Considering Project Accounting for Increased Profit

Many folks confuse the terms “project management” with “project accounting.” These terms are not synonymous. As might be inferred from their distinctions, project accounting is all about tracking the monies associated with projects. Project management is related to managing project tasks, time and resources.

While there are some software applications that handle both the project accounting (PA) and the project management (PM) aspects, most common applications handle only one side or the other. For example, Microsoft® Project™ is a very commonly used application for project management. It is worthless, however, for anything related to project accounting.

Why aren’t project management and project accounting found in the same application?

In most organizations, the fact that project management recording and project accounting transactions do not occur in the same application typically poses few hurdles to operational effectiveness. The reason for this is simple: typically the personnel intimately involved in managing tasks, time and resources (i.e., the project managers) are not the same folks who are intimately involved with handling the accounting aspects of the project (e.g., calculating, printing and sending the project invoices, making payments to project vendors, or assuring that expense or payroll transactions are processed on time). Therefore, the ability to share data via simple integrations or even via ad hoc queries or reports is quite frequently sufficient.

In fact, not infrequently, organizations actually prefer to have project managers and their activities kept separate from project accounting and its related activities. Doing so functions as a double-check and adds control in itself.

“We don’t do projects?” we hear you saying

You don’t think you’re in a “project”-type industry? Well, maybe you’re right. But consider these possibilities:

• Internal projects – Does your organization do internal projects for which you’d like to track costs accurately, even if you never bill anyone for the services? Do you do advertising campaigns? IT projects? Opening new locations? If so, then it is possible that your business could benefit from the additional controls provided by a project accounting solution.
  
• Engineer-to-Order – If you are a manufacturer in an engineer-to-order (ETO) industry, then project accounting might be applied to track your costs leading up to the manufacturing. Professional services and related costs and expenses can be tracked and managed using project accounting’s capabilities.
  
• Installation or After-Market Service – If your manufacturing or distribution operations extend themselves into the fields of installation, configuration or after-market service, then chances are project accounting is not the right solution for you. In such cases, you should read the section on Service Management.

What can Project Accounting do for you?

There many time-saving functions brought to you through the project accounting capabilities that dramatically reduce the time, energy and effort that would otherwise be required. Here is a sampling:

Profit Recognition

Projects may recognize profit/(loss) in several different ways. Most PA solutions allow users to assign the profit recognition method by project. The typical profit recognition methods include:

1. Manual
2. Cost-to-cost percent
3. Percent of revenues
4. Non-WIP
5. Project completion
6. Percent of elapsed time

“Percent of elapsed time” is a profit-recognition method commonly used with prepaid date-limited service contracts. If this is a common method in your firm, be sure to investigate Service Management solutions as well. In some circumstances, service management may be the more appropriate solution to apply.

Project Billing Methods

Project accounting software typically offers several options for billing and projects may be of different billing types:

1. Time and materials
2. Fixed price
3. Fixed price plus

When a project is designated a “time and materials” billing type, most project accounting systems allow the materials items to be passed through at cost to the customer, or billed with a mark-up add to designated materials and other non-labor charges.

Billing for Employee Time

Businesses that bill their clients for employee time spent on various projects often face the daunting task of keeping the billing correct based on agreements with their various clients. Not infrequently such agreements may involve complexities that would require considerable time and care if attempted without the support of a project accounting system.

For example, clients may negotiate different rates for different specific employees when working their projects. Indeed, they may end up negotiating different rates for the same specific employee on different projects—several of which projects may be underway at any one time with the same client. As you can imagine, assuring that project billings are assigned the right rate for the right resource on a project by project basis could become a difficult task. Project accounting systems handle such billings effectively and simply with little effort.

Add to the potential complexity described above the ability to also bill different rates to different projects or different customers based on the employees’ titles in their assignments to different projects and you can readily see that manually tracking all of the potential combinations could become a nearly impossible task. Here, for example, employee Jim Smith might bear the title “Project Manager” on one project for one client and, as the Project Manager be billed at $225 per hour. However, due to Jim’s lack of experience in another type of project, he may bear the title “Developer” on that project and be billed to the same client (or a different client) at a rate of only $150 per hour.

