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Optimizingprofitability andmanaging costs Management accounting using SAP BusinessObjects Profitability and Cost Management

2 Optimizing profitability and managing costs – Management accounting using SAP PCM2 Optimizing profitability and managing costs – Management accounting using SAP PCM

SAP BusinessObjects Profitability and Cost Management (PCM) is a tool designed to present activity-based cost information. It applies the concepts of activity-based costing (ABC) and time-driven activity-based costing (TD ABC). In contrast to traditional cost accounting methods, PCM does not allocate indirect costs using lump-sum overhead keys which, in many cases, do not reflect the actual origin of the costs. Instead, PCM allocates indirect costs to cost objects (products/services) based on the activities used. PCM can be beneficial in particular for companies with high overheads. It significantly improves the quality of information on the profitability of individual customers, products or sales channels and thus provides a valuable basis for making decisions.

This white paper provides an overview of the areas in which SAP PCM can be applied and the business benefits it delivers. It also highlights the specific challenges being faced by certain industries and how these can be effectively addressed with the help of PCM.

Summary

3Optimizing profitability and managing costs – Management accounting using SAP PCM

Contents

0 Management summary 5

1 The challenges of cost and profitability management 6

2 Brief overview of SAP PCM 7

3 Role of PCM within management accounting 8

4 Application areas and business benefits 11

5 PCM’s industry focus 15

6 Implementing PCM – a CFO’s view 16

4 Optimizing profitability and managing costs – Management accounting using SAP PCM4 Optimizing profitability and managing costs – Management accounting using SAP PCM


0 Management summary

CFO agendas have changed significantly in the first year of economic revival since the financial crisis. Last year, restructuring and short-term cost reduction measures were given top priority. Now, the focus has shifted towards issues such as improving efficiency and generating profitable growth. These issues are being addressed by the realignment of medium- and long-term strategies, including the development of product portfolios, the optimization of value added (make-or-buy decisions) and an increase in marketing and sales effectiveness (pricing and channel controlling). For this reason, key measures and activities are now aimed at improving the performance of primary value chain processes.

With a view to helping companies achieve operational excellence, CFOs need sound information upon which to base decisions. Such information also facilitates discussion with other functional departments. The importance of detailed, reliable and readily available financial information is growing steadily. The focus is now on analyzing the profitability of individual objects such as specific clients, orders or products. To avoid misinterpretation, it is crucial that indirect costs are transparently and fairly allocated based on the actual level of input.

The Profitability and Cost Management (PCM) module offered by SAP’s enterprise performance management (EPM) solution is aimed directly at addressing this issue. In contrast to many other analysis and reporting tools whose purpose is to present previously obtained data in an appealing way, PCM is an activity-based cost accoun-ting model for the functional department. It can be used to obtain calculations based on the (time-driven) activity-based costing (ABC) approach, to analyze cost drivers and to perform multi-stage contribution costing. The use of PCM is highly recommended when high indirect costs exist and these have to be allocated to cost or profit units transparently and fairly. It is also possible to use PCM in combination with existing systems. This can prove advantageous because PCM offers a variety of functions that do not usually form part of traditional cost accounting systems.

This white paper provides a detailed insight into the functions and scope of PCM. It will enable readers to gain an understanding of the suitability of PCM for their own organization in light of their business objectives and information requirements.

Challenges facing CFOs

Valid financial information

for controlling purposes is a key factor in achieving operational excellence

The aim of thiswhite paper

SAP PCM is suited to activity-based costing and profitability analysis

Growth and operational excellence in 2010 will require specific controlling instruments

6 Optimizing profitability and managing costs – Management accounting using SAP PCM

1 The challenges of cost and profitability management

In many cases, existing applications do not meet profitability management requirements. Transaction-oriented systems or modules (such as SAP Finance and Controlling [FI/CO]) cannot deliver all the information required for effective control. By acquiring BusinessObjects, SAP has rounded off its product portfolio with an application for cost and profitability management (PCM).

The benefits of PCM must be weighed up by each company individually, with consideration being given to the company’s industry and its reporting and steering requirements. This white paper analyzes possible areas of application for PCM and highlights industries in which PCM can prove advantageous. Our intention is to give accounting and financial control departments as well as decision-makers an insight into the role and business benefits of PCM.

