Year: 2020

The factors affecting pricing decisions are varied and multiple. Basically, the prices of products and services are determined by the interplay of five factors, viz., demand and supply conditions, production and associated costs, competition, buyer’s bargaining power and the perceived value. We would like to divide them as Internal Factors and External Factors.

Internal Factors

1. Marketing Objectives and Pricing Objectives

Pricing objectives may be as stated earlier profit objectives (return on sales investment and maximisation of profits), sales objectives (increasing sales volume and increasing market share) and maintenance objectives (price stabilisation and matching the competition). Various pricing objectives have important implications for a firm’s competitive strategy. Pricing objectives must not be in conflict with the marketing objectives of the firm.

2. Marketing Mix Strategy

Price of a product or service is highly influenced by other elements of marketing mix. The product life cycle through which the product is passing through, or the kind of sale (lease versus overnight purchase, or liberal returns policy may be followed). In the introductory product life cycle or liberal returns policy, the price is likely to be high. If the product requires services and those services are to be provided free, naturally the product will be highly priced.

The channels of Distribution, location of warehousing and the transportation involved also influence the price determination. Direct to the customer may enable the manufacturer to charge a lower price, but selling through many intermediaries mean the final price is to be very high to compensate the efforts of intermediaries.

Promotion efforts reflect into final price. The amount of money spent by, Coke and Pepsi, HUL or Proctor & Gamble reflect in the prices to be charged. If the intermediaries are to undertake promotion work, they will be charged a lower price and vice versa.

3. Costs

Cost of a product is the single most important factor to influence the final price. Six steps need to be identified while evaluating cost-price structure:

• Define the existing price structure;
• Identify the prices of competing products for each item in the product line;
• Decide which product items need attention;
• Calculate the profitability of the current product/service mix;
• Identify products and services for price changes; and
• Define the new price structure in the company.

4. Organizational considerations

All the marketers are to make profit. Profit is a function of costs, demand, and revenue. Hence their relationship must be understood by pricing managers. The costs may be fixed costs and variable costs. Break-even analysis is one unique technique to understand relationship between cost and price.

External Factors

1. Nature of the market and demand

What is the expectation of the market about the product or services? What is the demand level for the product at different prices?

Market must also be understood whether there is monopoly, perfect competition, oligopoly, monopolistic competition or duopoly.

To understand demand, the supplier or marketer prepares demand curves for the product at different prices. The marketer prepares separate curves for normal products and prestige goods. In addition to understanding price and quantity relationship, the marketer must determine the price elasticity of demand to understand price sensitivity of customers.

2. Competition

There might be pure competition (Many buyers and Sellers Who Have Little Effect on the Price), Monopolistic Competition (Many Buyers and Sellers Who Trade over a Range of Prices), Oligopolistic Competition (Few Sellers Who Are Sensitive to Each Other’s Pricing/ Marketing Strategies), or Pure Monopoly (Single Seller) and in each situation price determination will be different.

The competition may arise from different sources: Directly similar products like Coke and Pepsi, available substitutes speed post versus couriers, or unrelated products seeking the same rupee cricket match versus cinema, coke versus juice, new year dinner versus vacation for three days, etc.

Though many customers have poor price knowledge, yet retailers can’t charge more than the competitors. Retailers often give price guarantees either by way of price-matching policies (prices will not be higher than the prices charged by other retailers) or best price policies (protecting customers against future discounts). Four strategic options are available to a firm: Build (price lower than the competition), Hold (reduce price if competitor reduces), Harvest (much greater resistance to match price cuts for the products that are being harvested), and Responsive (repositioning to force change in price).

3. Other Environmental Factors (economy, resellers, & government)

Economic Conditions, Reseller Needs, Government Actions, Social Concerns do play an important role in price fixation.