Increasing throughput and profits

Now, you might say, “I don’t need all that complexity in my projects. We’re content with billing just one rate per project, one rate per client, or one rate per employee across all projects and clients.

Our question in response is this: “Why wouldn’t you want to make more money tomorrow than you are making today if you could do so without adding significantly to your operating expenses by doing so?”

We ask this because this is precisely what a project accounting solution could do for you and your firm.

Chances are your client’s aren’t stupid. They know that a good and effective project manager is more valuable to them than a heads-down programmer or a project secretary or, perhaps, a QA staffer. Right now, you are likely charging the same for each of these, which mean you must be using an “averaged” rate.

By adding project accounting’s flexibility, you are also adding the low-cost option of further segmenting your market and closing more deals. You can charge clients more or less based on how your crack sales team identifies the prospect’s or client’s view of “value.” Two projects that are virtually identical in their execution may have two significantly different values to two distinctly different clients. Consider the following chart:

Project ID	Est. Project Cost	Est. Project Revenues	Est. Project Profit
A	$ 165,000	$ 260,000	$ 95,000
B	$ 165,000	$ 220,000	$ 55,000
C	$ 165,000	$ 200,000	$ 35,000

Here we see virtually identical projects on the “cost” side. However, three different clients perceive the “value” of the efforts differently in their businesses. One is willing to pay $260,000 for the work; another is willing to pay $220,000 for it; and third sees only $200,000 in value and won’t pay a cent more.

If your PA system only allows you to charge these clients one rate—or if you don’t want to burden your accounting department with manually managing different billing rates per client—you may be tempted to turn down Projects ‘B’ and ‘C’.

Why give up the profits?

But, if your firm has the capacity to do projects ‘B’ and ‘C’, and no more profitable project prospects stand in your way, why would you turn down an extra $90,000 ($55,000 plus $35,000) in project profits simply because your accounting system makes it too difficult to manage. (Actually, that is not the reason such profits are all too frequently passed by. Instead, it is because executives and the sales team—hemmed in by preconceptions about their accounting limitations—never think of making these offers. Instead, they offer their ‘bids’ using the firm’s standard costs and markups and end up losing the deals for Projects ‘B’ and ‘C’.)

Leveraging new capabilities for new profits

In short, leveraging the new flexibilities delivered by a project accounting solution may allow your firm to dramatically increase revenues and profits through market segmentation. However, doing so means bringing to your firm new ways of thinking (as seen above) and an understanding how newly delivered capabilities can, in fact, be applied to create new markets or extend existing ones. This means finding the right implementation partner is essential.

It is imperative that you not make the common mistake made by some many executives and managers when considering the purchase and implementation of project accounting software. Typically they spend more than 90 percent of their time and effort in what the process of “software selection,” carefully considering a long list of features and functions. Then, when this is all done, they simply take whatever consulting firm and consultants come along with the software. We believe this is a wrong-headed approach and many firms to make investments in software with little return on their investment.

There are three critical aspects necessary for a project accounting implementation leading to rapid and high return-on-investment:

• The ability to unlock “tribal knowledge”
  
• The ability to reduce complex problems to simple solutions
  
• The ability to help your organization “design” new ways to leverage new capabilities for increasing throughput and profit

If the software reseller cannot bring to your firm these critical elements, perhaps you should look elsewhere.

Warnings for SMEs Seeking Manufacturing “Solutions”

Many small to mid-sized manufacturing enterprises (SMEs) come to us seeking manufacturing software. Not infrequently, when asked about their goals in applying manufacturing software, executives in the firms are seeking “to get a better handle on manufacturing costs,” or something similar.

Two warnings

In such circumstances we offer a two-fold warning: First, we tell them, if you implement software to support your manufacturing operations, it will be capable of producing mountains of reports. Enough raw data is collected by advanced manufacturing solutions to bury the typical SME in reports—reports that they don’t have today and, to a great extent, they will never have time to thoroughly analyze when they become available to them.

