At MAP, we often talk about the power of enhanced management accounts – going beyond the standard profit & loss and balance sheet to give you deeper, more actionable insights into your business. While topline revenue and gross profit are vital, a common area that sparks crucial conversations and can unlock significant profitability improvements is reporting on individual departments, service lines or pods.
During a recent internal discussion, we delved into the nuances of how different businesses approach this, highlighting that there’s no single “right” answer, but rather a need for an approach that genuinely reflects your business model and aids decision-making.
Why is cost allocation so important?
Imagine you have multiple service lines or “pods” within your business, each contributing to revenue. If you only look at their direct costs, you might assume they’re all equally profitable. However, once you factor in the shared overheads – things like rent, administrative staff salaries, utilities, or even leadership team salaries – the true profitability picture can change dramatically.
Consider the example of a client we discussed. They meticulously apportion their overheads to each pod based on headcount. This approach allows them to see the true operating profit of each pod, not just their gross profit. This level of detail has allowed them to:
- Identify High-Performing Areas: Discover that a new service is significantly exceeding profitability targets, leading to plans for expansion and new hires.
- Drive Healthy Competition: By transparently tracking revenue and profitability per pod, it fosters a sense of healthy competition and drives individual team performance.
- Make Informed Strategic Decisions: Knowing which areas are truly driving profit allows for more strategic investment, resource allocation, and even pricing adjustments.
The Different Approaches to Overhead Allocation
Our conversation highlighted that different clients have different preferences, and the “best” method depends on the desired level of granularity and the specific insights needed:
- Apportioning Down to Operating Profit: Providing a comprehensive view of each segment’s profitability after all allocated costs.
- Focusing on Gross Profit: Some clients prefer to stop allocating costs at the gross profit line, feeling that further apportionment becomes too granular or less relevant for their operational decisions.
- Direct vs. Apportioned Costs: There’s always a debate about where certain “direct” team costs should sit – above gross profit or within operating costs. For example, one client tracks billable hours as a non-financial KPI, while another includes all team costs above gross profit.
Beyond the Numbers: The Strategic Conversation
The method of cost allocation isn’t just an accounting exercise; it’s a strategic conversation. It forces you to ask:
- Which costs are truly attributable to which parts of my business?
- How do these allocations influence my perception of profitability?
- What decisions will I make based on this information?
At MAP, our goal with enhanced management accounts is to provide the insights that drive smarter business decisions. By working with you to define the most relevant cost allocation methods, we can help you uncover true profitability, identify areas for improvement, and ultimately, optimise your overheads to fuel sustainable growth.
If you’re ready to gain a clearer understanding of your business’s true financial performance, let’s talk about how enhanced management accounts can transform your decision-making.
