Cost Accounting provides insight into the relationship between financial sacrifices and financial benefits. There are a number of elements within this discipline that support this relationship. FP&A stimulates thinking about activities that create sacrifices in order to create benefits. These activities develop a framework for understanding what organizations are doing and where they are going. The question is: which element of Cost Accounting develops a meaningful framework that links activities to understanding?
I consider the most appropriate element of Cost Accounting to develop this meaningful framework to be cost behavior.
Cost behavior is the way that costs change relative to changes in activity usage. There are three types of cost elements within cost behavior. The first is fixed costs, total costs that remain constant regardless of changes in activity usage but unit costs that increase or decrease due to changes in activity usage. The second is variable costs, total costs that increase or decrease due to changes in activity usage but unit costs that remain constant regardless of changes in activity usage. The third is mixed costs, costs that have fixed and variable elements. Understanding these elements provide an opportunity to improve the process of learning about what organizations are doing and where they are going, i.e. FP&A.
Understanding cost behavior only provides an opportunity to improve the FP&A process; applying cost behavior properly leads to improving the FP&A process.
In my work as an FP&A practitioner I am asked to provide insight into financial plans that are centered on revenues and expenses. Expenses is where the application of cost behavior can improve the FP&A process. If an organization expects to incur expenses like salaries, calculating these expenses as a percentage of revenues is irrelevant because salaries are an excellent example of a fixed cost. In order to establish fixed costs within a financial plan it is best to use a bottom-up approach that focuses on commitments to people, processes, and technology. If an organization expects to incur expenses like wages, it is important to determine the number of hours that people are expected to work. I use salaries and wages as a simple example however there are a number of expenses that organizations will incur and these expenses will possess fixed, variable, or mixed characteristics. Producing a financial plan that provides insight into what organizations are doing and where they are going will be enhanced by understanding the financial effect of sacrifices intended to create benefits.
Understanding and applying cost behavior should be a part of developing meaningful financial plans.
FP&A is process that improves the ability of people to make better decisions. A way to make better decisions is to establish a data driven culture. Cost Accounting is a discipline that identifies, records, and communicates data. Incorporating this discipline into FP&A through cost behavior is not limited to financial plans that focus on revenues and expenses. Financial plans that focus on assets, liabilities, and stockholders’ equity also can be improved by understanding as well as applying cost behavior. In addition financial plans that focus on operating, investing, and financing activities can be improved. As FP&A practitioners we must look at ways to continuously improve our processes and cost behavior is an element that provides an opportunity for improvement.
Remember… Cost Accounting and FP&A go hand-in-hand.