To achieve company objectives, management has to monitor the profitability of business activities continuously. This is a challenging task – especially in times of economic crisis. For many companies, the decline in market demand results in lower margins and unused capacities – and these affect profitability.

In such situations, management must align internal processes and structures with changing market conditions – and do so quickly. This requires:

• The availability of accurate profitability information on relevant profit units and business segments• Information that is linked to internal processes• The ability to perform ad hoc analyses and simulate future scenarios and possible countermeasures• A clear and interactive reporting system for decision-makers

Profitability management is required because of the growing share of indirect costs in overall cost, the reasons for which include the structural shift towards a service-oriented society. Companies often lack the necessary transparency and ability to allocate indirect costs to profit units based on their actual origin. To effectively manage costs, companies need to have a continuous cost-cutting process in place. Focusing on short-term cost savings is not enough. This system of continuous monitoring must be supported by activity-based methods, which shed light on the cost of internal processes. The identification of these internal processes can be greatly facilitated by existing process documentation, such as process handbooks from Sarbanes-Oxley Act (SOX) projects.


2 Brief overview of SAP PCM

Profitability and Cost Management (PCM) is an application within the SAP Business Objects EPM solution. It offers comprehensive profitability and cost management functions and helps companies identify unprofitable clients or products. It also identifies inefficient activities. PCM is thus a basis on which to develop performance improvement measures.

SAP PCM functionalities at a glance

The following functions make PCM an especially useful tool for cost accounting and profitability analysis:

• Implementation of activity-based cost accounting models and profitability analyses using approaches such as activity-based costing and timedriven activity-based costing• Ease of use and end-user modeling• System-based calculation model• Cost driver analysis• Integration with SAP ERP and other ERP systems• Audit trail for transparent documentation



3 Role of PCM within management accounting

Besides its monitoring function, management accounting (controlling) should also provide decision-makers with relevant information. Depending on their relevancy for decision-making, current methods and controlling tools can be divided into three different levels:

• Transaction• Reporting and analysis• Decision-making

PCM is mainly used at the reporting and analysis level.

In PCM, cost and value flows can be modeled from cost types to revenue dimensions such as clients, products and sales channels. This enables gross margin and profit and loss calculations to be made. Models built into PCM do not have to be used exclusively for cost accounting. They can also be used to simulate scenarios through the simple variation of parameters such as cost structure and sales price. PCM permits ad hoc analysis and integrated

reporting, which highlights its focus on reporting and analysis. However, some PCM functions can also be assigned to adjacent levels of the information pyramid. The use of PCM at the transaction level focuses on using ABC as a modeling tool for cost accounting. To support the decision-making process, PCM offers several interactive, integrated tools such as dashboards and reports. Other functions at the decision-making level (such as value-added models, balanced scorecard, SWOT analyses) are not offered by PCM.

PCM bundles management accounting instruments and can be regarded as an interactive tool for managing departments that performs profitability analyses and indirect cost controlling. It is also possible to use PCM as a stand-alone tool for rudimentary cost accounting. Companies that have previously focused more on external reporting can gain a quick insight into their internal cost and revenue structures by using PCM.

Decision-making level

Reporting and analysis level

Transactional level

SWOT analysisBalanced scorecard

Value-based approaches

Investment analysis Investment planning

Forecast/integrated planning

Financial accounts

Operational planning Product cost controlling

Deviation analysisProject controlling

Scenario simulationAd hoc analysisReportingBreak-even analysis

Activity-based costingCost center accountingCost type accounting

DashboardsKPI

SAP profitability andcost management

PCM is aimed at the reporting and analysis level

Figure 1:

PCM as part of the

management accounting

pyramid


However, more often than not, companies already have cost accounting software in place. In such cases, the diagram above shows that PCM is not intended to replace existing applications but to complement them. For example, PCM can be applied parallel to integrated ERP systems. While core functions in manufacturing compa-nies (such as product cost accounting and deviation analyses with links to materials management and production planning) are preferably combined in integrated ERP systems, functions such as holistic simulations or the use of decentralized IT structures are better performed in PCM.

