Costs are an important part of the business. Let them spiral out of control, they will affect both your profitability and cash flow.
In meeting the needs and wants of customers, organizations have to employ the use of processes and activities. These processes and activities are critical for creating customer value.
However, to effectively and efficiently manage business costs, one has to have a thorough knowledge and understanding of all the activities and processes employed within the business to create value.
In addition to that, knowledge of cost drivers is very critical. A cost driver being a factor influencing the level of cost.
One technique that can be used to analyse and manage your business costs is Activity Based Costing (ABC).
This is a cost management technique which measures the cost and performance of activities, resources and the objects which consume them in order to generate more accurate and meaningful information for decision making.
As the modern business has become complex, it is no longer meaningful to assume that overheads are a function of volume only. Businesses now have multiple cost drivers, many of which are transaction-based rather than volume-based.
Most organizations have moved and some are still in the process of moving from managing vertically to managing horizontally. What this means is that, there is a shift from a function orientation to a process orientation so as to effectively and efficiently meet changing customer needs and wants.
This focus by management on process or horizontal view of their organizations to remain competitive is supported by ABC since it provides cost and operating information that mirrors the horizontal view.
The benefits of implementing ABC include:
- It helps you identify all the overheads caused by the same activities.
- One can easily identify the cost drivers for each activity thereby allowing you to control costs at their source.
- It can help you identify, for example, profitable products, services, processes, activities, customer segments, distribution channels, contracts and projects. This should help you when making pricing, product/service mix and design decisions.
- ABC allows for continuous improvement. By thoroughly measuring and looking at the costs and cost drivers of different processes and activities, improvements can be made. For example, by knowing the cost drivers, cost reduction can be achieved, either through outsourcing particular activities or moving to different areas in the industry value chain.