Managing Finance (MNGFIN)
Week 5: Strategic management accounting
The nature and role of strategic management accounting
Textbook reading (Atrill & McLaney: Ch. 9)
Last week’s objectives helped you develop an understanding of the role of budgets
in the strategic planning process. Budgets are useful tools for setting financial
standards of performance and act as motivators for effective management. However,
budget preparation, management, monitoring, and analysis represent only a small
portion of the role that management accounting can take within the strategic
planning process. Of course, strategic planning requires an organisation to fully
examine and analyse itself both internally and externally.
Management accounting is a unique field that is excellently positioned to assist with
both the internal evaluation as well as external analysis that organisations must
conduct to remain competitive. It may seem that management accounting is strongly
focused on the measuring of internal performance of the organisation. This was the
common belief for many years; however, in the contemporary business landscape,
companies are finding that they can also practice such analysis on their competitors
as well as their customers. Consequently, this forces them to be more outward
looking, to develop competitive strategies, and to monitor these strategies using the
appropriate range of performance measurements. The role of management
accounting is expanding from supportive to participative as new methods are being
used to help meet corporate strategic objectives.
Competitor and customer profitability analysis
Textbook reading (Atrill & McLaney: Ch. 9)
To better understand the expanding strategic role that management accounting is
acquiring within the organisation, it is important to examine two key areas from this
field: competitor analysis and customer profitability analysis. The methods and
techniques that you have examined and explored to this point have all been focused
on measuring and analysing the performance of the organisation itself. This
information is of great importance, as it provides detail with regards to profitability,
sustainability, etc. However, if the concentration remains solely on the individual
organisation, true analysis has fallen short, as companies do not operate in vacuums.
Managers must do their best to understand the competitive stance of other
organisations with regards to costs, strategies, resources, capabilities, and
objectives. In other words, an organisation must do its best to understand what its
competition might do if it were to reduce prices, launch a new product, or attempt to
enter a new market. While obtaining such precious information proves to be difficult
at times, there are numerous sources that can be utilised, such as public financial
reports, industry reports, government statistics, and simple observations of
behaviours and a ...
1. Managing Finance (MNGFIN)
Week 5: Strategic management accounting
The nature and role of strategic management accounting
Textbook reading (Atrill & McLaney: Ch. 9)
Last week’s objectives helped you develop an understanding of
the role of budgets
in the strategic planning process. Budgets are useful tools for
setting financial
standards of performance and act as motivators for effective
management. However,
budget preparation, management, monitoring, and analysis
represent only a small
portion of the role that management accounting can take within
the strategic
planning process. Of course, strategic planning requires an
organisation to fully
examine and analyse itself both internally and externally.
Management accounting is a unique field that is excellently
positioned to assist with
2. both the internal evaluation as well as external analysis that
organisations must
conduct to remain competitive. It may seem that management
accounting is strongly
focused on the measuring of internal performance of the
organisation. This was the
common belief for many years; however, in the contemporary
business landscape,
companies are finding that they can also practice such analysis
on their competitors
as well as their customers. Consequently, this forces them to be
more outward
looking, to develop competitive strategies, and to monitor these
strategies using the
appropriate range of performance measurements. The role of
management
accounting is expanding from supportive to participative as new
methods are being
used to help meet corporate strategic objectives.
Competitor and customer profitability analysis
Textbook reading (Atrill & McLaney: Ch. 9)
To better understand the expanding strategic role that
management accounting is
3. acquiring within the organisation, it is important to examine
two key areas from this
field: competitor analysis and customer profitability analysis.
The methods and
techniques that you have examined and explored to this point
have all been focused
on measuring and analysing the performance of the organisation
itself. This
information is of great importance, as it provides detail with
regards to profitability,
sustainability, etc. However, if the concentration remains solely
on the individual
organisation, true analysis has fallen short, as companies do not
operate in vacuums.
Managers must do their best to understand the competitive
stance of other
organisations with regards to costs, strategies, resources,
capabilities, and
objectives. In other words, an organisation must do its best to
understand what its
competition might do if it were to reduce prices, launch a new
product, or attempt to
enter a new market. While obtaining such precious information
proves to be difficult
4. at times, there are numerous sources that can be utilised, such
as public financial
reports, industry reports, government statistics, and simple
observations of
behaviours and actions. As the reading mentions, one of the
most sought-after areas
is the cost structure of competitors. Such details can uncover
valuable insight into a
competitor’s ability to match price reductions and to weather
changes in sales
volume.
The importance of understanding possible movements or
reactions of competitors
cannot be denied, yet it is equally important to properly analyse
the customers that a
business currently has or wishes to attract. Just as the internal
focus of management
accounting can be used to analyse the profitability of separate
business units or
divisions within an organisation, a strategic focus can be taken
with regards to the
profitability of a particular customer, or categories of
customers.
5. Consider an appliance manufacturer that produces and sells
three separate
products: refrigerators, ovens, and dishwashers. While it may be
beneficial to
understand the profitability of each product line, this company
may wish to compare
the profitability of its household versus commercial customers
or families versus
single customers. Doing so may help to reveal information or
trends that could
improve competitiveness, force pricing changes, or launch new
product strategies.
The examples provided in the reading (Example 9.1 and Figure
9.2) help to illustrate
how a simple customer profitability analysis can be conducted
and how it can reveal
vital information on a particular customer. The trend analysis in
Figure 9.2 shows
how costs have been rising in certain areas, and this analysis
assisted the
organisation in taking action to correct it.
