Operating cost ratios
Financial controllers have a key role to play in managing overheads; this is an especially important task during a recession. How can you use ratios to make this task easier?
Use of accounting ratios
It’s common practice to consider absolute cost numbers versus budget and prior year. However, accounting ratios show the relationship of one number to another relevant number which can be much more revealing. Using operating cost ratios helps you to identify inefficiencies in the running of your business which might otherwise be missed.
Denominators
Ratios can be applied to most of the overheads in your chart of accounts, with the overhead cost item as the numerator (top of fraction).
Operating cost ratios are frequently calculated across all overhead cost items using sales or total overhead costs as the denominator (bottom of fraction). But this approach is often too simplistic and will not highlight inefficiencies.
Tip. Look for ratios for the most material overhead costs in your business and focus your efforts on these.
Headcount driven ratios
Many overhead costs are affected by the number of people in your company. In these cases, use headcount as the denominator for the operating cost ratio.
Tip. Review your overhead costs and identify those relating to headcount.
Whilst some overheads are clearly related to headcount, for example training and recruitment costs, others may not be so obvious.
Example. The main reason forlandline and mobile phone costs fluctuating in many businesses is the number of people employed. The most appropriate ratio in this case will be telecommunication cost per head.
Tip. Don’t ignore fixed costs, as these can also be driven by headcount.
Example. The amount of office space required by a business is usually calculated with reference to headcount. Whilst you can’t usually flex your office space in the short term, monitoring the ratio of rent cost to headcount can be used to trigger a decision to sublet excess space.
Sales driven ratios
The level of sales is the relevant driver for some ratios.
Example. The cost of sales travel, subsistence and sales tools ought to be related to sales levels. In this case use sales as the denominator for these costs.
Tip. For marketing costs consider relating these to changes in the sales figures for new products or new customers rather than total sales.
Other ratios
Examples of other drivers to consider include the amount of space occupied, number of customers and the number of vehicles in a fleet.
For a free model to help calculate operating cost ratios, visit http://financialcontroller.indicator.co.uk (FC 02.04.10).
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