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How to Plan Finance Allocations: Why Less Is More

by Amy Morgan
May 09, 2018

Do you really understand your profitability from the products or services you provide?

There's more to the story than total sales at the end of the year. Incurred costs to develop, test, market and manage your product or service have a huge effect on the overall profitability of your company. If you're undercutting your competition's prices and making lots of sales, but you're not including overhead costs in your pricing, you could be losing money with each transaction. By putting together a simple finance allocations process to track expenditures and resource utilization across your organization, you can ensure that you're really pricing your products or services to make money.

Simplifying Your Finance Allocations

If you've already instituted a finance allocations methodology at your company, congratulations! You are significantly closer to measuring true profitability and making informed business decisions. But ask yourself this: Are the allocations easy to run? Is it a quick, painless process? Or does it take you hours or days every month? If so, then your allocations are probably overly complex.

Often, we see companies that are drowning in allocations data. They've built the Taj Mahal, with intricate allocations down to the penny. I've worked with clients who have processes in both Excel and Hyperion that need to run overnight. These are companies with a talented finance department and good systems and processes in place, yet at the end of the month, their allocations aren't netting out to zero. That's usually an indicator that things are too complex, and something got missed along the way.

With increasing levels of complexity comes an increase in the little places where things can break. That's why we encourage clients to aim for less complexity in allocations. We're not worried about how each penny gets spent, or even each dollar.

We want our clients to first be directionally correct. It's a matter of being a plus sign or a minus sign―are you costing money or making money? And then by order of magnitude, are you making $100, $1k, $10k? We aim for a level of precision that empowers our clients to make informed decisions, and then work toward getting accurate numbers in their allocations methodology to stay within that level of precision.

Creating Allocations That Work

Regardless of what software solution you're using, it's important to understand the drivers you use to allocate expenses. We typically see allocation drivers like headcount, square footage, revenue and number of customers.

Let's look at an example. Say a company wants to allocate out all their IT, HR and marketing costs. We've just named off a few departments, so that's a good grouping of drivers to start with. As we drill down to allocate the IT costs, it's easy to get caught up in the minutiae. But number of clicks in Excel is not going to be a good proxy for total effort in IT.

Most companies will base their technology costs on headcount. The same often holds true for human resources. So instead of having separate allocations for IT and HR, we create an allocation that pools those departments together, and call it the "IT and HR" allocation.

Or, if your company hires 10 remote employees, you don't need physical space in your office to house them on a day-to-day basis. You'll be spending a little more on snacks when they come to headquarters, but it's nothing like the cost of making room for them among the other workstations. Your facilities allocation will use a modified headcount driver, with those remote employees being counted as half a headcount. It isn't always going to be so simple, but it doesn't have to be too difficult.

Whether you are attempting to allocate costs for the first time or planning on overhauling a too-intricate allocations system, remember to keep it simple. Easy-to-understand finance allocations will enable smart financial decisions that will help guide your company into the future.

Discover more best practices for financial planning and analysis throughout Armanino's Financial Advisory blog and learn about technologies to help your organization's finance strategies.

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