Understanding your ABCs can give you a better
understanding of your company's business processes and underlying
expenses.
Activity-based costing (ABC) is a budgeting and analysis process
that evaluates overhead and operating expenses by linking costs to
customers, services, products and orders. It allows managers to see
which products or services are profitable or losing money.
The Process
Here's how it works: A company evaluates the resources, processes
and money required to produce a product or service.
The first step is to establish the activity centers and
activities. For example, in a large company, the IT department's
help desk can be an activity center. The ABC team must identify all
the events or activities within the help desk. A help desk activity
can be anything from installing software to routing a call to the
appropriate IT staffer who can assist the user with solving his
system problems.
Once the activities are established, you must determine the parts
of each activity that cost money. These can be hidden details that
may be taken for granted, such as the cost associated with each call
to the help desk. The key is to determine what makes up fixed costs,
such as the cost of a telephone, and variable costs, such as the
cost of each phone call.
There are many hidden costs managers must take into account.
For example, technology has replaced many human labor costs. A
voice-mail system can replace a human, but you still have to examine
the hidden costs associated with maintaining the service.
Once the cost drivers and activities are established, the data is
collected and input to an application. The software can be a simple
database, off-the-shelf ABC software or customized software.
From there, managers can determine what changes need to be made
to give a company optimal profitability. This is called
activity-based management — the process of using ABC to analyze how
efficiently activities are performed and how to manage them.
"It's important that IT people understand the true nature of
their costs," says Charlie Johnson, principal of CNJohnson &
Associates, a financial and systems consulting firm in Phelan,
Calif. "This is especially important when they are talking about the
costs associated with their clients. ABC allows them to be
co-managers with the business and understand how these costs affect
the overall business."
ABC implementation can take from six to 12 months, depending on
the scale. The Institute of Management Accountants (IMA) in
Montvale, N.J., recommends starting with a pilot study to see on a
smaller scale what can happen in the larger scheme of things.
"It's best to take your most difficult or expensive department
and, in the initial interviewing stage, find out things that would
be helpful without even crunching numbers," says Catherine Stanke,
managing director of finance and administration at the IMA. "In a
pilot, you'll get some easy successes. If you don't see a difference
in your costs, you haven't been successful."
A pilot program is a helpful way of getting support from upper
management. Management support is vital in implementing ABC because
the process requires input and resources from different departments.
Form a Team
The key to implementing ABC is to have a cross-functional team
that includes representatives from IT, finance and the people who
own the processes (such as human resources, sales or operations).
It's also helpful to have a consultant who can give an objective
view and guide the process.
"ABC is not an accounting tool — it's a management information
tool," says Jim Gurowka, director of Focused Management Information
Inc., an Oakville, Ontario-based training and consulting firm that
specializes in cost management and measurement strategies. "It
brings cost information out of the accounting department and into
the hands of people that make decisions for an organization."
As IT becomes more prevalent in the business arena, it's
important to be involved from the beginning.
"IT is becoming, by far, one of the biggest costs of
organizations," says Bob Wharam, a partner at Perform Consulting, a
management consulting firm in Phoenix. "ABC helps IT managers make
sure we're more effectively spending a huge amount of money."
Hints For Implementing ABC
Keep it simple. When determining the cost of drivers for
each activity, don't get bogged down with too many granular details
that can't be explained. However, a system that is too general may
not be accurate enough.
Train customers in advance. Customers, whether internal or
external, need to be prepared for the changes to come. Educate
customers to prepare them before you start the implementation
process.
Have a balanced team. Get input from all parties involved:
finance staff, IT staff, human resources and consultants.
Start with a pilot study. Start with your worst
department, where you'll be sure to have some successes. You'll be
able to get faster buy-in from upper management if you can quickly
point to cost savings.
Persuade management to change. ABC implementation must
have the support of all levels in an organization. ABC requires a
new way of thinking for all parties.
Establish a reasonable time frame. Six to 12 months is
aggressive, but reasonable. Too much time will lose the momentum of
the people involved. ABC and ABM can live on forever, but the
initial implementation must be well planned.
Related ABC Terms
Activity: Any event or transaction that causes a cost to
be incurred in an organization.
Activity Center: A collection of similar activities in one
place.
Cost Driver: A unit of output that's used to calculate the
cost of each activity.
Chargeback: Identifying the cost of providing a product or
service to a customer and billing the customer for that product or
service.
Activity-based Management (ABM): The use of activity-based
costing to help managers focus on the continuous improvement of
operations and processes.
Process Value Analysis (pva): A systematic approach to
understanding the activities required to provide a product or
service. PVA identifies all resource-consuming activities involved
in producing the product or service and labels these activities as
being either value-added or nonvalue-added in nature.
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