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Flexible budgeting meets sustainability at Bacardi Limited: this article is based on a study funded by the IMA[R] research foundation.

Bacardi Limited excels at innovation. One of its latest creations is an innovative application of flexible budgeting to physical measures of sustainability performance to get a more accurate picture of that performance. This picture is important because the company is seeking to become as environmentally friendly as possible and is leading and participating in a number of initiatives to do so.

One of the world's largest spirits companies, the family-owned and privately held enterprise is headquartered in Hamilton, Bermuda (its Americas headquarters is in Coral Gables, Fla.); employs nearly 6,000 people; and operates 27 production facilities in 16 countries on four continents. It's also an active member of the Beverage Industry Environmental Roundtable (BIER), a consortium of leading global beverage companies and suppliers focused on resource protection, energy efficiency, and climate change mitigation.

In 2009, Bacardi Limited became the only major spirits company to attain certification with all of its production facilities globally achieving ISO 9001, ISO 14001, and OHSAS 18001 certifications. The company began setting aggressive operating goals for quality, environmental impact, and health and safety under a global platform launched in September 2009. The underlying platform aims to connect and align all employees across the globe behind one set of values, strategies, and common ways of working. The Bacardi values are trust, passion, caring, and excellence. This ongoing foundation makes environmental, health, and safety objectives integral to the operations of every site through the use of key performance indicators (KPIs). The company has published Corporate Responsibility Reports since fiscal year 2008, and in 2011 its report followed the Global Reporting Initiative G3 framework at a self-declared application level B.

Bacardi pays special attention to nonfinancial performance measures, which are growing in importance. For example, the IMA[R] Statement on Management Accounting (SMA) titled "The Evolution of Accountability--Sustainability Reporting for Accountants" raises this issue: "One of the greatest challenges the management accountant will face is creating metrics that provide insight into an organization's performance in the nonfinancial areas of the triple bottom line." Yet companies need new decision-making tools to analyze their sustainability performance and resulting impacts. Bacardi Limited leadership asked Stephen Harvey, its global director of environment, health and safety, to develop a single efficiency measure for each sustainability KPI. In 2009, Harvey successfully developed and began applying an innovative measurement methodology to three environmental aspects: water consumption, energy consumption, and greenhouse gas emissions. The methodology advances the company's sustainability efforts through an application of the principles of activity-based flexible budgeting to produce indices of improvement (efficiency metrics) for sustainability KPIs based on physical quantities rather than monetary amounts. The new metrics have transformed the way Bacardi measures progress in meeting its key sustainability objectives, and they represent an innovative best practice for management control and for external reporting. The methodology can be readily understood by management, and it provides an avenue for management accountants to participate in the analysis and reporting of physical sustainability measurements. Consistent with many companies that begin the sustainability measurement journey, management accountants haven't been significantly involved in the Bacardi measurement process. But considering that the process is built on flexible budgeting principles, management accountants have an opportunity to significantly contribute to sustainability efforts by discussing the activity-based flexible budgeting approach outlined in this article with those charged with enhancing the organization's sustainability efforts.

The new methodology is a response to concerns that aggregate measures, such as total annual units of green-house gases emitted, don't capture the actual rates of improvement. For example, a shift in production mix from rum to Scotch whisky could cause total greenhouse gas emissions to increase even if emissions per unit of both Scotch whisky and rum are reduced. This can occur when there's a shift from the production of a product that emits lower levels of greenhouse gas per unit of production to a product that emits a higher level of green-house gas, such as the case when there's a shift from rum to Scotch whisky. The new methodology allows calculation of efficiency metrics, or KPIs, that aren't distorted by changes in the production mix. In addition, these metrics can be aggregated across product lines to provide company-wide measures of efficiency improvement (aggregate performance indices, or APIs) that aren't distorted by shifts in production mix. Bacardi Limited uses the efficiency metrics internally for decision support, planning, and control. The resulting APIs for each sustainability KPI (greenhouse gas emissions, energy consumption, and water consumption) are highlighted along with absolute measures of sustainability performance in the company's Corporate Responsibility Reports.