Inflation in economy is an important factor in pricing. In India during the last two years the inflation has been a great burden on the common man and even the government has failed to do anything. During recessionary conditions, the price level also drops, to maintain the same level of turnover. Presently due to increased interest rate by Reserve Bank of India, the manufacturers have to pay a higher cost of capital which will be reflected in the price to be charged.

Resellers needs are important in price determination. If you remember, petrol pump dealers went on strike a number of times and finally the oil marketing companies had to agree the margin for the resellers. It will naturally reflect in the final price to be charged to the consumers. In some cases, like butter, the retailers have to manage facilities like deep freezers which have both a capital cost and operating cost, the manufacturer will have to provide a larger margin to them.

The needs of intermediaries must be kept in mind otherwise product launches may not be viable. In February 2012, Maruti Suzuki for the first time in a decade increased Dealers’ margin on Petrol Cars by 10% as the sale has been going down and the dealers were earning merely 4% after discounts and freebies. The revision follows the increase in retail prices. Hyundai Motors and Volkswagen offer 7% by way of commission.

Government’s concerns about pricing are reflected in laws and regulations. Government regulations include price controls, import duties, quotas and taxes. Recent decline of rupee value vis-a-vis dollar also affects the prices of imported products or products using imported spares. The volatility in international markets also affects the prices at home.

The oil marketing companies were left with no alternatives except to increase price of petrol, when the oil prices in international markets went up. Public policy influences of the state include the pricing environment (many governments have gone with the winds of inflation remember, the Sushma Swaraj government of Delhi had to go because of onion price rise). In case of essential drugs the Department of Pharmaceuticals (DoP) regulates the prices. Recent decion of the Government of India to grant compulsory license to Natco Pharma to produce Bayer’s anti-cancer drug could pave the way for cheaper drugs for lifestyle diseases.

4. Willingness to Pay

Knowledge of consumers’ reservation price (“the price at which a consumer is indifferent between buying and not buying the product”) or willingness to pay (“reservation price at which the consumer’s utility begins to exceed the utility of the most preferred item”) is central to any pricing decision. Willingness to pay is important not only for pricing but equally important for new product development, value audits and competitive strategy.

Knowledge of consumers’ reservation prices also allows marketer to understand three demand effects due to change in price – the customer switching effect, the cannibalisation effect (when consumers derive more surplus from a new product offering than from the existing products, and the market expansion effect (non-category buyers now derive more positive surplus from the new offering).

5. Product Line Differentiation

For vertically differentiated product lines, companies are able to charge higher prices. Companies often add a high price product into the line to increase the demand for a product with middle-level price. For products in a horizontally differentiated product line tend to be uniform. Retailers charge the same for different flavours of yogurts, same price for clothes of different sizes. All the car manufacturers have different prices to cater to different market segments, namely economy cars, family saloons, executive cars, and so on.

6. Positioning Strategy

Positioning strategy involves the choice of target market and the creation of a differential advantage. Price can be used to convey this differential advantage and to appeal to a certain market segment. Price is a powerful positioning tool for many people as an indicator of quality, especially in products like drinks, perfume, and services where quality can’t be assessed before consumption.

7. New Product Launch Strategy

While launching new products, price should be carefully aligned with promotional strategy. High price and high promotion is called a rapid skimming strategy. One company that uses skimming strategy effectively is Bosch. Its skimming Price Policy is supported by a large number of patents, to its launch of fuel injection and anti-lock brake systems. High price (skimming) and low price (penetration) may be appropriate in different situations.

Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company’s operating income and net income. In performing this analysis, there are several assumptions made, including:

• Sales price per unit is constant.
• Variable costs per unit are constant.
• Total fixed costs are constant.
• Everything produced is sold.
• Costs are only affected because activity changes.
• If a company sells more than one product, they are sold in the same mix.

CVP analysis requires that all the company’s costs, including manufacturing, selling, and administrative costs, be identified as variable or fixed.

