Boost operational performance with Dynamic Costing®
A product will most likely not cost the same in 2021 as it did in 2019, but it may not even cost the same in May 2021 as it did in January 2021 – or it wouldn’t if the manufacturer is using Dynamic Costing®.
Many manufacturers set their cost standards annually, using historical data and taking into account certain expectations for the coming year. Unfortunately, no one expects a global pandemic or a week-long blockage of the Suez Canal or even just a sudden surge (or loss) in orders. Regardless of where the pressure originates, manufacturers need to see how certain unforeseen elements are affecting their cost standards and adjust accordingly. Dynamic Costing empowers manufacturers to do just that.
During the virtual PowerPlex 2021 conference, Cory Wendt, a principal in Baker Tilly’s supply chain and manufacturing group and practice leader of analytic and financial solutions, presented “Leverage Dynamic Costing® to enhance operational performance.” In the presentation, Wendt discussed what Dynamic Costing is, the differences between it and standard costing, and how to implement the approach.
The case for Dynamic Costing
A recent Baker Tilly survey of manufacturing clients revealed nearly 60% of them review their cost standards only annually, while 12% said infrequently. Just 16% of respondents said they review their cost standards on a quarterly basis and a mere 13% said monthly. What that reveals is more than 70% of them are driving their daily decisions with data that is over a year old.
In a nonpandemic period, businesses may be impacted significantly by factors specific to them or their industry, such as new customers, freight and cargo cost increases, and/or supplier shortages and tariffs. The pandemic presented businesses with a unique set of issues, forcing them to make modifications to accommodate employee-distancing requirements, which also meant adding shifts.
No matter the reason, those externalities impact the manufacturing business model, and if a company sets its costs standards for the year, as soon as one of those externalities occurs, it is still affecting the cost standard even if the actual cost being carried in the system does not appear to be.
Baker Tilly developed the Dynamic Costing solution with the belief that costs are not static in a business. The approach uses an action-driven cost aggregation to better align with business activities and the costs they are incurring. The goal of Dynamic Costing is for a business to see the continuum of factors reflected in its costs, using automation and data the business already has.
Businesses can use Dynamic Costing in supply chain, retail and sales, finance, operations and trade compliance to create one comprehensive view that can be understood by a variety of stakeholders.
The information presented through the Dynamic Costing module should help businesses see how well they are maintaining each of their products for their customers. They can see not only the actual cost of making each product, but also where a shift may be causing material variances. Additionally, businesses can see how they are performing against optimal outcomes. It is really up to the business how it will be used since the information can be customized to focus attention on the areas most important to that specific audience.
Differences between Dynamic Costing and standard costing
Standard costing looks backward. Its main components are labor, materials, fixed overhead and variable overhead. Whether a business makes 100 units or 1,000 units, standard costing takes all of those costs and applies them to the units it is making. Unfortunately, it might not include all the costs to make those units, showing only static standard costs developed many months prior to current production. It is fine for the purposes of generally accepted accounting principles (GAAP) and financial accounting, but it doesn’t necessarily mean it should be used for managerial accounting. For example, if sales underperform and the plant doesn’t make as much, does it mean the units cost twice as much to make? Even though somebody has to absorb that cost, it doesn’t mean the business should do it using an inaccurate cost allocation. By not incorporating the daily, weekly, monthly influences into costing, a business may be pricing itself out of a market by reflecting inaccurate or improperly absorbed costs. It is also failing to provide the business a clear picture of which products are responsible for its profitability.
Dynamic costing determines total product cost by using the aggregation of a collection of independent business models to provide a full view of the business.
To build a cost structure, it has to take into account all parts of production: material costs, labor, facility, equipment, storage, transportation, customer service, and operating expenses. These are historically different departments and have different functions, but Dynamic Costing requires all sorts of information that usually does not reside in one place. When properly implemented, the technology will continuously integrate all of these informational sources into a single view to help a business understand its cost structure of a given product family or given SKU.
How Dynamic Costing is implemented
The Dynamic Costing module is built upon the native Plex Manufacturing Cloud database architecture to enable decision makers to visualize their operations and financials as they haven’t been able to before.
Baker Tilly created the Dynamic Costing module to give businesses a real-time view of their profitability via data analytics in a consumable format. On a daily basis, stakeholders can identify anomalies in their data that need to be addressed, or they can simply use the data to cost or price the product more accurately based on what the numbers are indicating.
The base model Baker Tilly implements would cover the following areas:
- Sales and margin by customer and product line
- Work center monitoring
- Production throughput
a. Exception reporting - Dynamic cost allocations
- Budget-to-actual spending
- Customer invoicing
Because of the end-to-end visibility provided by the module, a business can quickly see which products are making it money and why.
In a legacy approach, establishing standards on an annual basis is complicated, as it requires a plant controller or CFO to conduct activities like an engineering study. Being that they are often somewhat physically removed from the assets in their facilities, it becomes difficult for them to allocate costs associated with the assets, leading many to apply a blanket allocation that is not indicative of actual costs at the item level.
Dynamic Costing Module Views are deployed in a curated, web-based environment that enables both desktop and mobile browsing. Dynamic Costing empowers organizations by significantly augmenting the responsibilities of technical developers across a variety of disciplines, as shown below. Baker Tilly estimates that annually, three or more full-time equivalents (FTEs) are augmented through the deployment and consistent use of our Dynamic Costing Module Views.
In the example below, when allocated as percentage of sales, Product Line 3 has a 24.5% margin and a $530 cost per unit, and Product Line 4 has an almost 35% margin and a $31 cost per unit.
When a business uses the Dynamic Costing approach and allocates as a percentage of the actual hours of work center activities, Product Line 3 now has a margin of 25.6% and $360 cost per unit, while Product Line 4 has a margin of 21.9% and a $39 cost per unit.
The examples show the percentage of sales might not be correct. The Dynamic Costing module also introduces “unutilized facilities costs,” an indication that sales didn’t sell enough of the product. The business will have to incur those costs, but, at an item level, should the unit cost more because sales are down if it costs the same to manufacture? If a company is absorbing those costs by charging customers more like if it is trying to make 10% or 20% margin on Product Line 3 and asking $580 or $630 a unit, it may be pricing itself out of the market since it should really be charging closer to $400 or $440 a unit.
Dynamic Costing helps businesses make more informed pricing decisions by having all of the data involved in production in one place. Management can sit with sales and operations and focus on how they are treating their best customers, and with their improved visibility, they can assess where they can offer other customers better prices to entice them to become even bigger customers. Management can also more effectively rationalize the specific items they manufacture, to determine which contribute to the bottom line meaningfully, and which do not.
For more on this topic, watch this webinar recording to find out if you cost standards are dynamic enough to keep up or visit Baker Tilly's Dynamic Costing solutions page.