Let's take a look at the activity-based flexible budgeting methodology Bacardi Limited developed for measuring performance improvements in sustainability KPIs.

Bacardi Efficiency Index Method (BEIM): A Flexible Budget Application

The example that follows is a hypothetical illustration of the innovative application of flexible budgeting to sustainability performance measures by Bacardi Limited. The company begins by measuring the relationship between the amount of a sustainability KPI relative to the activity level in a base year. For example, say Bacardi measures [CO.sub.2] emissions at a Scotch whisky distillery in the base year, 2010, and finds that it produced 10,000 liters of pure alcohol (K-LPA) while emitting 20,000 units of [CO.sub.2]. Thus, for 2010, the rate of emissions would be two units of [CO.sub.2] for each thousand liters of pure alcohol. At the end of 2011, the company combines the actual level of activity--let's say 12,600 K-LPA--with the rate from the base year. The resulting flexible budget for 2011 is 25,200 units of [CO.sub.2] (2 units x 12,600 liters). This means that if there is no change in efficiency, 25,200 units of [CO.sub.2] are expected to be emitted at the higher level of activity.

The company then compares the actual amount of [CO.sub.2] emitted during 2011 let's say 20,300 units to the flexible budget amount of 25,200 units. As management accountants, we usually look at this difference of 4,900 [CO.sub.2] units (25,200 - 20,300) and identify the amount as a favorable flexible budget variance. Instead, Bacardi Limited extends the analysis by converting the variance to an index number. The resulting index for 2011 is 81 (100 x 20,300 units /25,200 units). The interpretation is that there has been a 19% (100 - 81) improvement in the efficiency of [CO.sub.2] emissions at the distillery. The environment, health and safety group within the company is charged with the responsibility for collecting the data from each operating segment (such as distilleries and offices) and making the calculations.

Table 1 provides a hypothetical example for seven operating segments. A challenge that Bacardi Limited faces is how to provide a meaningful aggregation of sustainability KPIs across business segments with differing activity measures--say thousands of liters of pure alcohol vs. number of people employed within the operating segment. The company resolves this by continuing with the flexible budgeting approach. For example, it sums the amounts of [CO.sub.2] emissions projected by the flexible budget for 2011 to a total of 167,666 units to obtain the total emissions expected for all segments combined, assuming no efficiency improvement relative to the base year. The actual amount of total emissions across all segments for 2011 is calculated as 145,900 units. An overall index weighted by activity level is calculated by taking the ratio of 145,900 units to 167,666 units and multiplying by 100, yielding an index of 87 (see Table 1). The interpretation is that, aggregating over all segments, there has been a 13% improvement in the efficiency of [CO.sub.2] emissions even though total (absolute) [CO.sub.2] emissions have increased from 136,800 to 145,900 units.
Table 1: Bacardi Limited Efficiency Index Method (BEIM): Using
Flexible Budgeting to Aggregate Performance for the [CO.sub.2]
Sustainability KPI across Segments

