In today’s corporate America few executives and finance leaders fully grasp the benefits of developing an effective and streamlined corporate cost allocation process. Corporate allocations, when implemented correctly, can provide tremendous insights into the profitability of business segments, customers, and products. This knowledge can then help business unit leaders realign resources within the company, thereby increasing its overall profitability.
When cost allocations are implemented correctly, they can have a significant, positive impact on the operations and management of the business:
-Much improved visibility to true cost of products and services delivered by the company
-First real assessment of the true cost and rate of return on internal projects, products, or services
-Systematic way of measuring true costs of products which in the long-term provides companies with an opportunity to modify their behavior and increase their profitability.
Detailed corporate allocations models offer an ability to move all direct and indirect costs to the appropriate product/service and provide a fully loaded view of ALL costs associated with a given product or service. This in turn allows users for the first time to evaluate real profitability of all products and services that the company delivers. Based on the outcome of the profitability analysis some products and/or services may need to be dropped or scaled back.
In many cases, corporate allocations are viewed as much more of a burden than a benefit to the organization and are therefore often treated as a “necessary evil”. The corporate cost allocation models are very difficult to build from the standpoint of applying the correct methodology. They are therefore time consuming and the effort required is often viewed as taking precious resources from other projects which don’t simply “move around” costs without contributing anything to the bottom line (this at least is the common perception found within corporations).
Companies struggle with allocations for reasons that have to do as much with bad practices as with neglect:
-Lack of unified allocation methodology that would set the tone for consistent application of corporate allocations throughout the company. For companies that have very disparate business units this does not necessarily mean that every business unit needs to follow the same set of drivers and allocation logic. These can be all separate and customized for a given business unit. They need to however fit neatly, at a certain level, into the overall methodology and allocation logic of the entire company in order to provide a transparent way of allocating costs throughout the company that can be easily explained and defended when challenged by various decision makers.
-Willful misuse of allocations for purposes other than pure allocation of expenses. This confuses the definition of allocations and leads to inappropriate allocation methodologies. Some companies, for example, due to political infighting within the organization decide to punish and reward certain business units by making them look more or less profitable by artificially adjusting allocation drivers. Over time this leads to the creation of a completely inexplicable allocation methodology, one that cannot be fully trusted by the entire organization. Any reporting based on such methodology becomes quite meaningless.
-Lack of a designated allocations champion within an organization. The CFO definitely needs to be the driving force behind any well executed cost allocation strategy. He/she needs to be the person ultimately pushing the various business units to adopt a logical and comprehensive allocation methodology.
Most companies do not realize that even though the cost allocation process is all about moving costs/resources internally and exists only on paper there are serious consequences of corporate allocation failures which impact external and statutory reporting:
-Improper bookings of intercompany transactions
-Unsupported movements of chargebacks among legal entities due to improper inputs from the cost allocation model into the corporate transfer pricing model
-Tax and Accounting departments out of sync with the transactions conducted by the Finance department leading to questions from the IRS
Oracle provides a purpose-built application for creating and managing corporate cost allocations: Hyperion Profitability and Cost Management (HPCM). Alternatively, many companies decide to build dedicated cost allocation Essbase cubes which, once populated with the right sets of drivers and allocation logic, serve as monthly cost allocation engines as well as sources of all corporate allocation reporting.
Correctly implemented, a cost allocation framework can have a very meaningful impact on the bottom line by highlighting, often for the first time, the business segments, products and geographies from which most of the annual profits flow. This type of analytical model allows companies to focus their scare resources on the areas with the highest ROIs and to de-emphasize the areas of marginal profitability.