Contribution margin and contribution margin ratio

Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio. The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Said another way, it is the amount of sales dollars available to cover (or contribute to) fixed costs. When calculated as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed costs are covered, the next dollar of sales results in the company having income.

The contribution margin is sales revenue minus all variable costs. It may be calculated using dollars or on a per unit basis. If The Three M’s, Inc., has sales of $750,000 and total variable costs of $450,000, its contribution margin is $300,000. Assuming the company sold 250,000 units during the year, the per unit sales price is $3 and the total variable cost per unit is $1.80. The contribution margin per unit is $1.20. The contribution margin ratio is 40%. It can be calculated using either the contribution margin in dollars or the contribution margin per unit. To calculate the contribution margin ratio, the contribution margin is divided by the sales or revenues amount.

Break-even point

The break‐even point represents the level of sales where net income equals zero. In other words, the point where sales revenue equals total variable costs plus total fixed costs, and contribution margin equals fixed costs. Using the previous information and given that the company has fixed costs of $300,000, the break‐even income statement shows zero net income.

This income statement format is known as the contribution margin income statement and is used for internal reporting only.

The $1.80 per unit or $450,000 of variable costs represent all variable costs including costs classified as manufacturing costs, selling expenses, and administrative expenses. Similarly, the fixed costs represent total manufacturing, selling, and administrative fixed costs.

Break‐even point in dollars. The break‐even point in sales dollars of $750,000 is calculated by dividing total fixed costs of $300,000 by the contribution margin ratio of 40%.

Another way to calculate break‐even sales dollars is to use the mathematical equation.

In this equation, the variable costs are stated as a percent of sales. If a unit has a $3.00 selling price and variable costs of $1.80, variable costs as a percent of sales is 60% ($1.80 ÷ $3.00). Using fixed costs of $300,000, the break‐even equation is shown below.

The last calculation using the mathematical equation is the same as the break‐even sales formula using the fixed costs and the contribution margin ratio previously discussed in this chapter.

Break‐even point in units. The break‐even point in units of 250,000 is calculated by dividing fixed costs of $300,000 by contribution margin per unit of $1.20.

The break‐even point in units may also be calculated using the mathematical equation where “X” equals break‐even units.

Again it should be noted that the last portion of the calculation using the mathematical equation is the same as the first calculation of break‐even units that used the contribution margin per unit. Once the break‐even point in units has been calculated, the break‐even point in sales dollars may be calculated by multiplying the number of break‐even units by the selling price per unit. This also works in reverse. If the break‐even point in sales dollars is known, it can be divided by the selling price per unit to determine the break‐even point in units.

Targeted income

CVP analysis is also used when a company is trying to determine what level of sales is necessary to reach a specific level of income, also called targeted income. To calculate the required sales level, the targeted income is added to fixed costs, and the total is divided by the contribution margin ratio to determine required sales dollars, or the total is divided by contribution margin per unit to determine the required sales level in units.

Using the data from the previous example, what level of sales would be required if the company wanted $60,000 of income? The $60,000 of income required is called the targeted income. The required sales level is $900,000 and the required number of units is 300,000. Why is the answer $900,000 instead of $810,000 ($750,000 [break‐even sales] plus $60,000)? Remember that there are additional variable costs incurred every time an additional unit is sold, and these costs reduce the extra revenues when calculating income.

This calculation of targeted income assumes it is being calculated for a division as it ignores income taxes. If a targeted net income (income after taxes) is being calculated, then income taxes would also be added to fixed costs along with targeted net income.

Assuming the company has a 40% income tax rate, its break‐even point in sales is $1,000,000 and break‐even point in units is 333,333. The amount of income taxes used in the calculation is $40,000 ([$60,000 net income ÷ (1 – .40 tax rate)] – $60,000).

A summarized contribution margin income statement can be used to prove these calculations.