 BASE YEAR CURRENT
 YEAR

Activity Unit Activity [CO.sub.2]e Efficiency Activity
 Rate

Scotch Whisky K-LPA 10,000 20,000 2.00 12,600
Distilleries

Tequila K-LPA 30,000 57,600 1.92 39,900
Distillery

Scotch Whisky K-Cases 10,000 3,600 0.36 10,900
Bottling

Tequila Bottling K-Cases 10,000 4,800 0.48 13,300

Transportation Mtons 4,000 34,800 8.70 4,500

Offices No. of 8,000 9,000 1.13 8,200
 People

Business Travel No. of 8,000 7,000 0.88 8,200
 People

 136,800

 FLEXIBLE CATEGORY
 BUDGET

Activity Unit [CO.sub.2]e [CO.sub.2]e Index

Scotch Whisky K-LPA 20,300 25,200 81
Distilleries

Tequila K-LPA 59,700 76,608 78
Distillery

Scotch Whisky K-Cases 3,700 3,924 94
Bottling

Tequila Bottling K-Cases 5,800 6,384 91

Transportation Mtons 38,000 39,150 97

Offices No. of 10,100 9,225 109
 People

Business Travel No. of 8,300 7,175 116
 People

 145,900 167,666 87


The preceding example describes the current Bacardi Limited process for measuring efficiency improvements for sustainability key performance indicators. A notable feature is that the approach treats the sustainability KPIs as entirely variable. That's because the original derivation of the method the company used was based on the cost accounting method for financial reporting purposes in which fixed manufacturing costs are absorbed into unit product cost. But the effect is to incorrectly treat fixed sustainability KPI contributions as variable. The flexible budgeting method (the current method Bacardi Limited uses) can be readily adapted to include both fixed and variable components of the total emissions to yield a more accurate measure of efficiency change.

A New Approach

Bacardi Limited also has started a pilot study at the plant level to measure the fixed and variable components of its KPIs. The following examples illustrate the importance of measuring the fixed and variable relationships between activity levels and the relevant KPI.

The numbers in Table 1 illustrate an overall increase in activities relative to the base year. Table 2 uses the identical activity variations but considers that there's a fixed component in the sustainability KPI levels (7% for distilling, 10% for bottling, and 5% for transportation, offices, and business travel in the base year). As a result, a new efficiency rate is calculated for the variable component, and we find that the efficiency rate for the Scotch whisky distilleries variable component drops from 2 to 1.86. The fixed level of [CO.sub.2] emissions is estimated at 1,400 and is expected to remain unchanged over the budgeting period. In the final analysis, we see that the more accurate measure of the overall efficiency improvement drops from 13% to 11.9%. When growth occurs and the behavior of the sustainability KPI is incorrectly assumed to be entirely variable, the metric will overestimate efficiency improvements.
Table 2: BEIM: Flexible Budget with Growth in Activity Where the
Fixed Component Is Factored Out

