Determining Cost of Capital on Products and Customers 1 CPE

We discuss and illustrate a low cost method to determine the cost of capital for each product or service sold to each customer.  This information is useful to businesses requiring significant investment in working capital and/or fixed assets to serve customers.  Traditional accounting measures like “gross profit” do not reflect the financing and opportunity costs of these investments.  Seeing ROI or the economic value for each product and customer can be a competitive advantage.  The product and customer portfolio can be optimized to improve overall return on capital and cash flow.

Measuring ROI at the product level requires assignment of balance sheet resources to each product and customer.  Most accounting systems do not provide this level of resolution.  Value Point Accounting (VPA) uses financial analysis tools to assign balance sheet items to individual products and customers.  It does not require accounting transactions or allocations.  VPA is a management accounting technique to create complete financial statements at the product unit level – call it “nano-accounting”.

We review opportunities to use value point accounting information for enterprise performance management (EPM).  These include pricing strategy, product and customer mix optimization, operating capacity decisions, cost reduction initiatives and enterprise reporting.  This course can be useful to CFOs, controllers and cost accountants who provide profitability information to operating management.

Prerequisites

Prerequisite: Experience with finance and Cost Accounting

Advanced Preparation: None

Learning Objective

• Contrast the finance view versus accounting view of product and customer profitability and evaluate risks of relying on gross profit alone.
• Introduce the concept of Value Point Accounting that focuses on the unique performance of each product sold to each customer – a value point.
• Compute the cost of net working capital and the cost of capital on fixed assets associated with each value point.
• Construct complete financial statements and the economic profit for each value point.
• Explore uses of value point accounting information to challenge competitors and improve operating decisions.
• Identify industries where value point accounting is most effective.

Last updated/reviewed: March 23, 2024