Quantitative Analysis in Budgeting analyses fixed and variable cost elements from total cost date using high/ low method; explains how to estimate the learning rate and learning effect; applies the learning curve to a budgetary problem; discusses the reservation with the learning curve; applies expected values and explains the problems and benefits and explains the benefits and dangers of using spreadsheets in budgeting.

Quantitative Analysis in Budgeting

1. Analyse fixed and variable cost elements from total cost data using high/low method.

The high-low method is a “quantitative technique for analyzing costs into their fixed cost and variable cost elements.” It is used to separate the total cost into fixed and variable costs.

Here are the steps to be followed when using the high-low method:

Step 1: Review records of costs in previous periods

• Select the period with the highest activity level
• Select the period with the lowest activity level

Step 2: Adjust by indexing up or down

Step 3: Determine the following:

• Total costs at high activity level
• Total costs at low activity level
• Total units at high activity level
• Total units at low activity level

Step 4: Find the variable cost per unit (v)

• Formula: (Total cost at high activity level – Total cost at low activity level) ÷ (Total units at high activity level – Total units at low activity level)

Step 5: Find the fixed cost

• Formula: (Total cost at high activity level) – (Total units at high activity level x variable cost per unit)
• Estimate the learning rate and learning effect

Learning curve theory is used in situations where the workforce improves in efficiency when they gain more experience. Where there is a learning curve, there is a learning rate and a learning effect.

The learning rate is “expressed as a percentage value.”

The learning effect is that “as the workforce learns from experience how to make the new product, there is a big reduction in the time to make additional units.”

Apply the learning curve to a budgetary problem, including calculations on steady states.

There are two main approaches that are used to calculate the learning curve:

• The Tabular approach: uses a table to calculate the cumulative average time per unit and the total time to produce all the units produced so far
• The Algebraic approach

To calculate the learning curve using the algebraic approach, the following formula is used:

Formula: Y = axᵇ

• Y is the cumulative average time per unit to product x units
• x is the cumulative number of units
• a is the time taken for the first unit of output
• b is the index of learning (logLR/log2)
• LR is the learning rate as a decimal

Importance of Budget

Before we get into adding a new system, let’s review some of the basics of goals and uses of a budget.

1. Financial Resource Allocation

Money is the lifeblood of a company. Having enough of it to support operations, new business initiatives and acquisitions is vitally important. The budgeting process is essentially matching what is possible with the resources that exist.

Strategic Plan Support: The budgeting process should focus on the important steps you must take during the year to support your strategic plan. It should lay out the coordination of the departments and set the benchmarks to signal if the plan is succeeding.

Initiative Tracking: New initiatives are often the basis for growth. As they are an unknown territory, the assumptions made for revenues and costs usually have a wider range of possibilities. Once the year begins, the budget serves the purpose of tracking chosen initiatives to gauge their success or failure.

Expense Control: Budgets provide feedback to managers as to their performance and should incentivize them to take corrective actions when necessary, and identify overperformance and possible opportunities.

Some Basic Budgeting Best Practices

Before we get into an example of adding a quantitative methodology, I want to go over some best practices for budgeting in general. While certainly not exhaustive, I have found that these steps will save time and resources by reducing budget iterations and improving department coordination.

Set a Timeline: While obvious, the timeline should be detailed enough to allow for individual department budgeting, cross-departmental reviews and consolidated working budget reviews. I have seen companies doing budget consolidation reviews only days before a board meeting.

Convey Topline Guidance Early: Having a budgeting process commence by clarifying all top and bottom line goals and distributing the information to managers can save a lot of time later in the process. As a recent example, a COO told me about having done a budget with 8% growth, but the firm’s PE investor wanted to see 20%, so they had to go through the whole process again.

Team Collaboration: Siloed budgeting runs counter to the goal of a budget rigorously vetting the operational goals of supporting the strategic plan. Marketing, Sales, Product, HR, and Operations all rely on each other’s functions. Cross-team meetings early on with defined agendas and shared assumptions are helpful in this regard.

