Activity Based Costing (ABC) and Activity Based Management (ABM) are sound financial tools that can be applied to any business. Their use in business is now wide spread and are being used by strategic business managers to replace the traditional Cost Accounting processes and methods.
Activity Based Costing is an excellent tool to use in understanding the actual cost of a product or service that a company is producing and selling. For far too long businesses have been allocating or applying what were thought to be "indirect costs" based on some arbitrary assumption ... square footage or sales volume to mention just a few. At one time the cost of a good was mainly in the direct labour component but with the wide spread use of machines and robots in today's businesses it has now become a minor component. These allocations were also based on historical data which may or may not be relevant given the ever changing business environment in which we now work.
While it may seem an onerous task to implement ABC, by simply taking it one step, or product/service, at a time the process is very manageable. Some businesses find it easier to start with the end product/service and work back to its individual components. Take the product/service and map it back to its origins. What are the physical components that make up the final good? What labour is added at what stage in the process? How many processes are involved and how many times is the product handled along the way?
Once the mapping has been completed, it is time to cost out what these activities actually cost. How much does each component and step along the way cost in the production of the final product? What's the final dollar total?
Activity Based Management then takes this information and makes strategic business decisions based on this information. On a grand scale, these decisions may include whether to drop or expand an existing product or service.
It is also important to analyze the process in getting to the final product. The term "value added" is used in ABM. Does the activity that has been mapped add any value to the final product? If the answer is yes then the activity should remain. If the answer is no, very serious thought should be given to dropping this "non-value added" activity. While these two situations may seem very clear cut they are not.
What about those activities that add some value but that value may be questionable? This gray area requires more thought with the end user or customer in mind. Can this activity be eliminated and be invisible to the end user or customer? If the answer is yes to this question there is sound support for dropping the activity. However, if the answer is no, then the activity is more than likely best left in the process.
As with any new undertaking, employee input into the process of Activity Based Costing and Management is key to its success. Employees must feel that their suggestions and input are respected and valued. They need to understand why this process is being undertaken and the importance of it. They also need to see that senior management supports it and uses the information it provides in shaping the direction of the business.
ABC and ABM should be considered valuable tools to assist today's manager in making sound business decisions; based on information that accurately reflects their line of business and the true market conditions.
Copyright - Kelly Melanson, Certified Management Accountant |