Dear,
In the previous post we introduced the relevance of Capital Costs in non-financial business processes.
The basic rule for analyzing the profitability a business deal is determining its contribution margin. Historically, contribution margin calculation models, in non-financial business, have not included capital costs.
ERP systems in general and SAP in particular, are the result of modeling business processes in an era of capital abundance. As a consequence, capital costs of the business deals were not relevant enough to compensate the effort of including them in the calculation of its contribution margin.
Auditors would say that in an environment of capital abundance, the effect of the capital costs in most of the business deals was immaterial.
But this is the main difference of the new environment; we’re in the middle of a systemic crisis whose main characteristic is capital scarcity. The main symptoms of this capital scarcity are growing credit and market risk.
Those of you, who disagree, just look at the impact on international trade between the Eurozone and Switzerland, of this week’s revaluation of the Swiss Franc. In other words, how many European customers will have difficulties to honor their payment obligations in Swiss Francs, considering that those obligations have increased 20% in one week?
I don’t have a proper estimation of the magnitude of the issue, but by looking at the impact of this week events in the solvency of some Banks and Forex brokers, we can infer that the losses are going to be considerable.
Anyway, let’s come back to our initial example, we know that SAP ECC offers a very powerful integration between the Sales and Distribution and the Profitability Analysis modules (CO-PA) which offers a complete analysis of the margin of the business deal.
Not exactly, introducing capital costs in this (CO-PA) analysis represents a challenge, which is normally confronted with simplifications.
In fact, CO-PA has not been designed to deal with this kind of analysis, CO-PA is a multidimensional Profit and Loss structure, but it does not include balance sheet positions.
On the other hand, balance sheet positions are mandatory for a proper analysis of the capital costs of a business processes. This is the main limitation of SAP ECC for managing accurate margin analysis in an economic environment of capital scarcity.
We still can build simplified models for estimating the capital costs of the business deal, but they’re just simplifications.
For instance, some years ago we worked for a customer who required this kind of analysis.
We fulfilled his requirement by building an enhancement of the sales pricing procedure, including a statistical condition type which determined the expected loss as a percentage of the invoice net value. Additionally, the Probability of Default is maintained in a table depending of the customer rating.
The statistical condition type is mapped to a CO-PA key figure, providing the expected capital costs (due to credit risk) as an input in the contribution margin calculation.
This approximation is valid for those cases of moderate capital cost for credit risk, but is insufficient in those cases of business deals with higher risk exposures.
When the capital costs due to credit risk are significant, or we’re modeling more complex business processes, for instance including securitization of account receivables, the above approximation is insufficient.
For those cases, integrating the SAP logistics modules with the Risk engines of Bank Analyzer is an excellent option.
We’ll talk about it in the next post.
Looking forward to read your opinions.
K. Regards,
Ferran.
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