Activity-Based Costing
DEFINITION: Activity-Based Costing
The method of assigning indirect costs, including non-manufacturing overhead, to products and services. ABC assumes that almost all overhead costs associate with activities within the firm and vary with respect to the drivers of those activities. Some practitioners suggest that ABC attempts to find the drivers for all indirect costs; these people note that in the long run, all costs are variable, so fixed indirect costs do not occur. The method first assigns costs to activities and then to the products’ usages of the activities.
Source: Managerial Accounting, Maher, M.W., Stickney, C. P. and Weil, R. A., Copyright 1994, Dryden Press
The majority of business people have the false perception that the best customer is the one that accounts for the largest portion of your income every year. This is not always the case for the simple reason that the same customer may also be responsible for the majority your expenses. Activity-Based Costing may be a solution to the problem. Activity Based Costing, or simply ABC, if correctly applied, can be one of the tools used to rank your customers in terms of profitability. The concept is simple, however, the implementation is often complex due to interferences from uncooperative systems and, yes...people.
How do find value in ABC?
ABC also makes it very clear that integrated costs associated with the services that the customer demands play a crucial role in determining each customer's contribution to net profit. Understanding how these indirect and overhead costs impact the business profit provides information necessary to manage the product lines, level of research, manufacturing expenses, procurement strategy...virtually all aspects of operations.
Mr. Vilfredo Pareto, would definitely agree with the following, and help you produce the analysis to prove it. Studies have shown that 20% of all customers provide over 80% of the profits of a company. It is true for YOUR COMPANY! Another 60% break-even and the remaining 20% only reduce the bottom line. Again, Pareto analysis would reveal the same conclusion – 80% of the profits are provided by 20% of the customers. What is holding you back from getting the names of the customers in that bottom 20% and getting to work?
Use the Messenger
Contact Mercury Management to help break apart the overhead and general expenses and assign these expenses to the respective activities that use the services. Mercury Management will show you use this information get a better a better picture of the top 20%, attack the burden introduced by the bottom 20%, and create a process to dealing with the 60% of customers at or near the break-even point.
M² Offerings:
Interviewing Employees
Lean Operations
Diagnostics
Continuous Improvement
Activity-based costing
Process Mapping
Waste Minimization & P2
> See Services section for more
