Activity Based Costing
Activity Based Costing was first developed to help organisations understand the true profitability of dealing with individual customers or of selling specific products and services. As such it supplies information rather than solutions; after all if you want to sell at a loss you can. However the real benefit of using the technique is that it enables any organisation to identify quickly the cost of any process or product, course of action or function, and can, if appropriate take 90% of the organisation's overheads and drive them down to these levels. Because everything is reconciled back to the general ledger it fully answers the question, "what is the true cost of...?"
Activity Based Costing is as relevant in the public sector as it is in service industries and manufacturing, and can be used alongside conventional costing systems, either as a standalone management tool, or as part of a continuous improvement culture, or a positive programme of business re-engineering.
As it sounds, the main building block of the technique is the cost of activities and activities are things that people do. For that reason Activity Based Costing is an excellent tool for engaging with staff in any improvement or costing programme because it requires information about how they spend their time. However this benefit can be countered by suspicion that a "time and motion" exercise is being conducted with all the connotations of that old "industrial engineering" technique.
Importantly ABC is also about customers; whether in calculating profitability or in working out the true cost of service delivery and once staff understand this they very quickly come to appreciate which activities they undertake actually are for the customer's benefit and which are not.
We allocate all activities into one of three categories to illustrate this point.
Value Adding An activity that is necessary to complete the process and which helps the customer's requirements to be met.
Non-Value Adding An activity that is not necessary to complete the process and which does not truly satisfy the requirements of the organisation.
Sustaining Non-Value Adding An activity that does not meet the customer's requirements but does satisfy some requirement of the organisation, whether or not it is necessary to complete the process.
Once this is done and the cost of all activities is known it is a simple step to identify how profitability might be improved or costs might be reduced. Clearly those activities which do not add value should be stopped or at least done at a lower cost whilst those that truly add value should be kept and if possible increased. This accounting technique reveals far more than fiscal cost alone.
At ValueAdding.com Ltd we build simple models to suit individual clients' needs or deploy our own models which have been specifically developed to make the use of this technique easy.
One of these runs in Microsoft Access and sits on the hard drive of the project owner. It leads you through the process of interviewing staff, allocating activities to the categories above and presents you with a series of pre-programmed queries designed to show you the results that matter all being exported to Microsoft Excel for further manipulation of the numbers if required or to Microsoft Word for easy presentation to others.
Our second model is held online and allows you to set up the structure of the activities and processes in any way you want. Then it invites each staff member taking part to enter their own activity data before the results are downloaded by the appointed administrator into Microsoft Excel. This system is especially useful if results are needed quickly as following a short 15 minute training exercise anybody can use it to record what they do. For each employee the exercise takes approximately 45 minutes and being on-line we can collect data from several hundred staff in a few days if needed.