Second, we warn them—and this is the critical warning—when you start getting reports and data coming out of your manufacturing software, you are going to start believing what is on the reports!

And, “What’s wrong with that?” we hear you ask.

Where does it all start?

Well, to understand that warning, we have to take a step back to look at what goes into “bootstrapping” a manufacturing solution in an SME. Here is a short list of some of the data elements:

1. Routings/Bills of Materials

1.1. Quantity per Cycle

1.2. Economic Cycle Quantity

1.3. Materials

1.3.1. Quantity Required per Production Unit (including waste)

1.4. Labor

1.4.1. Move Time

1.4.2. Queue Time

1.4.3. Setup Time

1.4.4. Re-Setup Time

1.4.5. Quantity per Reset

1.4.6. Scrap Quantity / Scrap Rate

1.4.7. Production Effective Rate

1.5. Material Requirements Planning (MRP) by Routing

1.5.1. Planning Window Size

1.5.2. Planning Batch Size

1.5.3. Planning Maximum Quantity

1.5.4. Planning Minimum Quantity

1.5.5. Planning Percent Over

2. Operational Parameters

2.1. Work Schedules

2.1.1. Holiday Schedules

2.1.2. Planned Downtime Schedules

2.1.3. Planned Maintenance Schedules

2.2. Work Centers

2.2.1. Fixed Overhead (Allocation) Rates (dollars)

2.2.1.1. Run-time Rates

2.2.1.2. Setup Time Rates

2.2.2. Production Cost Rates (dollars)

2.2.2.1. Run-time Rates

2.2.2.2. Setup Time Rates

3. Material Requirements Planning (MRP) Parameters

3.1. Days in Planning Period

3.2. Planning Fence Days

 

That short-list includes more than 20 parameters, the majority of which will have some affect how the system calculates the firm’s “cost of manufacturing” for any given item in its SKU-list. Not only so but, if the SME implements SFC (Shop Floor Control) to capture so-called “actual” production time, the system will calculate new costs based on the variations in actual production times—and they will vary—adding to the confusion over what is profitable and what is not.

Beginning with guesses

Most SMEs interested in implementing manufacturing software will have (quite literally) no idea what values should be used for a great many of the parameters their new manufacturing software will require from them. And, with limited time to get the system implemented, they will be forced to make guesses and use these values for their parameters. The biggest of all the guesses—by our experience—will be in the dollar-amounts assigned to the various Work Centers for the costs of production and overhead allocations.

Now, consider this: Let us assume that a firm has 3,000 manufactured SKUs (Routings with five factors affecting cost on each Routing) running through eight Work Centers (each with 4 factors affecting cost). That works out to be:

3,000 Routings * 5 factors/Routing * 8 Work Centers * 4 factors/Work Center = 480,000

Such an SME has nearly half-a-million combinations of variables from the manufacturing system alone affecting reports that will be used by management to try to guide the firm to greater profitability. Now, consider that a good many of the factors involved—and now buried deeply in the processing—were guesses to begin with, and you may begin to see why we offer the warnings: the manufacturing software will produce lots of data and reports and—what is worse—management will believe the reports!

What is an SME to do then?

The sheer complexity of the problem means that an SME must be careful not to invest poorly in their manufacturing solution. Very expensive manufacturing software that is poorly implemented is probably more damaging to the SME than less expensive software that is properly implemented and practically applied.

Where should an SME look to find the skills?

Some SMEs seek to hire employees who have had previous experience at other firms in working with or implementing manufacturing software. At times this works out. However, there are two potential dangers in taking this approach. The first is that the employee comes to the new SME with the intention of implementing exactly the same software he had at his old employer’s firm and he or she intends to implement it in exactly the same way it was implemented at the other firm.

This is dangerous because no one knows for sure whether the other firm’s software is the right fit for the new SME’s deployment and, worse, no one knows if the previous firm’s implementation was done properly and effectively.