 BASE YEAR

Activity Unit Activity [CO.sub.2]e Efficiency
 Rate

Scotch Whisky K-LPA 10,000 1,400
Distilleries -
Fixed component

Scotch Whisky K-LPA 10,000 18,600 1.86
Distilleries -
Variable
component

Scotch Whisky K-LPA 10,000 20,000 2.00
Distilleries -
Total

Tequila K-LPA 30,000 4,032
Distillery -
Fixed component

Tequila K-LPA 30,000 53,568 1.79
Distillery -
Variable
component

Tequila K-LPA 30,000 57,600 1.92
Distillery -
Total

Scotch Whisky K-Cases 10,000 360
Bottling - Fixed
component

Scotch Whisky K-Cases 10,000 3,240 0.32
Bottling -
Variable
component

Scotch Whisky K-Cases 10,000 3,600 0.36
Bottling - Total

Tequila Bottling K-Cases 10,000 480
- Fixed
component

Tequila Bottling K-Cases 10,000 4,320 0.43
- Variable
component

Tequila Bottling K-Cases 10,000 4,800 0.48
- Total

Transportation - Mtons 4,000 1,740
Fixed component

Transportation - Mtons 4,000 33,060 8.27
Variable
component

Transportation - Mtons 4,000 34,800 8.70
Total

Offices - Fixed No. of 8,000 450
component People

Offices - No. of 8,000 8,550 1.07
Variable People
component

Offices - Total No. of 8,000 9,000 1.13
 People

Business Travel - No. of 8,000 350
Fixed component People

Business Travel - No. of 8,000 6,650 0.83
Variable People
component

Business Travel - No. of 8,000 7,000 0.88
Total People

 136,800

 CURRENT FLEXIBLE
 YEAR BUDGET

Activity Unit Activity [CO.sub.2]e [CO.sub.2]e

Scotch Whisky K-LPA 1,400
Distilleries -
Fixed component

Scotch Whisky K-LPA 12,600 23,436
Distilleries -
Variable
component

Scotch Whisky K-LPA 12,600 20,300 24,836
Distilleries -
Total

Tequila K-LPA 4,032
Distillery -
Fixed component

Tequila K-LPA 39,900 71,245
Distillery -
Variable
component

Tequila K-LPA 39,900 59,700 75,277
Distillery -
Total

Scotch Whisky K-Cases 360
Bottling - Fixed
component

Scotch Whisky K-Cases 10,900 3,532
Bottling -
Variable
component

Scotch Whisky K-Cases 10,900 3,700 3,892
Bottling - Total

Tequila Bottling K-Cases 480
- Fixed
component

Tequila Bottling K-Cases 13,300 5,746
- Variable
component

Tequila Bottling K-Cases 13,300 5,800 6,226
- Total

Transportation - Mtons 1,740
Fixed component

Transportation - Mtons 4,500 37,193
Variable
component

Transportation - Mtons 4,500 38,000 38,933
Total

Offices - Fixed No. of 450
component People

Offices - No. of 8,200 8,764
Variable People
component

Offices - Total No. of 8,200 10,100 9,214
 People

Business Travel - No. of 350
Fixed component People

Business Travel - No. of 8,200 6,816
Variable People
component

Business Travel - No. of 8,200 8,300 7,166
Total People

 145,900 165,543

 CATEGORY

Activity Unit Index

Scotch Whisky K-LPA
Distilleries -
Fixed component

Scotch Whisky K-LPA
Distilleries -
Variable
component

Scotch Whisky K-LPA 82
Distilleries -
Total

Tequila K-LPA
Distillery -
Fixed component

Tequila K-LPA
Distillery -
Variable
component

Tequila K-LPA 79
Distillery -
Total

Scotch Whisky K-Cases
Bottling - Fixed
component

Scotch Whisky K-Cases
Bottling -
Variable
component

Scotch Whisky K-Cases 95
Bottling - Total

Tequila Bottling K-Cases
- Fixed
component

Tequila Bottling K-Cases
- Variable
component

Tequila Bottling K-Cases 93
- Total

Transportation - Mtons
Fixed component

Transportation - Mtons
Variable
component

Transportation - Mtons 98
Total

Offices - Fixed No. of
component People

Offices - No. of
Variable People
component

Offices - Total No. of 110
 People

Business Travel - No. of
Fixed component People

Business Travel - No. of
Variable People
component

Business Travel - No. of 116
Total People

 88.1


Table 3 illustrates a decline in the activity levels for the current year. Assume that total (absolute) [CO.sub.2] emissions decline from 136,800 to 108,075 units. Presuming that the sustainability KPI is entirely variable, the efficiency improvement appears to be 10.7% (100% - 89.3%). Using the same activity variation but factoring out the fixed portion, which is identical to the approach used in Table 2, Table 4 shows the more accurate measure of efficiency improvement of 11.5% (100% - 88.5%). The consequence of treating the behavior of the sustainability KPI as entirely variable results in a more conservative estimate (i.e., underestimating efficiency improvements).
Table 3: BEIM: Flexible Budget with Decline in Activity Where the
Fixed Component Is NOT Factored Out

 BASE YEAR CURRENT
 YEAR

Activity Unit Activity [CO.sub.2]e Efficiency Activity
 Rate

Scotch Whisky K-LPA 10,000 20,000 2.00 9,000
Distilleries

Tequila K-LPA 30,000 57,600 1.92 25,000
Distillery

Scotch Whisky K-Cases 10,000 3,600 0.36 8,900
Bottling

Tequila Bottling K-Cases 10,000 4,800 0.48 8,512

Transportation Mtons 4,000 34,800 8.70 3,700

Offices No. of 8,000 9,000 1.13 7,800
 People

Business Travel No. of 8,000 7,000 0.88 7,800
 People

 136,800

 FLEXIBLE CATEGORY
 BUDGET

Activity Unit [CO.sub.2]e [CO.sub.2]e Index

Scotch Whisky K-LPA 14,500 18,000 81
Distilleries

Tequila K-LPA 38,208 48,000 80
Distillery

Scotch Whisky K-Cases 3,015 3,204 94
Bottling

Tequila Bottling K-Cases 3,712 4,086 91

Transportation Mtons 31,160 32,190 97

Offices No. of 9,595 8,775 109
 People

Business Travel No. of 7,885 6,825 116
 People

 108,075 121,080 89.3

Table 4: BEIM: Flexible Budget with Decline in Activity Where the
Fixed Component Is Factored Out

