Activity Based Costing

Businesses recognise that their customers, products and distribution channels consume different levels of resources and as such incur a varying “cost to serve”. The challenge lies in identifying which of these customers, products and channels are consuming relatively more costs and why. The ability to understand the cost to serve and the true net profitability of individual customers, products and channels comes through the implementation of Activity Based Costing (ABC). The basic principles of ABC are that activities use up resources and different levels of activity are caused by individual customers, products and channels. Thus, costs are allocated to individual customers, products and channels based on the proportion of activities they actually consume. For example, the process of invoicing and collecting payment, costs the average company between $30 and $40 per invoice raised. Therefore, customers who order on a frequent basis in small volumes are more costly to service than customers who consolidate their orders. This is reflected in an ABC model by driving the overhead accounts receivable costs onto individual customers, products and channels based on the number of invoices generated. Typically, high cost to serve customers and products are ones that make frequent use of the organizations resources. That is, customers who are serviced regularly by a sales rep, raise frequent invoices which in turn lead to admin, product picking and packing and frequent distribution costs. Products with high cost to serve are ones that require relatively more technical support, are ordered, stocked and distributed on an ad-hoc basis, use more back-office processes due to small order volumes and returns and are marketed excessively.

By using an activity-based cost model, organizations are able to gain insight into the costs that drive their business and how these costs are consumed throughout the supply chain. Each customer, product and channel has a different cost profile which is exposed through the results of an ABC model. This way, customers, products and channels with low margins or eroding margins are identified. It is then not a case of abandoning these customers/products/channels but a matter of working with these customers to identify more efficient ways of doing business and developing different managing strategies for the products and channels to improve their margin.

For more articles go to www.activitybasedcosting.com.au

For information on ABC software go to www.algsoftware.com.au

For information on ABC services go to www.bestrane.com.au