The Operations dashboard demonstrated that an organisation is able to split the decision and data, using profitability analysis to analyse decision in operations to mitigate short term risk of the business.
The business has to be able to apportion the different costs in all lines of business and market segments to the correct revenue stream. An internal transfer rate is a cost allocation that will apportion “To Build” costs by market segment.
The following set of diagrams will demonstrate the theory in allocating product costs to market segment using Internal Transfer Rates.
The colour index code can be followed as we drill down through each diagram in the model.
Figure 7. Corporate Decision Structure for business operations.
The corporate decision structure demonstrates the different levels of decision making. The CEO, other CxOs down to Line of Business and Market Segment are involved in the long term strategy of the organisation : CAPEX, aquisitions or reinvest into business, taxes, interest and intangible assets. This is why the CxO’s are paid the big dollars and bigger bonuses to ensure the business reaches the organisation’s 5 year plan.
Though, I don’t understand why some, undeservedly, get paid the big bonuses when these goals are not reached or before the end of the 5 years or their decision causes problems later on. “They” should make bonuses be paid over time, eg, the length of the investment decision made. Then “they” would have to suffer like the rest of us. Just my rant… 
Business operations must align with the long term strategy of the organisation. To make the business operate the organisation needs all the solid blocks, above, to reach the long term goals but the business needs to mitigate short term risks within these blocks.
The business has to analyse the decisions made for product and relate the decisions to a revenue stream within market segment. There is a need to split all lines of business, decision and cost, into the different market segments. This is to ensure that decisions made for one product does not affect the market segments and other lines of business. The business cannot make decisions on the cost of one product only as market segments and lines of business are interrelated.
Figure 5. Level 2 Operations dashboard by Product by Market Segment. (in the ops dashboard , as by Market by Lines of Business).
The business also has to split the blocks of Line of Business in Figure 7 to be the proportions of the “to Build” and “Other Expenses (LOB)”, in figure 5. The business will build the product as a sum total of the business as it would be inefficient to have different production lines for different segments making the same product. These proportions will differ by market segment depending on demand.
Internal Transfer Rates
Internal transfer rates are costs that are allocated by line of business to the market segments. The internal transfer rate is to allow the analysis for product profitability by market segment. These rates are based on the total planned demand for the year and the total costs to operate the line of business.
The “To Build” and “Other Exp (LOB)”, in figure 5, costs will be initially allocated to all to build costs. The other expenses should not exist in a perfect business model that is working towards demand, if the business is over supplying, these excess capacities will be shown in other expenses.
Figure 8. Annual planned demand by market segment and budget cost to supply by product.
The internal transfer rate is based on total planned demand and total budget costs to build the product. The unit cost can allocate the total costs by the proportion of actual units sold by market segment.
Figure 9. “To Build” and “Other Exp (LOB)” cost allocation by market segment.
General Ledger vs Product profitability for costs at time point X.
The effect the transfer rate has on the product profitability analysis will show the actual costs based on actuals sales by product by market segment. The delta between the total actual cost from the general ledger and the calculated costs from the transfer rate will give the “Other Expenses (LOB)”.
Other Expenses (LOB) :
1. Will never be negative,
a) The business will always plan to have excess capacities for any unforeseen demand
b) To ensure service level agreements
c) Seasonal skews
d) Other costs to support the line of business
2. If negative,
a) The line of business is over charging market segments with the transfers rates and overstating initial costs, therefore budget costs for product are higher than the actual costs, and
b) There has been an unexpected windfall in cost reductions 
Figure 10. Level 2 Operations dashboard by Market by Line of Business.
The profitability analysis for product by market segment show the actual costs “To Build” using actual units sold and the transfer rate. The General Ledger is able to apportion the costs into “To Build” and “Other Exp (LOB)”. The operations dashboard now has the additional margin analysis, Product Variable Margin. The business can now measure decisions made for product by market segment.
Conclusion
The internal transfer rate will apportion the “To Build” cost by market segment. This will allow the business to identify and mesure decisions made for product by market segment to mitigate short term risks in operations within product.
Recent Comments