 BASE YEAR

Activity Unit Activity [CO.sub.2]e Efficiency
 Rate

Scotch Whisky K-LPA 10,000 1,400
Distilleries -
Fixed component

Scotch Whisky K-LPA 10,000 18,600 1.86
Distilleries -
Variable
component

Scotch Whisky K-LPA 10,000 20,000 2.00
Distilleries -
Total

Tequila K-LPA 30,000 4,032
Distillery -
Fixed component

Tequila K-LPA 30,000 53,568 1.79
Distillery -
Variable
component

Tequila K-LPA 30,000 57,600 1.92
Distillery -
Total

Scotch Whisky K-Cases 10,000 360
Bottling - Fixed
component

Scotch Whisky K-Cases 10,000 3,240 0.32
Bottling -
Variable
component

Scotch Whisky K-Cases 10,000 3,600 0.36
Bottling - Total

Tequila Bottling K-Cases 10,000 480
- Fixed
component

Tequila Bottling K-Cases 10,000 4,320 0.43
- Variable
component

Tequila Bottling K-Cases 10,000 4,800 0.48
- Total

Transportation - Mtons 4,000 1,740
Fixed component

Transportation - Mtons 4,000 33,060 8.27
Variable
component

Transportation - Mtons 4,000 34,800 8.70
Total

Offices - Fixed No. of 8,000 450
component People

Offices - No. of 8,000 8,550 1.07
Variable People
component

Offices - Total No. of 8,000 9,000 1.13
 People

Business Travel - No. of 8,000 350
Fixed component People

Business Travel - No. of 8,000 6,650 0.83
Variable People
component

Business Travel - No. of 8,000 7,000 0.88
Total People

 136,800

 CURRENT FLEXIBLE
 YEAR BUDGET

Activity Unit Activity [CO.sub.2]e [CO.sub.2]e

Scotch Whisky K-LPA 1,400
Distilleries -
Fixed component

Scotch Whisky K-LPA 9,000 16,740
Distilleries -
Variable
component

Scotch Whisky K-LPA 9,000 14,500 18,140
Distilleries -
Total

Tequila K-LPA 4,032
Distillery -
Fixed component

Tequila K-LPA 25,000 44,640
Distillery -
Variable
component

Tequila K-LPA 25,000 38,208 48,672
Distillery -
Total

Scotch Whisky K-Cases 360
Bottling - Fixed
component

Scotch Whisky K-Cases 8,900 2,884
Bottling -
Variable
component

Scotch Whisky K-Cases 8,900 3,015 3,244
Bottling - Total

Tequila Bottling K-Cases 480
- Fixed
component

Tequila Bottling K-Cases 8,512 3,677
- Variable
component

Tequila Bottling K-Cases 8,512 3,712 4,157
- Total

Transportation - Mtons 1,740
Fixed component

Transportation - Mtons 3,700 30,581
Variable
component

Transportation - Mtons 3,700 31,160 32,321
Total

Offices - Fixed No. of 450
component People

Offices - No. of 7,800 8,336
Variable People
component

Offices - Total No. of 7,800 9,595 8,786
 People

Business Travel - No. of 350
Fixed component People

Business Travel - No. of 7,800 6,484
Variable People
component

Business Travel - No. of 7,800 7,885 6,834
Total People

 108,075 122,153

 CATEGORY

Activity Unit Index

Scotch Whisky K-LPA
Distilleries -
Fixed component

Scotch Whisky K-LPA
Distilleries -
Variable
component

Scotch Whisky K-LPA 80
Distilleries -
Total

Tequila K-LPA
Distillery -
Fixed component

Tequila K-LPA
Distillery -
Variable
component

Tequila K-LPA 79
Distillery -
Total

Scotch Whisky K-Cases
Bottling - Fixed
component

Scotch Whisky K-Cases
Bottling -
Variable
component

Scotch Whisky K-Cases 93
Bottling - Total

Tequila Bottling K-Cases
- Fixed
component

Tequila Bottling K-Cases
- Variable
component

Tequila Bottling K-Cases 89
- Total

Transportation - Mtons
Fixed component

Transportation - Mtons
Variable
component

Transportation - Mtons 96
Total

Offices - Fixed No. of
component People

Offices - No. of
Variable People
component

Offices - Total No. of 109
 People

Business Travel - No. of
Fixed component People

Business Travel - No. of
Variable People
component

Business Travel - No. of 115
Total People

 88.5


More Accurate Evaluations

The Bacardi Efficiency Index Method is a decision support tool that helps the managers evaluate sustainability performance more accurately, and it provides more meaningful aggregate performance measures for external reporting. Bacardi Limited has used this innovative methodology to establish sustainability performance targets and to report sustainability performance improvements in its Corporate Responsibility Reports since 2008. (Visit www.bacardilimited.com/corporate-responsibility/corporate-responsibility-policy for more information.)