Budgetary systems which are tools of planning and control occur at various levels in the performance hierarchy and to different degrees. Plans made at the higher level provide a guideline for the plans at the lower levels. Plans made at the lower level essentially carry out the plans made at the higher level.

Strategic Level (Corporate Plans/ Strategic Plans)

• Focus on the overall performance
• Sets plans and targets for each department
• Can be qualitative

Lower Management Level (Tactical Plans)

• Less than 12 months
• Individual departmental plans with guidelines set by senior management
• Many include non-financial budgets
• Overall budget is expressed in financial terms with accompanying financial statements
• Links strategic plans at senior level and operational level
• Budget target should be in line with strategic objectives
• Approved by senior management

Junior Level (Operational Plans)

• Based on objectives about what to achieve
• Specific
• Targets are listed quantitatively
• Detailed specs of targets and standards
• Short term
• Operational plans are prepared with goal of reaching budget targets

Budget

A budget is a written projection of a particular department’s financial performance, a specific project, a business unit, or an organization for the period under consideration. Usually, budgets for businesses or departments created for an accounting period, i.e., for one year. However, the period could be less or more than a year. Complete flexibility is there as the method remains the same, and the business can make or plan a budget for the period they want.

There are different types of budgets and, thus, budgeting methodologies.

Budgeting

Primarily, the activity of preparing a budget is called budgeting. In many organizations, it is a separate department taking care of only the preparation and implementation of budgets.

Importance of Budgeting

In the business world, we can not afford to overstate the importance of a budget. At every stage of decision making, planning, and coordination budgets or plans are the essential tools for Management Control.

It gives a direction to the entire organization internally where it needs to run and reach on the one hand and will help management in communication and guiding the team with full clarity. On the other hand, this document is useful to the outside world also. It shows what the business is trying to achieve and whether the path and direction are right or has a flaw. Whether the objective and targets or aligned with the market realities. Whether the budget is only a dream on paper or it has a clear cut and well-defined plan of action to achieve those dreams.

Types of Budgets

1. Incremental budgeting

Incremental budgeting takes last year’s actual figures and adds or subtracts a percentage to obtain the current year’s budget.  It is the most common method of budgeting because it is simple and easy to understand.  Incremental budgeting is appropriate to use if the primary cost drivers do not change from year to year.  However, there are some problems with using the method:

It is likely to perpetuate inefficiencies. For example, if a manager knows that there is an opportunity to grow his budget by 10% every year, he will simply take that opportunity to attain a bigger budget, while not putting effort into seeking ways to cut costs or economize.

It is likely to result in budgetary slack. For example, a manager might overstate the size of the budget that the team actually needs so it appears that the team is always under budget.

It is also likely to ignore external drivers of activity and performance. For example, there is very high inflation in certain input costs.  Incremental budgeting ignores any external factors and simply assumes the cost will grow by, for example, 10% this year.

2. Activity-based budgeting

Activity-based budgeting is a top-down budgeting approach that determines the amount of inputs required to support the targets or outputs set by the company.  For example, a company sets an output target of $100 million in revenues.  The company will need to first determine the activities that need to be undertaken to meet the sales target, and then find out the costs of carrying out these activities.

3. Value proposition budgeting

In value proposition budgeting, the budgeter considers the following questions:

• Why is this amount included in the budget?
• Does the item create value for customers, staff, or other stakeholders?
• Does the value of the item outweigh its cost? If not, then is there another reason why the cost is justified?

Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures although it is not as precisely aimed at that goal as our final budgeting option, zero-based budgeting.

4. Zero-based budgeting

As one of the most commonly used budgeting methods, zero-based budgeting starts with the assumption that all department budgets are zero and must be rebuilt from scratch.  Managers must be able to justify every single expense. No expenditures are automatically “okayed”. Zero-based budgeting is very tight, aiming to avoid any and all expenditures that are not considered absolutely essential to the company’s successful (profitable) operation. This kind of bottom-up budgeting can be a highly effective way to “shake things up”.

