The main point of interest for me in this chapter was the relationship between understanding your costs and a business being profitable.
Firstly a customer needs to feel they are acquiring something of value over and above what they are will to pay for it, be it a bottle of milk or an entire house, it does not matter. Secondly, the business in turn needs to exchange that item in return for something of value to the business – to cover all of its costs and make a profit!
How does a business know how much to sell a bottle of milk for; what price will leave all parties involved to walking away, satisfied? It is a merry-go-round between the market (customers, supply and demand) and the business. It is manager’s role to make sure all costs are factored, direct and indirect, into the unit price with an appropriate (realistic) margin hopefully resulting in that all important outcome of a profit……..which determines many customers will purchase the goods………which determines the price of goods and so forth. Of course there so are many facets to consider within these broad points I have mentioned such as suppliers, efficiency within the business units, competition etc.
For years I worked in a Government Health organisation, a public hospital, and believe it or not even this type establishment was looked at the same way as any other business – is the hospital performing efficiently and cost effectively, are staff attending to enough patients to meet budgets, raising enough revenue, are the managers doing their part to minimise costs and improve customer service eg wait times for patients. This chapter really touched base with my experience at the hospital. Everything was weighted (or attached to) against the costs involved in delivering a service, everything from giving a patient Panadol, a nurse putting in an IV drip to a doctor delivering a baby (direct costs) – all of these activities have obvious direct costs but don’t forget about the exorbitant costs incurred behinds the scenes eg cost of using the $200,000 defibrillator (allocation of machinery hours costs), the staff making the patient meals (indirect costs).
Government hospitals are a perfect example of activity based funding. Costs are incurred when someone comes in, for example, to get some sutures – the string, the doctor and nurses labour, the administration officer out in reception who took these patient’s details. The level and complexity of activity directly dictates how much is required to be funded by the Government (look at this in terms of how much to “charge” the government for these services). It makes sense when you look at it – the number and difficulty of services performed will determine how many doctors and nurses, supplies etc are needed – it goes hand in hand.
Patient presentation data is captured and costs are weighted on this information. How many people came in for services, what they were in for and how long the procedure/stay took were paramount to ensure that the hospital received the correct amount of funding. Just like a manufacturer or retailer takes into account the labour, plant, electricity etc to determine how much to charge to cover costs for that bottle of milk, the very same principles are evident in how much money the government with allocate to the hospital.
How does a business know how much to sell a bottle of milk for; what price will leave all parties involved to walking away, satisfied? It is a merry-go-round between the market (customers, supply and demand) and the business. It is manager’s role to make sure all costs are factored, direct and indirect, into the unit price with an appropriate (realistic) margin hopefully resulting in that all important outcome of a profit……..which determines many customers will purchase the goods………which determines the price of goods and so forth. Of course there so are many facets to consider within these broad points I have mentioned such as suppliers, efficiency within the business units, competition etc.
For years I worked in a Government Health organisation, a public hospital, and believe it or not even this type establishment was looked at the same way as any other business – is the hospital performing efficiently and cost effectively, are staff attending to enough patients to meet budgets, raising enough revenue, are the managers doing their part to minimise costs and improve customer service eg wait times for patients. This chapter really touched base with my experience at the hospital. Everything was weighted (or attached to) against the costs involved in delivering a service, everything from giving a patient Panadol, a nurse putting in an IV drip to a doctor delivering a baby (direct costs) – all of these activities have obvious direct costs but don’t forget about the exorbitant costs incurred behinds the scenes eg cost of using the $200,000 defibrillator (allocation of machinery hours costs), the staff making the patient meals (indirect costs).
Government hospitals are a perfect example of activity based funding. Costs are incurred when someone comes in, for example, to get some sutures – the string, the doctor and nurses labour, the administration officer out in reception who took these patient’s details. The level and complexity of activity directly dictates how much is required to be funded by the Government (look at this in terms of how much to “charge” the government for these services). It makes sense when you look at it – the number and difficulty of services performed will determine how many doctors and nurses, supplies etc are needed – it goes hand in hand.
Patient presentation data is captured and costs are weighted on this information. How many people came in for services, what they were in for and how long the procedure/stay took were paramount to ensure that the hospital received the correct amount of funding. Just like a manufacturer or retailer takes into account the labour, plant, electricity etc to determine how much to charge to cover costs for that bottle of milk, the very same principles are evident in how much money the government with allocate to the hospital.
Each activity is weighted (costed) taking into account all of those indirect and direct costs, and then allocated for each activity – the sutures procedure may incur a cost $1,000 to do, and a baby $25,000 as it was weighted as a more cost intensive procedure (is that they right word??!).
Accounting organises these costs to allow executives to visually see and make decisions about how much money they are going to ‘pay’ for hospital, to keep it in business (similarly when a customer purchases something). I found that if data being recorded is not accurate or being skewed than this picture being presented to the executives, they cannot get a clear picture of what is going on. Is the hospital running efficiently or is there room to improve in a department – possibly outlay some capital and buy a new ultrasound machine, expensive but now 20 patients at $300 each can be seen opposed to only 15 – the cost of outlaying the capital for the new equipment will quickly be outweigh by the benefits.
Accounting organises these costs to allow executives to visually see and make decisions about how much money they are going to ‘pay’ for hospital, to keep it in business (similarly when a customer purchases something). I found that if data being recorded is not accurate or being skewed than this picture being presented to the executives, they cannot get a clear picture of what is going on. Is the hospital running efficiently or is there room to improve in a department – possibly outlay some capital and buy a new ultrasound machine, expensive but now 20 patients at $300 each can be seen opposed to only 15 – the cost of outlaying the capital for the new equipment will quickly be outweigh by the benefits.
The hospital has only recently converted over to an activity based funding model and was originally block funded on ‘historical costs’ – roughly put, taking last years budget and whacking on a little indexing, say 3%. This supports the course text that past costs are a good place to start in regards to looking to the future and estimating costs forecasts – of course trends can change in a heartbeat.
I do question how managers of extremely large companies deal with bad record keeping or accounting which filters through to decision making. I feel a little cynical because I am always knocking on in my blogs or assignments about trust in accounting or the lack thereof. I have a motto of ‘Rubbish in, Rubbish out’! If your accounting data is not quite right going into the system, then of course your decisions on that data coming out is not going to be as accurate as you would like to hope - almost like having one eye blind folded.
This could be anything from a cost centre manager saying ‘just allocate the cost to that department’s cost centre as there is stack of money still left in it’. In the big scheme of things it may be quite harmless as the bottom line of that business ends with the same results when all cost centre are brought together at year end……..but this really does hinder a decision makers ability to say ‘yes run that program again with the same budget’ and if all costs are not accounted for then determining an accurate cost base is virtually impossible - there is a large portion of expenditure still sitting in another cost centre, not to mention skewing that cost incurred for that other department.
The core concepts I have taken away for this chapter are:
- All costs need to be examined and factored over business activities to cover costs, keep pricing competitive and to ensure a profitable outcome;
- Intimate knowledge of the partnership between activity levels and what is needed to cover costs – can the business sustain fluctuating activity;
- Understanding the difference between fixed costs, variable costs and where these costs are coming from within the business are paramount to moving the business forward, improving profitability and efficiencies;
- There are difference ways of measuring the costs dependant on the various processes within a business and subsequent allocation of costs to a cost object;
- Managers need to keep their finger of the purse about where, what, why and how much expenditure is being incurred to predict any adjustments to be made to run the business effectively.
Oh, by the way I have absolutely no idea how much a defibrillator costs......or for that matter the costs involved for the delivery of a baby!! But I am sure you get where I am going.
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