Business leaders often complain that with today’s massive data loads, they can’t see the forest for the trees, and BPM practitioners are used to helping them gain the high-level overviews they need. But in the search for a clear understanding of business performance, decision-makers also face the opposite problem: They can’t see the trees for the forest.

The forest in this case is the financial performance of the entire business, as displayed through its income, balance sheet, and cash flow statements. While companies can derive important operating performance measures from these statements, such as return on investment (ROI) on total assets, total net assets, and net working capital, these metrics apply to the company as a whole. They don’t describe the individual components that drive the organization’s overall performance — namely, each product and service sold to each customer.

There’s a good reason for this. It can be difficult and prohibitively expensive to distribute each account in the income statement and balance sheet to each product or service that the organization sells. Most businesses use gross profit (sales minus the cost of goods sold) to measure product and customer performance. But this simple profit measure ignores a product’s specific effect on general and administrative (G&A) expenses and on the various balance sheet assets and liabilities. If you rely exclusively on the gross profit metric, you can’t see the ROI on the individual products and services you’re selling.

ROI is a fundamental tool in corporate performance management, but it’s one that’s often misunderstood and underused. A careful ROI analysis can show you whether a product, customer, or operating process is earning the company’s cost of capital — that is, the weighted average return expected by the providers of debt and equity financing to the company. While this is termed a “cost,” it’s really a profit goal; it’s the target rate of return (or hurdle rate) on investments in operating assets such as facilities, equipment, inventory, and accounts receivable. Earning or exceeding the cost of capital increases the economic value that the business provides to its shareholders.

In contrast, products and customers with ROI below the target cost of capital reduce business value. The challenge is: How do you identify them?

How VPA Works

Value point accounting (VPA) is a low-cost way to leverage ROI information and thereby secure an advantage over competitors who manage by gross profit. VPA views a business as a portfolio in which each investment — each “value point” — is a specific product sold to a specific customer. Exhibit 1 shows a simple value point grid of product and customer combinations. Of course, the number of products and customers can be extended indefinitely; depending on its size, a business can have dozens or millions of value points.

VPA considers each priced item on a customer’s invoice as a value point with its own income statement and balance sheet. It calculates the investment performance of each value point and uses that data to support better business decisions.

The critical difference between value point accounting and other approaches to business performance management is that, in VPA, balance sheet operating assets and liabilities are applied to products and customers along with income statement expenses. This enables you to calculate ROI performance and determine true economic value. VPA can bring out the numerous miniature financial statements embedded in the company’s product and customer data. Call it “nano-accounting.”

VPA uses concepts from modern cost accounting, financial analysis, and operations management — including activity-based costing, working capital turnover analysis, operating capacity analysis, and economic value measurement — to determine the total corporate performance of each value point. The key to cost effectiveness is to apply these concepts to a simple, rather than complex, business accounting structure. With VPA, there’s no need to explode the number of general ledger accounts or keystrokes in the accounting department. A VPA chart of accounts is built around a handful of costing objectives that are applied to the unique characteristics of each value point.