Bottlenecks in Accounting: Impact & Management

“Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.”

- Diane Garnick

 

In a general sense, a bottleneck means a constraint. If we define a bottleneck from an accounting perspective then it means- any process or operation that has reached its full potential or capacity and it can no longer accept additional tasks beyond it.

 

If you have seen the neck of the bottle then you must have noticed that it is narrow and the quantity of liquid that comes out from the neck area is always constricted. This is why we use bottlenecks to show a constraint in a manufacturing process.

 

What are Bottlenecks in Accounting?

 

There are so many definitions of bottlenecks in accounting. But every definition points towards two points that are:

 

1. Bottlenecks in accounting of an organization are what constricts the sales and revenues.

 

2. It will show how much money is lost in each constricted process.

 

In some organizations bottleneck accounting is used as a managerial tool for finding out the lost money. Let us start from the beginning and understand the concept of bottleneck accounting step by step.

 

Firstly, we know that there are several stages in the manufacturing process. These stages include productions, assemblies, distribution and sales. Practically, bottlenecks occur during the delivery stage in order to limit the firm’s delivery capacity.

 

There are many authors like Kaplan and Schmenner that state- If we have to improve the output and the production process then we need to identify all the bottlenecks and correct them. 

 

The Law of Bottlenecks by Schmenner in 1998 also states that- Productivity of an organization will only improve if we remove the bottlenecks. Every organization must focus on the activities that constrict its production capacity in order to produce more and earn more.

 

Bottleneck accounting method can be used for variance analysis as well. In variance analyses we find out the differences between the projected sales and actual sales. Normal variance analysis tells us how many quantities were short. 

 

With Bottleneck accounting we can easily find out why and where we went slow, which limited the sales. Now, people might be confused with bottleneck accounting and bottlenecks in accounting. Let us understand the difference between both.

 

Bottlenecks means congestion point. Bottlenecks in Accounting are the areas which are congested and Bottleneck Accounting is a tool that helps us find those congested areas. Both these are interdependent as without having bottlenecks we cannot use the tool.

 

Let us understand what is the bottleneck in accounting with the help of an example. Suppose you manufacture furniture. You have to transfer the raw material like metal and wood to the production process. Then labor and machines will carry out production.

 

Once the production is complete, finished goods will be transported to the godowns. When the furniture is sold, its COGS is accounted for. Now, let us see how bottlenecks will affect this whole chain of processes.

 

If a bottleneck is present in the start of the process then raw materials will be constricted from moving to the production dept. It will impact the production capacity as machines will not work and labor will sit idle. It will lead to wasted hours.

 

Since hours are wasted, there will be underutilization of the resources. These underutilization will cause an increase in the cost of the product. Moreover, high opportunity cost and increase in the delivery time are some of the consequences of bottlenecks in accounting.
 

Also Read | Implicit and Explicit Cost

 

Some Common Accounting Bottlenecks

 

“The entire bottleneck concept is not geared to decrease operating expense, it’s focused on increasing throughput.”

― Eliyahu M. Goldratt

 

By now we understand that bottlenecks not only put a constraint in a process but they also minimize the efficiency by reducing speed. Overall quality of the product is also threatened. 

 

In accounting the most important thing is timely generation of financial statements. But because of the bottlenecks we fail to do so. We need to understand the areas where these bottlenecks arise and try to reduce the effect.

 

Given below are some of the common bottlenecks in accounting:

 

1. Review

 

In the accounting process, the most common area where a bottleneck arises is during the review stage. Accounting reconciliations and documents are sent to management for review once they are prepared.

 

What happens is that so many documents and reports are sent for review and the number of people reviewing them are limited. We know that the management comprises some KMPs but the people preparing these documents are obviously more in number.

 

It inevitably leads to mistakes and omissions. It is one of the biggest bottlenecks that you will encounter. How can you fix it? In order to remove such issues you can divide the work in stages.

 

For example- You can do cash reconciliations every Monday and petty cash reconciliations every Tuesday. It will remove confusions and at the same time give reviewers time to review everything properly.

 

2. Monthly Closing

 

There are many small businesses that choose to prepare monthly statements. In order to find out the revenues and expenses and profits made. There is a sequence in which monthly closing is accounted for in the books.

 

The sequence is as follows:

 

1. You need to calculate the net income of the month.

 

2. Then you have to prepare the income statement.

 

3. Lastly, the monthly closing Balance sheet.

 

Each step has to be done in a proper order. If any bottlenecks occur then the next stage will be automatically hampered. What can you do to prevent the bottlenecks? 

