Using “profit center accounting” to assess and financially control innovation projects and their investments can be a valuable approach for organizations looking to manage their innovation efforts effectively. Profit center accounting is a method of organizing and analyzing financial data based on individual business units, divisions, or projects, treating each as a separate entity responsible for its revenues, costs, and profits.
A step-by-step Guide:
1. Create Dedicated Profit Centers for Innovation Projects
Designate each innovation project as a separate profit center within your organization’s accounting system. This allows you to track the financial performance of each project independently of the rest of the organization.
2. Define Financial Objectives for Innovation Projects
Clearly outline the financial objectives for each innovation project. These objectives may include revenue targets, cost limits, return on investment (ROI) goals, payback period, gross margin, net profit, and others relevant to the project’s objectives or other relevant financial metrics.
3. Budget Allocation and Investment Decision-Making
Allocate budgets to each innovation project based on its potential return and strategic importance. Consider using techniques like cost-benefit analysis and discounted cash flow to evaluate the financial viability of each project before making investment decisions.
4. Track Costs and Revenues
Monitor and record all costs and revenues associated with each innovation project separately. This includes direct costs (e.g., research and development expenses, prototype manufacturing) as well as indirect costs (e.g., administrative overhead, shared resources).
5. Performance Measurement
Regularly measure the financial performance of each innovation project against its predefined objectives. Assess whether the projects are meeting revenue targets, staying within budget, and achieving the expected ROI.
6. Risk Assessment
Incorporate risk assessment into profit center accounting for innovation projects. Identify potential risks and uncertainties that may impact the financial outcomes of each project, and develop strategies to mitigate them.
7. Resource Allocation and Reallocation
Based on ongoing performance evaluations, make informed decisions about resource allocation and reallocation. Projects that show promise and strong financial performance may warrant additional investments, while underperforming projects may need to be reconsidered.
8. Learning and Adaptation
Use the financial data and insights gathered from profit center accounting to learn from past projects. Apply these lessons to optimize future innovation initiatives and refine your organization’s overall innovation strategy.
9. Transparency and Accountability
Implement a system of transparency and accountability where project managers and teams are responsible for their profit centers’ financial outcomes. This creates a sense of ownership and encourages better financial management.
10. Structuring a 3-year Financial Plan
By structuring a 3-year financial plan for the innovation project using profit center accounting principles, you can gain greater insights into the project’s financial performance, make data-driven decisions, and ensure effective financial control throughout the project’s lifecycle.
Cost Estimation: Break down the project’s costs into various categories such as research and development, prototyping, testing, marketing, and production. Estimate the costs associated with each category for each year of the three-year plan.
Revenue Projections: Forecast the expected revenues from the innovation project over the three-year period. This could be based on market research, sales projections, or any other relevant data.
Cash Flow Analysis: Conduct a cash flow analysis for the three years, taking into account the timing of cash inflows and outflows. This analysis will help identify potential cash flow gaps and the need for financing during specific periods.
11. Management Reporting and Decision Support
Provide regular reports and analysis to top management and stakeholders on the financial performance of each innovation project. This helps facilitate data-driven decision-making and ensures alignment with the organization’s broader financial goals.
Remember that profit center accounting is just one tool within a larger framework for managing innovation projects. It should be integrated with other project management methodologies and innovation best practices to create a comprehensive approach to drive successful and financially sound innovation within your organization.
© 2023, Innovator’s Guide / E.W. – July 10, 2023