PCM complements other cost accounting tools

With regard to pure functionality, it should be noted that some functions can be performed in ERP and PCM. For instance, traditional controlling modules also offer process cost accounting or profitability analysis (e.g., Controlling-Profitability Analysis [CO-PA]). However, these functions can be implemented in PCM much more flexibly and transparently. Thanks to PCM’s ease of use and transparent modeling functions, controlling departments can, for the most part, service and maintain PCM with no external help.

The following diagram shows the main areas of application of the different cost accounting systems on the basis of a contribution margin structure.

Break-even analysesIncome statement(cost of sales method)

Coverage bySAP applications

Revenue

– Direct labor costs

– Direct material costs

= Contribution margin I

– Labor overhead

– Material overhead

= Contribution margin II

– Other costs

– Research and development costs

– Distribution costs

– Administration costs

= Operating result

Revenue

– Cost of sales

= Gross profit

– Research and development costs

– Distribution costs

– Administration costs

= Sub-total for reconciliation

+ Other income

+ Other expenses

= Profit

FI

CO

SD

PCM

Figure 2:

Income statement, break-even analyses

and SAP applications

10 Optimizing profitability and managing costs – Management accounting using SAP PCMOptimizing profitability and managing costs – Management accounting using SAP PCM10


4 Application areas and business benefits

As previously mentioned, the focus of PCM in the information pyramid is cost and profitability management. In this context, there are four main application areas:

Application area 1: Process-oriented cost managementIf indirect costs make up a high percentage of a company’s total costs, the allocation of these costs using lump-sum overhead keys which do not reflect the actual origin of the costs can lead to inaccurate assessments of the profitability of a product or customer. PCM applies ABC for a more accurate and exact assignment of indirect costs according to their actual origin. ABC is a refinement of traditional cost accounting methods. For industries with very standardized processes or activities and a high share of indirect costs, this approach could prove helpful.

Besides providing cost transparency, ABC also supports the monitoring and optimization of business activities and processes.

ABC involves assigning indirect or overhead costs based on their actual origin and the reason for them. The costs allocated to a certain cost object (product/service) depend on the activities necessary for its creation.

PCM as an instrument for process-oriented cost

management

However, traditional ABC does not identify unused capacity, which means that products or customers are burdened with idle-time costs. The newer approach of TD ABC identifies unused capacities so that cost reduction measures can be taken. Furthermore, TD ABC supports continuous cost reduction by monitoring unused capacities. Since PCM architecture is based on ABC approaches, value and allocation streams within a company can be modeled and calculated according to internal requirements.

Business benefits:• Creation of cost awareness and transparency due to a process-oriented way of thinking• Identification of inefficiencies and improvement potential within processes• High degree of precision in the assignment of indirect/overhead costs according to their origin (thus improving the effectiveness of decisions) • Analysis of processes regarding direct (value-adding) and indirect (non-value- adding) activities


Application area 2: Multi-dimensional profitability analysisManaging a company solely on the basis of profit and loss data is not usually ideal from a decision-making perspective. Many decisions require a detailed basis for analysis, such as information on the profitability of individual customers, products or sales channels. The data in integrated controlling modules often fails to fulfill these requirements due to a lack of flexibility and usability.

PCM’s trace-back function facilitates the process of retracing cost data flows from profit units (customers/products) to cost types. PCM is a multi-dimensional model that can handle even complex calculations quickly and accurately. It also features reporting tools that generate detailed and flexible analyses.

Business benefits:• Sound analysis of individual orders, customers or product profitability• Database for individual, cost-oriented pricing• High traceability of results due to drilldown and trace-back functions• Flexible reporting tools, even for high data volumes• The management accounting (controlling) department can maintain structures with no external help

Profitability analyses for customers and products

Applications 1 and 2 imply the use of PCM within an existing ERP landscape. Analyses done in PCM are based on primary postings from the financial accounting department. This information is enriched by data from sales and distribution systems such as invoicing data per customer and sales channel, for example.

Figure 3 shows an example data flow and explains the complementary use of PCM within traditional CO modules. For instance, within an integrated SAP system, direct costs and revenues are enriched in the module CO-PA (profitability analysis) by adding dimensions such as customers, products or sales channels. Together with a breakdown of indirect costs per cost center from Overhead Cost Controlling (CO-OM), these additional dimensions serve as a basis for cost allocation in PCM.


