Allocations – The Tip of the Iceberg

Allocations & Cost Management is a really unusual area of a business. All other reporting needs focus on taking lots of transaction or balance level detail, tweaking & adjusting it and then aggregating it together for reporting. Allocations is the inverse of this – which presents a unique set of challenges.

In allocations you take 1 high level number and split it out into tens, hundreds, thousands of ways. This presents a pretty unique set of circumstances, not always well suited to classic financial management approaches, and the tools (such as hyperion planning) they often use.

Every PBCS consultant knows how to write an allocation function – but the real power is in knowing how to effectively model the business, and not using PBCS at all!

I’ve seen many custom allocations implementations over the years running on Essbase or relational databases. They all have their pro’s and con’s, but there are some real benefits to not hand crafting a solution and using an off the shelf product such Oracle’s Profitability and Cost Management Cloud Services  (or the latest versions of HPCM for customers that are still working on-premises). Using a product designed for the purpose provides a number of key benefits, but even so, the whole approach cost management needs to be carefully designed to ensure the right outcome – and the best product in the world can’t mask over design deficiencies.

Tread Carefully

Not following this can be fraught – and I’ll give you an example. I was working with a customer whose HPCM model was running slowly – they were a multi-million pound organisation. However, their cost input data was only small – covering approximately 1200 cost centres (both on input & output sides) & projects across a handful of account codes. They had a 9 stage waterfall allocations model, of which 6 of these were real allocations stages – the others were technical stages used to help manage and maintain the model.

This should have been super fast, right? No! – in fact, the allocations process ran incredibly slowly. So I investigated and found some really compelling facts:

To allocate the 1200 input records, approximately 120000 records of driver data was being loaded.

That large numbers of the rules were spread across the entire cost centre hierarchy in any given stage.

There were many instances where allocations of less then £1 were being allocated out across hundreds of target cost centres!

My final analysis identified that if the business deleted 98% of the allocations, the final allocation results to the profit centres would still have been 99% accurate. Or to put it another way, the allocations model would have run in <10 minutes and the variance by profit centre output would have been <£10 (on a £100 million total cost value).

I of course shared this – and I remember the conversation vividly. As a profit driven organisation, the fund managers were fiercely defensive of the allocation of any new costs to them – to the extend that the CFO had recently been called to mediate on a discussion where a fund manager was refusing to accept a £5 cost – because that £5 could be the difference between hitting a target and not………

Anyway, the outcome of all of this was that I defined a number of cost allocations best practices….

Allocations Best Practices

Transparency

Allocations must always be transparent. Offline driver value derivations into a % number only explain the what, not the “why”. The drivers must be something meaningful, easy to identify and easy to explain. Examples of good drivers are:

  • Headcount
  • Time Spent
  • Square Footage
  • Revenue

but a generic % driver – very hard to explain!

Don’t be afraid of splitting an allocation across multiple stages – better split into 2 stages (easy to do using rulesets in PCMCS)

Allocations Threshold

I’ve seen instances where a company was attempting to allocate a 50p cost across 100 different target cost centres. Computationally, this requires the same effort as allocating £5,000,000 – so define a lower allocations threshold, below which you won’t attempt to model it.

Pre-Aggregate

Where multiple allocations form part of a programme allocating lots of costs – consider aggregating these together before the allocations model – £50 x 10 going onto the same target give the same result as £500 x 1 – but is 10x quicker for the computer to allocate.

Evenspread Drivers

Almost never use them! An evenspread driver allocates evenly out across all the target cost centres – so if you allocate to the top of the cost centre hierarchy, it’ll allocate out evenly across the whole hierarchy – the performance impact on doing this can be large, and it’s almost always an error.

In general terms, even spread is great for allocating across to a seperate stage, or splitting a number across a small handful of cost centres, but should never be core to the allocations methodology.

Allocate Fully

Never leave costs unallocated – always make sure you allocate the total cost forwards. Failing to do so means reconciling becomes impossible – is that balance due to a break in the driver data, a new set of costs that need modelling – or something else?

Simplify Simplify

Keep FX conversions out of the allocations model – leave all “classic” reporting and forecasting functions outside of the allocations tool. Make FX conversion a reporting function, not an allocations function.

Consider also layering PBCS in front for driver data capture & definitions – you can integrate PBCS & PCMCS together using Qubix Cloudbridge

Be Logical

Finally – don’t be afraid to split the model into logical segments/applications with integration (or even an x-ref calc) linking the 2. (e.g. IT vs Business costs).

Business Buy In

The final one – but the most important of all – ensure the business really buys in to the allocations methodology! Allocations are galvanising – people either love them (because they get less cost on their cost centre) or hate them (because they get more).

It’s very important to ensure there is complete business buy in and that the CFO is behind the project – especially when contentious allocations are being modelled.

It’s also key to ensure that the business’ expectations are aligned to the project.

  • Make sure the business understand the effort vs value of trivial allocations.
  • A clear definition of the allocations model required – before development starts.
  • That the business agrees with a lower threshold of allocation value
  • That the allocations model is complete

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