The zero-based approach is good to use when there is an urgent need for cost containment, for example, in a situation where a company is going through a financial restructuring or a major economic or market downturn that requires it to reduce the budget dramatically.

Zero-based budgeting is best suited for addressing discretionary costs rather than essential operating costs. However, it can be an extremely time-consuming approach, so many companies only use this approach occasionally.

Read More: https://indiafreenotes.com/budgeting-introduction/

Budgeting introduction

The purpose of the sales mix and quantity variances is to show how much of the sales volume variance is due to a change in the mix of the products sold (sales mix variance) and how much is due to a change in the quantity of the products sold (sales quantity variance).

Sales Mix Variance

The sales mix variance shows how much of the sales volume variance was due to a difference between the actual sales mix and the budgeted sales mix.

The variance is calculated by taking the difference between the actual sales volume and the actual sales volume at the budgeted mix and multiplying this by the budgeted price to give a monetary amount.

The sales mix variance formula is as follows.

Sales mix variance = (Actual sales volume – Actual sales volume at budgeted mix) x Budgeted price

It should be noted that the term standard is often used when referring to unit prices, so budgeted price in the above formula could be replaced with the term standard price.

If actual volume is greater than the actual volume at budgeted mix the sales mix formula gives a positive result and the sales mix variance is a favorable variance. If actual volume is lower than actual volume at budgeted mix the formula will give a negative result and the sales mix variance is said to be unfavorable.

Sales Quantity Variance

The sales quantity variance shows how much of the sales volume variance was due to a difference between the actual volume sold at the budgeted mix and the budgeted volume.

The variance is calculated by taking the difference between the actual sales volume at the budgeted mix and the budgeted sales volume and multiplying this by the budgeted price to give a monetary amount.

The sales quantity variance formula is as follows.

Sales quantity variance = (Actual sales volume at budgeted mix – Budgeted sales volume) x Budgeted price

If the actual volume at budgeted mix is greater than the budgeted volume the sales quantity variance formula gives a positive result and the sales quantity variance is a favorable variance. If actual volume at budgeted sales mix is lower than budgeted volume the formula will give a negative result and the sales quantity variance is said to be unfavorable.

Summing the Sales Mix and Quantity Variances

The sales volume variance is based on the difference between the actual volume of sales and the budgeted volume of sales multiplied by the budgeted unit price.

Sales volume variance = (A – B) x BP

Where A is the actual sales volume, B is the budgeted sales volume and BP is the budgeted unit price.

Using this sales volume variance formula we can now show that the sales volume variance is equal to the sum of the sales mix and quantity variances.

If the term actual sales at budgeted mix (ABM) as discussed above is added and subtracted from this formula we get the following.

Sales volume variance = (A – B) x BP

Sales volume variance = (A – ABM + ABM – B) x BP

Sales volume variance = (A – ABM) x BP + (ABM – B) x BP

Sales volume variance = Sales mix variance + Sales quantity variance

Sales Mix and Quantity Variances Using Contribution and Profit

The above analysis uses the budgeted price per unit of the product to calculate the monetary value of the sales mix and quantity variances. As an alternative for absorption costing the budgeted profit per unit or for marginal costing the budgeted contribution per unit can be substituted for the budgeted price in the above formulas.

Environmental accounting principles and practices are mainly used by organizations to more accurately trace environmental costs back to specific activities. Government agencies, private businesses, local communities and individuals all take responsibility for conserving natural resources and operating sustainably in most developed nations. Governmental agencies and businesses are accountable to the public for setting environmentally related efficiency goals that lead to cost reductions and improved operational processes. These organizations are more likely to implement methods from environmental accounting which is a growing subset of traditional accounting. Here are some of the job duties of environmental accountants, the typical education and training needed to become an environmental accountant and the professional development certifications that position them to be competitive in the job market.