BW/BI*

PCM

ERP

Optional

Direct costs

Overheads

Overheads

BusinessObjectsBI Solutions

PCM(Profitability and

Cost Management)

CO-OM(Overhead Cost

Controlling)

CO-PA(Profitability Analysis)

FI(Finance)

SD(Sales)

CO-PC(Product CostControlling)

* Business Warehouse/Business Intelligence

Figure 3:

Use of PCM in an integrated

SAP landscape

Application area 3: Scenario simulationIn order to simulate certain scenarios, some parameters (such as costs per cost center, capacity, consumption, demand or prices) have to be adjusted for different economic situations and decisions. A flexible and user-friendly simulation function is often essential, especially when dealing with strategic decisions such as how to structure a company’s product portfolio.

Scenario simulation is done in PCM by creating parallel versions with different input parameters in an existing cost accounting model. Adaptations to the existing model in PCM can be made by management accounting (controlling) departments flexibly and independently.

The advantage of this solution is that it enables the effects on the profit and loss statement to be fully simulated. Furthermore, the reconciliation to actual figures is easily manageable since all calculations are based

on one consistent model and simulation results can easily be compared. This also facilitates the process of identifying the reasons for different results.

It is also possible to compare simulation results with targets met when analyzing deviations between planned and actual figures in subsequent periods.

Business benefits:• Real-time simulation for decision support• No maintenance effort for separate, stand-alone applications/Excel tools• High data integrity and accuracy of simulations due to a uniform and consistent cost accounting model• Presentation of simulation results with integrated reporting tools• Drill-down functionalities, also in reporting• Flexible and simple customizing can be done by the functional department• Good interface to Excel

Simulations performed by operating department


Application area 4: Use in a heterogeneous or decentralized system landscapeTo control business units or segments, corporate groups often require a consistent cost and activity-based accounting system for their subsidiaries. When ERP landscapes are heterogeneous or decentralized it is often difficult for subsidiaries to adhere to corporate standards. Furthermore, in many cases it is not possible to compare individual entities with regard to specific cost objects.

Another reason why corporate groups require a flexible and central solution to manage the costs of their subsidiaries is the frequent change in shareholders – which does not always take place together with system integration. Both a consistent cost accounting model and a central IT platform are needed to control segments.

Consistent cost management in corporate groups

Thanks to its flexible link to different heterogeneous data sources or SAP systems, PCM is able to fulfill the requirements previously described. These interfaces are managed by an ETL tool (extract, transform, load), which handles links to any pre-system, irrespective of its producer. The Financial Information Management tool (FIM) offered as a part of the SAP BusinessObjects EPM suite also enables sub-system data to be imported into PCM.

Business benefits:• Flexible data integration with ETL tool• Group-wide profitability analysis and comparability• Flexible tools and dashboards for automated, periodic reporting

The flow of data in a scenario like the one described can be depicted as follows:

PCM

Heterogeneous data sources

Direct costs and overheads

ETL

PCM(Profitability and

Cost Management)

Financial accounting

Software fortime recording

Software for billingand sales Other sourcesFigure 4:

Use of PCM in a heterogeneous

system landscape


5 PCM‘s industry focus

The application areas mentioned above highlight industries and sectors in which the use of PCM could prove beneficial. In general, PCM offers advantages in industries that have: • A high proportion of indirect costs and standardized processes• High demand for detailed profitability analyses and large data volumes

PCM is less suited to industries with a high proportion of direct costs, since the focus of PCM is the allocation of indirect/overhead costs. In particular, PCM is not suitable for calculating product costs and this is usually a key requirement of manufacturing companies. However, PCM could be used for indirect cost allocation in these companies and for this reason it may complement any controlling system already in place.

Example applications

Controlling standard processes in indirect business functions

Obligation to disclose calculations

Analysis of product or customer groups in terms of KPIs (revenue, profit contribution)

Financial accounting systems without a cost accounting function or transition to double-entry bookkeeping

Multi-dimensional profitability analyses

Supporting outsourcing decisions

Industry

e.g., financial services, transport and logistics, shared service centers

e.g., utility providers (electricity, gas)

e.g., retail/wholesale

e.g., public enterprises

e.g., telecommunications

e.g., service providers


6 Implementing PCM – a CFO’s view

The following table presents a number of questions regarding management accounting instruments and requirements as well as questions on general company characteristics. If you have to answer these

questions in the negative, you might consider using PCM. Each organization will need to apply its own weighting to the issues covered.