 

You can prepare timelines, monthly goals, deadlines and even a checklist of what to do. This way you will have clear expectations and you know what to do and when to do.

 

Also Read | What are Operating Expenses?

 

3. Financial Reporting

 

Just like you prepare monthly closing statements, annual Financial Reporting is done in the same way. Mostly, big enterprises follow annual reporting. It is more complex as compared to the monthly statements.

 

You cannot do corrections easily. Moreover, all your future decisions will depend on the annual statements. You need to pass these to all your stakeholders along with the internal and external audit engagement team.

 

To remove bottlenecks while preparing annual statements you need to take a lot of care. You must assign tasks accordingly, select the best accounting team, ensure quality checks and reviews as well.

 

Selection of the best team is the key part to remove any possible bottlenecks in Financial Reporting. Accountants that are capable enough can deal with the auditors while the rest can freely complete their tasks.

 

4. Implementation

 

Once the annual accounts are closed, a new year begins. Each year you will see new implementations of accounting policies and taxation laws. Sometimes these policies can be very tedious and demanding, while in some years relaxations will be given.

 

The bottlenecks that you can face while implementation can be incorrect determination of the impact of the new policies and rules. It is essential to analyze the impact that new policies will have on the business.

 

Unsuccessful guesses or incorrect predictions can lead to heavy losses and legal issues. What can you do to minimize such situations? You need to stay updated with all the amendments and reforms that are done in accounting standards before they are applied to the business.

 

The staff you recruit should be energetic and capable enough to track all the changes and understand them. They should be able to compare the previous year statements and then work on the new ones. This way you can control the bottlenecks.

 

Also Read | Order to Cash Process (OTC)

 

Steps to Manage the Bottlenecks in Accounting

 

Bottlenecks in accounting create a negative impact on the whole firm. Some of the common impacts that every organization faces due to bottlenecks are:

 

1. Limited Potential to generate profits.

 

2. Increase in COGS.

 

3. Minimized customer service quality.

 

In order to remove such negative impacts, given below are steps that every firm can take to manage the bottlenecks in Accounting.

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Steps to manage Bottlenecks in Accounting

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1. Identify the Bottleneck

 

The first and the foremost step is to find out the bottleneck process or activity. We need to look for the particular task that is limiting our efficiency. It can be anything. Labor, machine, operations, raw materials or even the space we use.

 

These bottlenecks can be preexisting or can develop with time. Sometimes new constraints arise after removing one bottleneck. Changes in external and internal factors are a major reason for having bottlenecks.

 

 

2. Optimize the Constraint

 

When you have successfully identified the constricting factor, you need to work on it. You can optimize it by keeping a check on it and ensuring that you make the most out of it. In short, you need to optimize the constraint and make more profits from it.

 

You can compute the contribution margin i.e. Sales less the variable costs. Once you calculate the contribution margin per unit of a constricted factor, you can improve it. The main aim is to earn profit.

 

Once you have the CM you need to divide it with the total constricted resources to find out which product will be more profitable for the business. 

 

 

3. Prioritize

 

There can be some areas where no bottlenecks are identified and that use limited amounts of resources. You need to prioritize all the bottlenecks and shuffle resources from non-bottleneck areas to bottleneck areas to minimize it.

 

Companies can impart training to personnel in order to transfer them to bottleneck areas. This will help to remove constraints. So, companies need to prioritize the areas and activities.

 

 

4. Improve the Bottleneck Step

 

If you are successful in prioritizing then you can remove the bottleneck. Else, you need to reorder and reassess the bottleneck. You need to work harder to make the bottleneck activity more productive and profit-oriented.

 

For example- If there is limited space in the godown for storing finished stock, the company needs to purchase more godowns.

 

 

5. Return to the First Step and Repeat the Process

 

When you have sorted out the bottleneck, there are chances that you can encounter another one. What to do then? Imagine you have a toy factory. When you improved the production speed by optimizing the bottleneck you moved to the next step.

 

But what if on the next step you found insufficient labor to pack the toys and move them to godowns? Here in this case you found another bottleneck after removing the first one.

 

You have to follow the steps from the start and work on the bottleneck again. In short, if you encounter another bottleneck, you have to return to the first step and repeat the process once again.
 

Also Read | Revenue Deficit

 

Bottlenecks in Accounting can be found at any stage. It can occur at the preliminary stages or even when everything is done. What is important is that you understand how to manage them. You need to perform the steps one at a time and deal with the shortcomings.