Practices and Benefits of Environmental Accounting

While environmental accounting can focus on environmental management accounting or financial accounting, the most prominent benefits come from the application of environmental management accounting methods. This type of accounting focuses on gathering, estimating and analyzing costs associated with the use of energy and physical materials like timber, metal or coal. Standard accounting practices tended to place these costs in the catch all category of overhead, but environmental management accounting allows accountants to apply activity based cost principles to more accurately associate these costs to various projects or events. Decision makers who can see exactly where these natural resources are used across various projects can locate areas of synergy that allow them to reduce the amount of wasted materials at the program or enterprise level.

Job Duties of Environmental Accountants

Environmental accountants help decision makers to establish energy efficiency goals by doing research on historical data and recent trends about the raw materials used to produce company goods or services. These accountants also keep track of the availability of the raw materials that are used in company goods and services. They conduct calculations to determine if appropriate raw material substitutes can produce lower lifecycle costs as well as reduce environmental impacts that are associated with their companies’ current practices. Environmental accountants are also the business professionals who conduct break even and cost benefit analyses for replacing traditional energy systems with alternative ones like wind turbines and the new solar shingle roofs.

Education and Training Required for Environmental Accountants

The niche field of environmental accounting has not yet matured, and there are only limited university level academic programs that focus directly on this accounting category. For example, Aquinas College in Michigan offers students a Bachelor of Science in Sustainable Business and Dalhousie University in Canada has a Natural Resources MBA. However, most environmental accountants earn traditional undergraduate degrees in accounting, and they usually return to school to gain graduate certificates in environmental science. Many environmental accountants earn specialized credentials like the Certified Environmental Auditor (CEA) designation that is administered through the National Registry of Environmental Professionals. Certifications like the CEA require environmental accountants to have undergraduate degrees from accredited universities, a minimum of four years of environmental auditing experience and successful completion of the CEA exam.

Methods of Environmental Accounting

Businesses use three generally accepted methods to implement environment accounting: financial accounting, managerial accounting and national income accounting. Financial accounting is the process of preparing financial reports, such as earning statements, for presentation to investors, lenders, governing bodies and other members of the public. In this instance, environmental accounting estimates are presented as part of the financial accounting reports.

Managerial accounting is used solely for internal decision making. In this capacity, department heads use environmental accounting to collect data used by senior management to make business-critical decisions, such as those surrounding procurement. Alternatively, environmental accounting is used by government agencies to calculate the nation’s gross domestic product and how business decisions affect the country’s economic wellbeing.

Rationale of Environmental Accounting

Environmental costs are defined by the Environmental Protection Agency as “the many different types of costs businesses incur as they provide goods and services to their customers.” An example of this is leftover manufacturing materials. In addition to allowing a business to operate in a “greener” fashion, environmental accounting management provides it with monetary benefits. For example, if an environmental accounting report indicates that a business consistently discards a large amount of excess material, a company can use this information to choose to purchase less material. While this allows the business to minimize the waste it dispenses in the environment, it is also allows it to save money by not purchasing excess.

Implementation of Environmental Accounting

Environmental accounting can be implemented by businesses of all sizes. Whether administered by a global corporation or a small business, elements need to be in place for success. The firm’s senior management team must support these practices. These leaders are instrumental in setting a positive tone when communicating the benefits of environmental accounting practices to the employee population. The senior management team would be best served by developing cross-functional teams to administer the process. Consisting of employees across all business lines, including finance, sales, manufacturing and procurement, these teams ensure that all environmental accounting policies and procedures are communicated and followed.

Improved management of environmental costs is often good for industry and society, and accountants are used to recognize opportunities for the reduction of environmental costs or to support environmental initiatives that create revenue streams. Subsequently, tracking more granular cost data often leads to better management of resources when it comes to environmental accounting.