The second danger in taking this approach is that the employee is likely to bring with him or her preconceptions about how manufacturing or other business processes work together with the manufacturing solution. However, the new SME’s business processes and manufacturing flows may be significantly—or wholly—different from the other firm’s processes. The preconceptions may be entirely out of place in the new manufacturing environment.

The right implementation partner

Everything we have discussed up to this point emphasizes the importance to the SME of finding the right implementation partner for the manufacturing solution.

What should a good manufacturing solution partner look like?

It is rightly said that no consulting organization will ever understand the SME’s business as well as the folks in the SME organization itself do. It is also clear that it is highly unlikely that any business enterprise will ever come understand the software it uses as well as the consulting organizations that specialize in its application across multiple enterprises. So, the best implementation partner for any SMEs manufacturing solution should meet the following qualifications:

Able to unlock “tribal knowledge”

New manufacturing software will not help you:

Create new manufacturing capacity

Sell more products

Reduce inventories

Ship more orders on-time

Increase customer satisfaction levels

However, an implementation partner with the skills and experience necessary to unlock what your people know—the “tribal knowledge” carried about in the heads of your employees and managers who get things done day-after-day despite the difficulties—is one who may also be able to help you do all of these things while implementing your new manufacturing solution.

Unlocking “tribal knowledge” requires tools and skills built through years of experience. It requires a deep and thorough understanding of businesses from customer acquisition to cash collections and financial reporting. Any “implementation specialist” that only looks at—or only has the skills to see—what’s happening on the manufacturing floor may implement the software but will not help your firm reap the most return for your investment.

Able to reduce complex problems to simple solutions

The more complex a problem appears to be, the simpler the solution must be if it is to be manageable, reliable and sustainable. Consider the following simple illustration of two systems:

Many executives, managers and consultants view their organizations much like “System 1.” They see A, B, C, D and E as just so many departments and functions, each to be considered, managed and optimized separately. This leads to “complex” solutions that frequently do not produce predictable—or even, desirable—results. The solution must be “complex,” because the system appears to be complex. In order to affect areas A through E, we must touch each of these areas individually.

However, through the process of unlocking “tribal knowledge,” it is possible to get a view of an organization that looks like “System 2.” Now we find a “simple” solution. We understand that if we affect just function A in a certain way, doing so will a predictable affect on all of the other areas. We have, thus, reduced apparent complexity to find a simple, yet elegant, solution.

Able to help your organization “design” its own solution

Something you won’t hear from too many software resellers is this truth: the software is not “the solution.” The solution is to be found in the context of your SME organization. The solution is the blending of people, technology and processes with a holistic view of what it will take to help your organization make more money tomorrow than it is making today.

Getting to that end does not mean—as some software resellers would like you to believe—simply “buying the right software” and “implementing” what you bought. Rather, it means getting the whole organization involved in creating a new “solution” by reshaping the way people see and believe in the operation of the whole enterprise—and, in particular, their role in that “big picture.” We believe it is essential for your organization to be involved in creating the solution—creating the blend of people, processes and technologies—because in guiding them in the creation of the solution, we are automatically helping them create success.

Success becomes virtually automatic result because people don’t fight against their own invention. They may fight against what is thrust upon them from management on-high, but they will never struggle against nor undermine the solution that is the invention of their own thought processes.

Don’t put the emphasis in the wrong place

Far too many SMEs considering the purchase and implementation of manufacturing software spend some 90 percent of their efforts in what they call “software selection,” and then end up taking whatever consulting firm comes along with the software. We believe this is a wrong-headed approach and has led to many of the horror stories with which the ERP (enterprise resource planning) software industry is rife.

Remember these three critical aspects necessary for a manufacturing implementation with high return-on-investment:

The ability to unlock “tribal knowledge”

The ability to reduce complex problems to simple solutions

The ability to help your organization “design” its own solution

If the software reseller cannot bring to your SME firm these three critical elements, perhaps you should look elsewhere.