Competitive advantage through cost leadership
Textbook reading (Atrill & McLaney: Ch. 9)
6. You are probably familiar with the popular strategies that many
businesses employ
to help solicit customers. Retailers are notorious for conducting
‘sales’, ‘reductions’,
or ‘clearance events’ that are aimed at attracting new customers
and retaining
existing ones. The intent in gaining the competitive advantage
is to make up for
lower profit margins with a higher sales volume. While
temporary price reductions
may help to boost sales and steal volume away from the
competition, such strategies
are often limited in their duration, as many organisations cannot
sustain their
operations over the long term with profit margins that are
minimal or nonexistent.
Remaining competitive on a low-price strategy requires that the
company work to
maintain low costs, as this will provide the organisation with a
wider margin of safety
and the ability to be profitable while charging a lower price
than the competition.
One of the greatest examples of this strategy has been Wal-
Mart. The organisation
7. focuses on low-pricing strategy for its customers and has been
able to do so through
effective cost management throughout its value chain. By
analysing the entire
sequence through which products flow from beginning to end
and eliminating
activities that are wasteful and add unnecessary (or redundant)
costs, Wal-Mart has
been able to keep costs down at each step of the chain, making
it a cost leader in
the retail industry.
Such value-chain analysis is an example of incorporating the
total life-cycle of a
product as part of the cost management process. Your reading
examines this and
two other costing approaches, target costing and kaizen costing,
which were covered
during the discussion of pricing and costing in a competitive
environment (Week 3).
As you will see, these costing methods are not intended for
independent use; rather,
they should be used to complement and support the other
8. methods as a part of the
total life-cycle costing approach. By effectively managing costs,
rather than simply
trying to reduce them, organisations better position themselves
to remain competitive
over the long term. Cost leadership is not so much a collection
of techniques, but
rather a philosophy that an organisation should strive to follow.
The organisation can
help make cost management an integral part of what the
company is—rather than
just what it does—by making individuals at all levels
responsible for costs,
encouraging and promoting ideas, and utilising benchmarks to
encourage and
measure performance.
Using the Balanced Scorecard
Textbook reading (Atrill & McLaney: Ch. 9)
Scorecards are great models for measuring performance. They
are used frequently
in various contests as a method for judging the performance
against a set of
specified criteria. Robert Kaplan and David Norton developed
9. the Balanced
Scorecard for organisations as a model for measuring and
evaluating performance
against certain standards. It is important to note that the
Balanced Scorecard is not a
‘ready-to-use’ tool, already set with criteria. Rather, it is a
framework that forces the
organisation to look at four separate functional key areas:
financial, customer,
internal business processes, and learning and growth. It is up to
the individual
company to develop its own standards and measures based on its
unique situation.
The primary purpose of the Balanced Scorecard is to force the
organisation to
critically look at all areas within the company, rather than
simply focusing on only a
few. While financial performance is important, it could come at
the expense of long-
term success; thus, it is important to also consider the customer
as well as learning
and growth issues. Customer satisfaction is vital; however, an
organisation must also
achieve certain financial results to remain competitive.
10. The Balanced Scorecard forces the organisation to consider the
effects of each area
on the other. Long-term financial success requires investment in
human resources,
attention to improving internal business processes, and a focus
on increasing
customer satisfaction. The relationship between these areas
must be strong, as they
are highly dependent on each other and must be addressed
together to enhance the
likelihood of organisational success. The example provided in
the reading, (Un)Real
World 9.10, helps to demonstrate why organisations must
address a wide range of
activities concurrently and shows the resulting complexity that
these organisations
are faced with. The (Un)Real World example depicts a situation
that does not
address the complexity of the operations as an integral set of
activities. In this
scenario, the use of the Balanced Scorecard would enhance
operational
11. performance, improve customer satisfaction (safety in this
case), and ensure that the
rest of the financial and non-financial issues would all be
addressed simultaneously.
Shareholder value analysis in strategic decision making
Textbook reading (Atrill & McLaney: Ch. 9)
The ultimate goal of managers within an organisation is to
increase the wealth of its
shareholders. These are the individuals who own the
organisation and have given
the responsibility to managers for securing an adequate return
on their investment.
As you can imagine, this places pressure on managers to
perform and achieve
financial viability within a reasonable amount of time. Failure
to do so may very well
result in a release from one’s duties! However, this goal must
also be balanced with
the long-term sustainability and competitiveness of the
organisation.
Traditional methods for measuring shareholder wealth have
centred on the
standardised financial reporting methods, such as profits. The
12. use of such traditional
evaluation standards has long been under fire due to the
inability to incorporate risk,
variations of accounting methods, and the short time period in
which profit is
measured. As a result, new approaches have surfaced to better
measure and
analyse the returns to shareholders over time. The reading for
this topic introduces
you to two concepts believed to better track such returns:
shareholder value analysis
(SVA) and economic value added (EVA
®
).
Based on the concept of net present value analysis, SVA looks
at the free cash flows
that an organisation generates through key variables such as
sales revenue,
operating profit margin, tax rate, additional investment in
working capital, and
additional investment in non-current assets. By working through
the examples
provided in the reading, you will see that organisations can
increase the wealth of
13. investors by focusing on increasing or decreasing these key
variables. These value
drivers become important considerations with regards to
strategic decisions, such as
acquisitions, new product development, or restructuring.
EVA
®
is based on economic profits and helps to evaluate whether
returns will
exceed the required returns of investors over the long term. The
formula for EVA
®
is
provided in your reading (p. 371) and illustrates that the key
variables of
concentration are net operating profit after tax, shareholder
required rates of return,
and amount of capital invested. By completing such analysis,
the organisation is able
to determine whether or not the business is increasing the
wealth of the investor or
has long-term growth potential. This allows the organisation to
choose strategies that
will increase EVA
14. ®
to its fullest extent. As you read through this section, you will
find
that both SVA and EVA
®
have their respective benefits and drawbacks. The
examples provided help to illustrate and reinforce the
usefulness of each approach.