Throughput Accounting (TA) can be understood as a simplified accounting system based on Theory of Constraints (ToC) principles. TA makes growth-driven management and decision making simpler and understandable even for people not familiar with traditional accounting.

Beyond simplifying, TA has a different approach compared to traditional accounting. The latter will focus on cost control (cost of goods sold) and minimizing the unit cost while TA strives to maximize profit.

Throughput Accounting sets the base for Throughput Analysis, helping to make decisions in the ToC way.

Throughput Accounting focuses on increasing revenue (throughput), improving cash flow (investment) and providing capacity (operating expense). Every management decision is made based on expected changes in throughput, investment and operating expense. Throughput Accounting allows managers to take a more balanced approach to decision making, giving an accurate picture of the results of decisions. Throughput Accounting also demonstrates ways to make more profitable pricing and marketing decisions.

Throughput Accounting shifts the emphasis in decision making from managing costs and budgets to maximizing throughput and profitability. It emphasizes the improvement of flow through the system, providing feedback on the financial impact of the constraint. It drives management decisions to improve the constraint’s efficiency; ensuring all company resources support the constraint, so that profit can be maximized.

This approach differs substantially from Traditional Cost Accounting because the company is not focused on every machine and employee working at optimal efficiency. Instead, its basis is that if a company optimizes any non-constraint, it will overload the constraint and create excess inventory.

Throughput Accounting provides a way to measure productivity improvement efforts based on how they affect cost and throughput. It can be applied to decisions that affect all aspects of a company including product price, process improvement, reward structures, investment justification, transfer pricing, and performance management. The result is a thorough understanding of how a company is functioning as a whole and the ability to analyze the true impact of management decisions before they are made.

Throughput Accounting will probably not replace GAAP in short nor medium term, but provides a limited set of simple KPIs, sufficient to:

• Manage and make decisions in a growth-oriented and ToC way
• Allow faster reporting and near to real-time figure-based management
• Help people in operations to understand the basics of accounting
• Set a common base for controllers and operations to discuss decisions, investments, etc.

Throughput Accounting uses 3 KPIs and 2 ratios

Throughput (T)

Throughput, defined as the rate of producing goal units (usually money) and translates as revenue or sales minus totally variable expenses in accounting terms.

Totally variable expenses can be simplified to the cost of direct materials because labor is nowadays paid on a (relatively) fixed amount per time period, hence a constant expense to be considered as part of Operating Expenses.

Operating Expenses (OE)

Operating Expenses are all expenses, except the totally variable expenses previously mentioned in the calculation of throughput, required to run and maintain the system of production. Operating Expenses are considered fixed costs, even so they may have some variable cost characteristics.

Investments (I)

Investments, formerly call Inventories, is the amount of cash invested (formerly “tied”) into the system in order to turn as much of the Investments into Throughput as possible. This encompasses the stored raw material waiting to be transformed into sellable products as well as investments in capacities / capabilities to produce more units.

Net Profit (NP)

Net Profit is defined as Throughput minus Operating Expenses, or Sales – Total Variable Costs – Operating Expenses.

Return on Investment (ROI)

Return on Investment is the Net Profit compared to Investments (ROI = NP/I).

Drivers for achieving the Goal

Throughput Accounting offers a simplified way to identify and use the drivers to achieve the Goal, assuming the Goal is to make money now and in the future.

In a very simple way this can be summarized by the following picture which means strive to maximize Throughput while minimize the Operating Expenses and Investments.

ToC practitioners recognize that Throughput has no limit while Operating Expenses and Investments have limits beyond which no safe operations can be further envisioned.

The priority focus on improving T (focusing on the constraint exploitation) rather to go for all-out cost cutting explains the (usually) superior results when going the ToC way compared to unfocused improvements.

Throughput Accounting KPIs can be presented in a Dupont-inspired model in order to make the levers and consequences clear.