Wednesday, 1 February 2012

Controlling Costs With Adempiere ERP

by Zeeshan Hasan
(First published in the January 2012 edition of CIO Bangladesh)

One of the benefits of ERP software is greater ease of monitoring and controlling costs. Traditionally, costing was a difficult and laborious process requiring a cost accountant to manipulate massive spreadsheets summarizing purchase, inventory and manufacturing data. As these numbers are generated in different departments, just finding them is difficult without an integrated ERP. Simplification of data-gathering from differerent departments is in fact the basic promise of any ERP software; including the open-source Adempiere ERP used in my company, Kazi Farms.

Once an ERP is implemented, the first hurdle of acquiring costing data from its sources in different departments is overcome; the integrated database of any ERP contains all the data of the whole organization. However, the question then arises as to whether the accounts department uses a costing method which makes controlling costs easier. Many companies have their beginnings in simply trading; especially in developing countries like Bangladesh, where many items are traditionally imported as finished goods. For a trading company, the main generator of cost is in purchase. In this case, any costing method, whether average costing or FIFO (first in, first out) will work, as both these costing methods focus on monitoring the prices at which inventories are purchased.

But the scenario is more complex in a manufacturing setting. Once a company makes the jump to manufacturing, simpler costing methods such as average cost and FIFO are generally of limited usefulness. This is because purchase of raw materials is only one of the elements of the cost of the manufactured product. Other cost elements also need to be monitored, such as labour, power, spare parts used and depreciation expense incurred. The price and quantity of each of these required for a unit of production can vary depending on how efficiently the production process is managed.

Cost control of manufacturing generally requires a manufacturing budget to be established for the finished product which will specify target costs of raw materials, labour and power and depreciation. This is best done through adoption of standard costing. Like most ERP softwares, the Adempiere open-source ERP package supports standard costing.

Implementing standard costs accordingly requires estimation of target costs for each individual input. As each item of production is actually completed, the ERP system will capture actual data of those costs. These are then compared with the standard (budgeted) costs by means of variance accounts. For example, an inefficient production process which wastes raw materials will show positive variance on raw materials; an efficient production process which used less than the budgeted raw materials will show negative variance. By examining variance accounts, more efficient production processes, workers and managers can be identified. This can result in cutting costs and a better bottom line, which is the efficiency that ERP promises.

The difficulty with the above is that many costs are only available at the end of the month (for example, when monthly salary and utilities bills are paid). Therefore, an ERP system has to include some means of estimating what those costs will be with each item produced. By including this estimation of monthly costs as a monthly provision distributed to each unit of production, Adempiere ERP can give an estimated daily costing and (when combined with actual sales revenues) a daily income statement.

Daily product costing, detailed monitoring of the costs through variances with standard/budgeted costs and actually being able to provide a daily income statement are ultimately the tools which management requires in any company to understand which products, workers and managers are more effective. Identifying and replicating such successful practices are key to the goal of continuous improvement and lean manufacturing as exemplified by the incredible successes of the Toyota production system in Japan. There is often a tendency on the part of complacent managers to assume that such modern business philosophies are foreign to Bangladesh and will never work here; but being competitive in the global economy requires that these ideas ultimately be made to work. Modern ERP softwares are one tool to help companies cut costs and realise these gains.

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