Question Functionality in PCM

Background: controlling indirect costs is especially important for companies with a high proportion of indirect/overhead costs.

Are indirect costs allocated transparently and according to their actual origin and reason (e.g., assignment of indirect/overhead costs to products)?

In situations where strategic decisions have to be taken (e.g., continuation of business units), can effects from indirect cost allocation be analyzed reliably?

Are existing controlling tools able to support decisions regarding the outsourcing internal processes? Can internal processes be benchmarked to market prices?

Assumption: the proportion of indirect costs is expected to rise.

Is the current method of indirect cost allocation still capable of assigning costs accurately when the proportion of indirect costs increases significantly?

Are unused capacities identified appropriately?

Assumption: the company uses internal transfer prices.

Are internal transfer prices continuously reviewed for adequacy?

Are steps currently being taken to ensure that all available opportunities for increasing profitability are identified and taken advantage of? Can this also be guaranteed in the future?

Is the management accounting/controlling department capable of calculating profitability per customer, product or sales channel accurately using existing tools?

Has a periodic, system-based reporting system been established?

Do existing systems support sophisticated multi-level contribution accounting?

ABC

ABC

TD ABC

ABC

Profitability analysis

Profitability analysis

Flexible reporting tools

Reporting/books/dashboards

Application area 2: Multi-dimensional profitability analysis

Application area 1: Process-oriented cost management


Question Functionality in PCM

Does the existing cost accounting system support pricing decisions (e.g., calculation of a minimum price)?

Are existing applications capable of supporting short-term decisions by simulating different scenarios?

Are existing applications capable of supporting strategic decisions or decisions regarding product policy?

Is the number of auxiliary calculations (e.g., in Excel) limited and have steps been taken to ensure that relevant calculations or analyses are not performed outside the central ERP system?

Do all the employees who use the current cost accounting application properly understand the interdependencies within cost accounting?

Can existing applications be easily extended to accommodate growth?

Is the group-wide cost accounting function or centralized control of business units or segments fully automated?

Does the current cost accounting system allow the group to make shared conclusions regarding different decentralized business units/segments?

Can existing controlling applications deal with (parallel) accounting standards?

Flexible Berichtswerkzeuge

Calculating back/driver analysis

Scenario analysis

System-based calculation model

Easy modeling

Scalability

Flexible data import/independency in relation to source systems

Versions

Application area 3: Scenario simulation

Application area 4: Use in a heterogeneous or decentralized system landscape


Prior to purchasing a new software component, basic traditional investment calculation methods should be applied:

• Total cost of ownership (TCO)• Cost-utility analyses• Check lists and requirement profiles

Quantifying the benefit of a tool for accounting purposes is usually a complex task. First, the additional value from accurate controlling information and the efficiency gain must be factored in. Experiences from abroad have shown that activity-based cost accounting may even result in competitive advantages. Other important criteria to be considered are data integrity and error. The existing IT strategy is also highly relevant, as it usually aims to

keep the application landscape as homogeneous as possible. Last but not least, the buy-in of the departments concerned is crucial for the success or failure of software implementation. So an array of qualitative and quantitative criteria has to be taken into account when assessing the potential benefit of new software. The functions, areas of application and criteria for use described above provide an initial basis for the decision.

If you wish to discuss how PCM could be deployed in your company, please do not hesitate to contact us. We are at your service.

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Ludger Weigel

Rothenbaumchaussee 7820148 HamburgGermany

Phone: +49 (40) 36132 12456E-Mail: [email protected]

Contact:

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Our services to assist your solutions

We can support you with a wide range of tried-and-tested services that you can bundle to meet your individual requirements. In this regard, we can vary our role as required. We will coach you behind the scenes or lead you and your team through complex tasks. The choice is yours:

• A quick check of current controlling and management tools in your company• An analysis of the possible uses of PCM specifically in your company• Support in the design and modeling of PCM • A comparison of SAP PCM with other profitability management solutions

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