offs:

  • Captures the costs (wages, expenses, capital costs) of your business
  • Allows an understanding of the relationship between costs and volume produced and sold.
  • Allows calculation of cost (and hence margin) that are reasonably accurate.
  • Is simple enough you can gather the proper input data, and update it periodically.

I have argued the critical nature of understanding your costs at the most granular level. Now what in the world does that mean? The least granular level of a business is the annual financial statement, particularly the Income statement. This will tell you if the business as a whole made money. Increased granularity could be; does a product line make money? Or a geographic region? Or a certain type of customer? The most granular is a specific product to a specific customer in a specific time period.

Understand What Level of Granularity You Need

Picking the right level of granularity is the first concept in building your Cost Model. This decision requires well judged consideration of the objectives above. A Cost Model lumped at a high level of granularity will be useless for decision making. I will allow it does depend on scope of the decision maker. The CEO of a $5B corporation will have little issue deciding to sell off or shutdown a perennial money losing $25M operation based solely on its income statement. The GM of that business would be best served to be way more granular and figure out why they are losing money product by product.

Understand the Product Process

The second element of a Cost Model is the idea of Process. The cost of a product is really a sum of the cost of all the process involved in getting that product to a customer. In manufacturing it’s very common to define all the manufacturing processes and collect and measure the cost to manufacture. There are however other processes involved in getting the product to the customer. Selling costs can be included (rep commissions, sales wages), royalties and licensing fees, and often very important outbound freight costs for products shipped FOB customer dock. In a custom or semi-custom build environment (think special equipment or even items such as residential doors and windows) there is an engineering cost to fulfilling each order, and often an engineering cost for simply quoting even if the order is not won. In a design services firm, the cost is heavily weighted to professional staff tasks.

Choosing the right processes to include in your cost model is the second concept in building your Cost Model. The familiar issues of granularity and materiality will drive these decisions. Is the process a significant part of cost? Does it vary meaningfully across customer/product types or is an average good enough? Can you identify the costs so that you can provide meaningful inputs to the cost model?

Traditional concepts in financial accounting reporting are often not very helpful once you step outside very direct costs (material and labor in a manufacturing environment, or billed hours in a services environment). GAAP rules often will record costs in lumped categories of overhead that meld specific costs and general overhead. Freight is often one of the most problematic, both on inbound and outbound costs as many ERP costing systems do not give good tools for capturing landed cost, or outbound freight cost. Getting good cost inputs for the important processes may require reconfiguring your financial reporting systems at lower granularity, creating challenges within the organization.

An important consideration is understanding if the process costs vary across product/customer segments. If it does than it’s an important Cost Model candidate. If it is pretty much the same a simple average can be used or decisions need be made understanding that these costs must be covered by margin. As example is helpful. If all products have a sales person commission of 3% there is no need to include commission in the margin calculation. And any product with under 3% margins is a clear loser.

Understand Whether to Include Variable, Semi-variable or Fixed Costs

Choosing the “Level” in the cost structure is the third concept to establishing your Cost Model. You have decided on the granularity level and the processes to include. The last decision is deciding if you want to include only variable costs, or also add semi-variable or fixed costs into your Model.

First capturing the variable costs is mandatory to have any usefulness to your Cost Model. A Cost Model that captures only variable costs results in a margin know as Incremental Margin. If you sell at anything less than Incremental margin you are by definition shipping dollar bills along with the product. In a manufacturing environment variable costs will include materials, labor, supplies, consumable tools. In a service environment they would include the labor for the hours worked on the service, any supplies used, and perhaps costs to drive to the customer location. The costs would NOT include costs that would likely not go away for that specific job or order. These could include supervisors’ salaries, or the cost of the maintenance staff. Incremental margin is useful only for a specific order and selling based on low incremental margins is a quick trip to business failure.

 The second level is semi-variable costs. These costs generally do not go up or down with ONE specific order but over time and multiple orders are related to the number of products produced. These can include supervision, maintenance, software licenses, quality assurance, and support tasks such as purchasing, shipping, or expediting. These costs are variable over a period of time typically ranging from 6 – 18 months. The resulting margin is generally called Contribution Margin. Selling products on an ongoing basis, for no Contribution margin is a recipe for losing money. Contribution margin lets you make decisions about the lowest prices you can possibly accept for some portion of your business sales.

The third level is fixed costs. Fixed costs are costs that do not go up or down with monthly or even 6 month variations in volume. The most common are rent, insurance, and top executive salaries. These can also include depreciation on machinery, or lease costs for machines or equipment used in a business. Fixed costs are spread (allocated is the common technical term) across all products in a manner that is rational and seems reasonable. When fixed costs are included the cost is referred to as Full Cost and the margin, Gross Margin.

