How to add value in value based management?

Value Based Management is the management philosophy and approach that enables and supports maximum value creation in organizations, typically the maximization of shareholder value. VBM encompasses the processes for creating, managing, and measuring value.

Adding value to your business is very important for better profits. Recent years have seen a phase of new management approaches for improving organizational performance like flat organizations, profit driven organisation, total quality management, empowerment, continuous improvement, team building, and so on.

Many have succeeded - but quite a few have failed. Often the cause of failure is not meeting the targets that were unclear or not properly aligned with the ultimate goal of creating value. Value-based management is the solution for this problem. The thinking behind VBM is simple. The value of a company is determined by its discounted future cash flows. Value is created only when companies invest capital at returns that exceed the cost of that capital. It provides a precise value upon which an entire organization can be built leading it towards profitability.

Strategies for cost management

Strategic cost management is the process of reducing total costs while improving the strategic position of a business. This goal can be accomplished by having a thorough understanding of which costs support a company's strategic position and which costs either weaken it or have no impact. Subsequent cost reduction initiatives should focus on those costs in the second category. Conversely, it may be useful to increase costs that support the strategic position of the business.

It is almost never worthwhile to cut costs in strategically important areas, since doing so reduces the customer experience and therefore will eventually lead to a decline in sales. Consequently, management needs to be involved in cost reduction activities, so that they can provide input regarding how certain costs must be incurred in order to support the competitive position of the firm.

Strategic cost management is a continuing process, since the strategy of a firm may change over time. Thus, certain costs may be sacrosanct when one strategy is being used, but can be readily eliminated when the strategy shifts.

Activity Based Costing: A better way to analyze profits

What is Activity Based Costing?

Activity-based costing is an accounting method that identifies and assigns costs to overhead activities and then assigns those costs to products. An activity-based costing system recognizes the relationship between costs, overhead activities, and manufactured products, and through this relationship, it assigns indirect costs to products less arbitrarily than traditional costing.

Companies implement activity-based costing to: Identify specific products that are unprofitable, Improve production process efficiency, Price products appropriately, with the help of accurate product cost information and reveal unnecessary costs that become targets for elimination.

Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. ABC will use many cost drivers instead of just one cost driver such as machine hours to allocate a manufacturer's indirect costs. This is relevant to all the manufacturing companies which have a vast product and customer range. It also enables improved product and customer profitability analysis.

Is traditional costing irrelevant?

  

What is traditional Costing?

Costing is any system for assigning costs to an element of a business in which one of the old methods is traditional costing. Traditional cost allocations are based on volume such as number of products manufactured, production machine hours, direct labor hours, square feet, etc. But, it is becoming more frequent that the indirect costs that require allocation are not caused by volume. In short, allocations of traditional cost are more over based on something other than the costs.

Why is it irrelevant?

If you see it is just relevant to most of the trading companies where there is only purchase and selling price and no overheads, but with manufacturing companies it is irrelevant since the overheads are charged on to the products and customers equally.

What should be done?

For knowing the true cost of any product or customer traditional costing is not the right method. Therefore activity based costing was developed to overcome the problems of traditional method. ABC will use many cost drivers instead of just one cost driver such as machine hours to allocate a manufacturer's indirect costs.

For calculation of better profits it is necessary that you shift from traditional costing to activity based costing, since maintaining the leadership title in this competitive world is very important.