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Strategic Management in Large Multinational Corporations
Strategic Sources, Inc. is a multinational organization that operates in 20 countries around the world. They offer a wide variety of products and services to their customers. Their extensive business portfolio includes some portions of the organization that serve as suppliers for other parts the organization. In an effort to increase profit margins, the Chief Financial Officer has been appointed the task of presenting options for cost accounting that will help to maximize profit margins not only in the individual units, but in the organization as a whole.
The following will present the options for achieving this goal. It will address three different approaches to cost accounting including making individual managers cost center managers, profit center managers, or investment center managers. It will also examine three different approaches to costing products or services. It will explore marginal or variable costing, full or absorption costing, and activity-based costing.
Cost Center Management
Companies may choose to classify their divisions as cost centers when the divisions of the company are clear. When costs are easy to measure establishing business units as cost centers makes accounting easy for the unit and for the parent company. However, cost centers can create incentives for managers to reduce operating costs within their unit to benefit themselves. This can have a negative impact on the parent company by creating bad customer experiences, which will ultimately result in lost sales and lost brand equity. The cost center can have a negative impact on profit and cost centers can be easy targets for layoffs and downsizing when budgets are cut.
Operational decisions in the cost center are often driven by cost considerations. Indirect costs are often difficult to translate into their affect on profitability. For instance, new equipment purchases might not realize a profit until sometime in the future. Cost centers may not see the benefit of such long-term purchases and therefore may not make the decision to buy them. Cost centers tend to want to realize profit quickly and in a way that is easily measurable. Cost centers must be able to immediately justify expenditures, which is not always easy to do.
A cost center does not necessarily directly generate revenue, but contributes generation of revenue in the company is a whole. Some cost centers do not generate revenue it all, such as personnel or a customer call center. The services are paid for by the company's sales, but they do not directly create sales themselves. Yet, without them, sales for the entire company would decrease. An IT department is an example of this type of cost center for many companies (Bahel, 2010).
In a cost center profitability is usually determined by subtracting only the costs that that manager can control and can be directly attributed to their unit from the revenues. When costs are shared between several divisions, one unit may receive a disproportionate benefit from the expenditure, but they will still share equally in the expenditures. Cost centers often have disproportionate cost and benefits relative to their use of capital within their unit. This is usually good for companies that are fairly centralized.
The more assets and overhead they can share, the better success they will have with the cost center management approach. For instance, in a manufacturing facility where all of the units are located under a central roof and share utilities and personnel, the cost center approach would be effective. In this case, all of the cost centers share equally in operational costs, but they also receive some benefit from them as well. One of the key disadvantages of the cost center approach is that the manager will have to absorb costs that they could not control and that were handed down to them from above. Yet, they must find ways within their department to absorb them and still remain profitable. Power and control in the cost center approach is weighted towards the company as a whole and often individual cost centers will have to struggle if their unit wishes to meet their goals.
Profit Center Management
A profit center differs from a cost center in that it is treated as if it is an entirely separate business entity. Profits and losses at each center are calculated separately. The manager of the profit center is responsible for both revenues and expenditures. The manager of the profit center must drive sales so that the cash inflows outpace cash outflows. This is similar to running one's own business. This differs from the cost center where the manager is only responsible for keeping down costs and their activities are limited to those activities that will produce tangible results.
Management can easily follow how much each cost center contributes and they can compare it to the contributions of the other cost centers. The profit center has an advantage in that it is easier to track in terms of performance. However, it has a disadvantage in that one manager can have a detrimental effect on the rest of the business in the actions that they take. The profit center approach is much easier from an accounting perspective and from a management perspective because one can easily see which divisions are profitable and which ones are not. It has the advantage of being able to quickly diagnose a problem so that the resolutions can be implemented.
Profit center approaches are typically applied to businesses that are decentralized. They must often attain their own facility and assume their own operational costs such as utilities and personnel. In a cost center, several units may share a centralized administrative staff or perhaps they may use the same main and staff. However, if the units of the business are scattered far away, each center must have its own administrative staff, maintenance staff, electrical service, and they must provide their own physical building. They do not have the advantages of sharing the services as with the cost center approach, but they receive direct benefit from their expenditures. Often managers that are using the profit center approach are under extreme pressure to meet goals because they are directly responsible for them. With the adoption of activities-based costing, the definition of cost and profit centers is changing (Kaplan, 2006). There is a growing trend to transform cost centers into profit centers (Leonard, 2006).
Investment Center Management
The investment center approach is to measure is the unit's performance against its use of capital. This differs significantly from cost or profit centers which are measured against raw costs or profits. One of the advantages of this method is that it accounts for all uses of capital, not just those that are directly associated with profit activities. Divisions are often measured against a set of criteria. A key disadvantage with this method is that managers with a short-term focus my not make the best decisions for the long-term goals of the company.
The investment center is the center that has control over the investment of funds that will benefit the entire company. Many companies have a centralized corporate headquarters that serves as an investment center. The investment center approach is not focused on short-term gains, but rather on the long-term goals of the entire organization. Some organizations may have smaller Investment Centers within them, but they must often meet the needs of a centralized investment unit. The key advantage to the investment center approach is that the focus is on long-term goals, rather than short-term actions and results.
There are advantages and disadvantages to each of these approaches in cost accounting. As a manager, of a large multinational corporation, it is likely that all three of these approaches will be used in combination with in the entire organization. It is likely that a central headquarters will be set up as an investment center. The various units operating within the different countries will be set up as profit centers and within each of these profit centers will be individual cost centers. The profit centers would be the unit to report directly to the investment center. Each profit center would be responsible for the generation of its own revenues. Due to the geographical distance involved, each profit center would not have the luxury of sharing resources with others. However, they would operate different cost centers within their organization that they share resources within that profit center.
In terms of choosing a certain cost accounting approach for a large multinational corporation, it is unlikely that a single type cost accounting approach would be appropriate for the entire organization. Cost accounting in complex organizations often develops as a result of slow company expansion. It is difficult to use cost centers in areas that are geographically distanced. However, each profit center is often a large company unto itself. Therefore, within it are various cost centers. Each profit center must generate enough revenue to cover the costs of non-revenue producing units. In this case, some of the units produced supplies for other units. These units would be considered…[continue]
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