Three-Way Path to Fair Analysis of Performance

International Journal of Applied Finance For Non-Financial Managers (ISSN: 1742-528X) Volume 1 Issue 3

Is the operating manager being burdened with an unfair share of the company’s costs? Clearer performance reporting, measuring his unit’s contribution, is needed.

By Professor Mike Harvey

Budgeting gives quantitative expression to plans. Budgetary control involves extracting significant deviations from the budget in the form of variances and analysing these in order to assess and control events. Care is needed in the way budget and performance information is presented, because this is likely to influence its reception.

A way of setting out the information, based on its segregation into those items which the operating manager can and cannot control, will help in the appropriate and efficient analysis of various aspects of the organisation’s performance.

For simplicity, in the following discussion the word ‘unit’ will be used to mean either a department or other operating unit or the enterprise as a whole. What is said will be equally applicable to all levels within the organisation.

An initial step in budgetary control concerns the classification of costs. This is because it is important to draw a distinction, for control purposes, between:

Fixed costs are those not affected by the level of output over the time period being considered. Examples of fixed costs include the costs of managing a unit, the occupancy costs of rent, rates and so on, all of which tend to remain the same whether the unit produces at 60%, 90% or some other percentage of capacity.

Variable costs are related to the level of output, although not necessarily having a linear relationship with it. Examples of variable costs include the cost of the direct materials used in production, royalty payments and the use of power directly related to the levels of production.

Indirect costs are expenses which are jointly incurred by a number of different cost centres. Thus, for a manufacturer who produces a number of products, at different units but for the same market, an advertising expense incurred by jointly advertising all of those products in a particular publication will have to be allocated between the various units concerned. In the large organisation, the general manager’s salary will have to be apportioned over a number of departmental cost centres. In the production unit, consumables will be allocated over the different products.

Direct costs are those costs or expenses directly attributable to a cost centre, that is the operating unit, and the ‘directness’ will depend upon the level of the unit being considered. Direct costs in any factory department will include costs of production, ie those costs associated with raw materials used direct labour, direct expenses and so on.

Controllable costs are those over which the operating manager has some control, although this may be only within certain limits – for example, the power used to heat his department, or the cost associated with substandard production due to insufficient training and supervision of operatives. Uncontrollable costs are those ‘imposed’ on the operating manager, such as the rent for his unit negotiated by higher management, or the rates dictated by the local authority.

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