As we showed here, Bacardi Limited has developed a useful measurement tool for sustainability improvement that other companies can use. To recap, we examined several scenarios that included a treatment where the behavior of a sustainability KPI is entirely variable vs. the recognition of both the variable component and the fixed component. We also included the scenarios of increasing and decreasing activity level. In the implementation process, Bacardi Limited has reached the point of beginning to factor out the fixed component of the sustainability KPIs at the plant level. Separation of the KPIs into both fixed and variable components allows the company to better plan, manage, and control sustainability efforts.

Future and Emerging Applications

As integrated reporting develops, there will be more need for companies like Bacardi to plan, manage, and control such sustainability performance indexes and impacts and include this information in their integrated reports. Integrated reporting is being promoted by the International Integrated Reporting Council (IIRC), which defines it as "the language for sustainable business and the means by which companies communicate how value is created and will be preserved over the short, medium, and long term." Through its pilot program, the IIRC is attempting "a new approach to corporate reporting that demonstrates the linkages between an organization's strategy, governance, and financial performance and the social, environmental, and economic context within which it operates." (See www.theiirc.org for more on this subject.) Linkages like those Bacardi is exploring can become the cornerstones of improvement on nonfinancial measures included in integrated reports.

By Jon Bartley, CPA; Frank Buckless; V.S. Al Chen, CMA, CFM, CPA, CGMA; Stephen K. Harvey, P.E.; Scott Showalter, CPA, CGMA, CGFM; and Gilroy Zuckerman

Jon Bartley, CPA, Ph.D., is professor of accounting and former dean of the Poole College of Management at North Carolina State University in Raleigh, N.C. He also is a member of IMA's North Carolina Triangle Chapter. You can reach Jon atjon_bartley@ncsu.edu.

Frank Buckless, Ph.D., is KPMG Professor and department head of accounting at the Poole College of Management at North Carolina State University. He is a member of IMA's North Carolina Triangle Chapter. You can reach Frank at frank_buckless@ncsu.edu.

YS. Al Chen, CMA, CFM, CPA, CGMA, Ph.D., is professor of accounting at the Poole College of Management at North Carolina State University. He also is a member of IMA's North Carolina Triangle Chapter. You can reach Al at alchen@ncsu.edu.

Stephen K. Harvey, RE., has served as the global director of environment, health and safety for Bacardi Limited for the past six years. You can reach Steve at skharvey@bacardi.com.

D. Scott Showalter, CPA, CGMA, CGFM, is a professor of practice at the Poole College of Management at North Carolina State University. He also is a member of IMA's North Carolina Triangle Chapter. You can reach Scott at scott_showalter@ncsu.edu.

Gilroy Zuckerman, Ph.D., is associate professor of accounting and former associate dean of Academic Affairs of the Poole College of Management at North Carolina State University. He also is a member of IMA's North Carolina Triangle Chapter. You can reach Gil at gilroy_zuckerman@ncsu.edu.
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Title Annotation:COVER STORY
Author:Bartley, Jon; Chen, Y.S. Al; Harvey, Stephen K.; Showalter, Scott; Zuckerman, Gilroy
Publication:Strategic Finance
Article Type:Company overview
Date:Dec 1, 2012
Words:3862
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