Ever made a purchase that should have been avoided? Or not been able to invoice your customer as you were not aware of the cost at the right time? These issues are often a result of businesses not having the appropriate systems in place for tracking committed cost.
Since the accounting system is designed to look backward, it’s not easy to keep track of everything that ultimately will hit your accounting books.
So why not focus more on what actually makes an impact on your business?
It is at the time you make a commitment that you can make a financial impact, the P&L in the accounting system will at the end of the day only provide the outcome.
In this article, we will provide some insight into what financial commitments are, who benefits most from tracking financial commitments, and how you can get full value from tracking your financial commitments.
What is a committed cost?
A committed cost is an investment that a business entity has already made and cannot recover by any means, as well as obligations already made that the business cannot get out of. One should be aware of which costs are committed costs when reviewing company expenditures for possible cutbacks or asset sales.
Picture: Example time lag from a financial commitment to cost incurred in the accounting system
In a project or in your general business, you make financial commitments. In many situations it can take a lot of time from a commitment is made until the invoice is received from the supplier and booked in your financial system (cost incurred). This represents the time lag from commitments to cost incurred.
Many companies already track their committed cost in some shape of form either by maintaining a list of purchase orders, tracking costs in a project, keeping track of a marketing budget, or general expenses in the company.
Often managed by multiple spreadsheets covering the needs of the originator.
Who benefits most from commitment accounting?
Some businesses benefit more from tracking commitments than others. Some reasons for this can be:
- Volume – the more external purchases make up of your total business, the more important it is to keep track of your committed cost.
- Lead time – Longer lead time (time from a commitment to cost incurred) means a higher volume of open commitments at any time and increases the need for insight.
- Margins – lower margins increase the need for financial discipline
- Complexity – more complex commitments/purchases (ie non-standard purchases) increase the importance of making the right decision at the time of commitment.
How can you benefit from tracking committed cost?
The main benefits of tracking committed cost relate to making better decisions (impact) and increased efficiency through insight.
Make better decisions (impact)
Since it is at the time you are making a cost commitment (for example a purchase) that you can impact the end result, this is the point of time you need the right process and insight to make the right decision. Below are some examples of key questions you could need to make the right decision/impact.
- Is the supplier correct? Should you quote for multiple suppliers?
- Is the scope for the purchase correct?
- Are the terms and conditions correct?
- What has the price we paid last time? Or what was the volume last 12 months?
- Should another colleague approve the purchase?
- Is the purchase within my budget?
Increased efficiency through insight
Most businesses have processes where they need insight into commitments. These might be
- The department manager or project manager needs to know progress against budget
- The purchaser needs to know what purchases are still outstanding
- The accountant needs the insight to make the right financial accruals
- The accountant needs proper insight for handling invoices correctly
- Finance needs to update the company cash flow forecast
As a result, multiple people are often occupied handling this manually on an ad hoc/monthly basis By tracking your financial commitments, you will have the insight to automate these processes.
How can you track committed cost?
The three most common ways of tracking committed cost are:
- Accounting system with commitment accounting – often only the larger, more complex accounting systems has this type of functionality.
- Purchase order software – you can effectively track your financial commitments in a purchase order software
- Spreadsheets – many companies use spreadsheets to track their financial commitments. It is easy to implement but comes with several limitations.
Picture: Part of approval view in CostTracker providing real-time insight into financial commitments
CostTracker is a cloud-based purchase order software designed to provide you total control of financial commitments and improve financial decision making. CostTracker makes cost control easy for many customers all over the world and can be used as stand-alone or integrated with your accounting software.