HOWEVER, there is a grey area in the realm of Fixed Costs. Manufacturing firms typically include all manufacturing and costs of running their plant in fixed cost but exclude any administrative functions and sales. In large construction firms, almost all costs are loaded into Full cost including administrative, financing, and everything but true bottom-line Profit. Service firms vary considerably in their treatment.

Implementing your Cost Model is often done with tools such as Excel or with the costing module of your ERP system. Excel based solutions give the greatest flexibility and ability to deal with complex shared costs but suffer for collecting detail data of bills of material and process costs captured in ERP systems. ERP solutions often are frustrating for their lack of flexibility and ability to move up and down in granularity. The ideal is often an Excel linkage to the ERP database, using advanced Excel modeling tools coupled to the mass detail in the ERP system.

The next article will look at four practical costing situations.

Todd Peter is a FocusCFO Principal based in Cleveland.

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Hands on Guide to Cost Modeling

10 Reasons Why Costing is Important

10 Reasons Why Costing is Important

Article 2 in a Series of 5

By Todd Peter

The goal of most businesses is to make money. Doing so is simple if you sell your offerings for more than it costs you to acquire, make or provide them. Let’s look at some of the core elements of a business and how understanding cost will impact these decisions. (Again, in this article I will refer to “products” for writing simplicity, and mean products or services or a combination of both. In later articles I will discuss some of the issues uniquely related to the costing of services.)

First a clarification, that was noted in the introductory article. The idea of cost is to understand the cost of a single item that you sell. Fully understanding the cost of what you sell can be a challenge. Often you must make assumptions and estimates. Sometimes the best you can do is to understand the costs of a group of like products. However, the goal is a cost at the most granular level.

1. Calculation of Margin

Margin is simply the price you charge less the cost of the product you provide. Margin $/unit and particularly margin % (margin/sales price) are likely the top analytic measure that will help you understand the profitability and health of a business. Almost invariably a business with negative margins is doomed.

 

2. Pricing

Closely related to margin is pricing. Many businesses develop their prices based on their estimate of their cost for a unit. Pricing is a decision; cost is a calculation. Setting prices is perhaps the most important determinant of business success and failure. While setting your price is always a decision, sometimes the negotiating power is with the customer and they will usurp your decision making and tell you what they are willing to pay and then your decision is whether to take the order or not.

3. Business Process Development

An owner evaluates his business and its costs and finds that his cost is too high to make a margin at prices the customers will bear. To stay in business the owner must reevaluate their business processes: how they buy, how they add value, investments in capital or other assets, how they pay their employees, etc. Understanding cost is fundamental to these evaluations.

4. Sourcing & Hiring

All businesses need to understand where their input costs (material and labor) need to be to manage what they pay for these inputs.

5. New Product Development

Any new product plan should require a target price, margin and hence a target cost. The new product development process must carefully include ongoing cost calculations to assure the end result is potentially a success.

6. Price/Volume Considerations

Most businesses are faced at one time or another with considering taking on a “big” new order or customer who wants special pricing treatment. Understanding current costs and also cost/volume behaviors are key to making these decisions.

3. Business Process Development

An owner evaluates his business and its costs and finds that his cost is too high to make a margin at prices the customers will bear. To stay in business the owner must reevaluate their business processes: how they buy, how they add value, investments in capital or other assets, how they pay their employees, etc. Understanding cost is fundamental to these evaluations.

4. Sourcing & Hiring

All businesses need to understand where their input costs (material and labor) need to be to manage what they pay for these inputs.

7. Capital Expenditures

Most capital expenditures (new machines, new buildings, new software or technology) will have an impact on cost. These presumed cost improvements can justify the purchase. Conversely capital spending to increase output will impact costs and understanding the full impact of these costs may lead to deciding yes or no on these expansions.

8. Outsourcing

A business may have opportunities to outsource some or all of its processes. Cost is one of the key determinants of informing these decisions.

9. Customer and Channel Management

Costs will often vary based on specific customers and specific channels of going to market.

Understanding how cost varies by these segments will impact decisions on what type of customers toseek out and which you might consider firing.

10. Mergers and Acquisitions

In the process of evaluating an acquisition the impact of the acquisition on product costs can make a substantial impact on the synergy (or lack) in the deal negotiation. In negotiating a sale understanding post sale costs and margins can create opportunities to negotiate a bit more of the synergy into the sales price.

Cost is a core knowledge point for running a business. Few business decisions can be intelligently made without understanding cost and its behavior. The 10 above considerations are of great strategic importance. I’m sure the diligent reader can identify another 10.

In the next article, we turn to a look at the core decisions for building your cost model.

Todd Peter is a FocusCFO Principal based in Cleveland.

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