What Does It Cost - Activity-Based Cost Management

Category: Others/ Misc

Presentation Description

Using ABC/M as a profit enhancement methodology


Presentation Transcript

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What Does It Cost? An Activity-Based Approach ~ a CORE Business Management Webinar ~ UHY Advisors, Inc. Farmington Hills ~ Michigan


Activity-Based Costing (ABC): A method of assigning costs to products or services based on the resources they consume. ABC is an alternative to traditional accounting in which a business’s overhead amounts (indirect labor, production facility, marketing, etc.) are allocated in proportion to an activity's direct costs. The concern . . . two activities that absorb the same direct costs can use or require very different amounts of overhead . . . . Activity-Based Cost Management Fundamentals


Activity-Based Costing (ABC): ABC became popular in early 1980’s . . . The primary issues: 1. ABC requires that a business define, break-down and track cost details by individual business activities. 2. ABC requires Clean & Accurate DATA. 3. ABC was thought to be a replacement for traditional accounting methods . . .it’s a supporting Management Decision Tool . . . not a replacement. Activity-Based Cost Management Fundamentals ABC is an “Approach” that provides an effective way to view and interpret information by measuring Cost and Performance of business processes and their outputs.


The “New & Revised” ABC/M Approach: Beginning in 2005, the approach to ABC/M was modified to focus on: 1. The Cost Per Time Unit associated with supplying resource capacity, and 2. The Unit Times of Consumption of resource capacity by products, services and customers. Activity-Based Cost Management Fundamentals What does this mean? D etermining and using Cost Drivers . . . examples would be: - Stamping Operation: $/Machine Hour by Cost Center - Food Distributor: $/Distribution Drop - Machine Fabricator: $/Direct Labor Hour - Specialty Meat Producer: Lb./Product Sold by Customer Type


Benefits of an ABC/M Approach: P rovides decision makers with details regarding which products or services make or lose money. D esigned to provide profitability information for each segment of a product/service market matrix. ABC/M is a Management Tool that can be used understand and address specific products , services or customers that make or lose money for your organization. ABC/M highlights how efficiently & effectively activities are being performed and who are the benefactors of the activities performed. Activity-Based Cost Management Fundamentals

Recommended Approach to ABC/M:

1. Develop a Cost Management Strategy: Establish a Cost Management Task Force or Team Map and analyze your Key Processes Review, analyze, test and validate your General Ledger Detail Collect and verify the accuracy of your Process Data 2. Develop a Cost Model Establish Fully Loaded Labor Rates Establish Equipment Replacement Values and Rates Incorporate Process Maps, Bills of Material, Service Steps, etc. 3. Determine Costs and React Establish unit costs for products or services by customer, product line, cost/machine center, department, etc. Activity-Based Cost Management Recommended Approach to ABC/M

Step 1: Cost Management Strategy:

Step 1: Cost Management Strategy

Costs to Control & Assign:

Costs to Control & Assign Resource Costs Activity-Specific Costs Activity-Support Costs Customer Support Costs Unabsorbed Costs Non-Specific Costs Activity-Based Costing Activity-Based Cost Management

Traditional Costs ~ Manufacturing Perspective ~:

Traditional Costs ~ Manufacturing Perspective ~ + + Process Cost per unit of output Total Cost Total Output ( ) Activity-Based Cost Management $/Unit

Activity Based Costing Approach:

Activity Based Costing Approach Activities and their drivers create a meaningful link between products, customers, and the resources they consume Customer A Customer A Customer A Customer A Customer A Customer A Product 1 Product 1 Product 1 Product 1 Product 1 Product 1 Cost Driver 1 Cost Driver 1 Cost Driver 1 Cost Driver 1 Cost Driver 1 Cost Driver X Activity 1 Activity 1 Activity 1 Activity 1 Activity 1 Activity 1 Activity-Based Cost Management

Flow of Costs . . .:

Costs Activity Analysis Internal support activity Activities with no direct link Activity driven by products, services & customers Allocation Methods Allocation Methods Allocation Methods Products Services Customers Non-Specific Costs Activity costs assigned to specific products, services , customers, cost centers, etc. using the “Driver Volume” of each activity Flow of Costs . . . Activity-Based Cost Management

Map your “Value Streams”:

Process Mapping – an examination of the expectations and requirements between departments . . . . includes both internal and external customers PRODUCT (“Result of a process”) MONITORING AND MEASUREMENT OPPORTUNITIES (Before, during and after the process) Output Input PROCESS “Set of interrelated or interacting activities” EFFECTIVENESS OF PROCESS = Ability to achieve desired results (Focus of ISO 9001:2000) EFFECTIVENESS OF PROCESS = Ability to achieve desired results EFFICIENCY OF PROCESS = Results achieved vs resources used (Focus of ISO 9004:2000) EFFICIENCY OF PROCESS = Results achieved vs resources used (Includes Resources) Map your “ Value Streams”

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Process 1 Value Stream Map Delivery Value Stream Map Follow a “product” or “service” from beginning to end. Draw a visual representation of every process in the material & information flow. Identify Value-Added and Non-Value Added steps. Process 3 Process 2 Activity-Based Cost Management

Strategy Development . . . :

Strategy Development . . . Review and test your general ledger to identify which accounts are allocated “what” costs and then validate! Determine the most appropriate cost drivers to allocate the costs . . . . Cost Center C Account $ Cost Center B Account $ Cost Center A Account $ Example: Employment Costs - Fully Loaded Costs: Salaries , taxes, pensions, etc . Occupancy Costs - Rent, utilities, repairs, etc. Equipment Costs - Lease, property tax, utilities Activity-Based Cost Management

Assigning Base Costs to Activities . . . :

Assigning Base Costs to Activities . . . Activity-Specific Costs Costs General Ledger Activity Analysis Allocation Methods Employment Costs: Hours worked per activity or % of time spent Occupancy Costs: Square feet of facility space used Network Costs: Log-on time, Processing time etc. Activity-related costs are assigned to individual activities on the basis of rational allocation methods Example : Activity-Based Cost Management

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Activity-Based Cost Management Step 2: Develop a Cost Model

Important Aspect . . . :

VA = SR – (MC + OS) VA = Value Added SR = Sales Revenues MC = Material Costs OS = Outside Servicing Costs Structure your operations via a “Value-Added” approach . . . Important Aspect . . . Incorporate a “Checkbook” Mentality Activity-Based Cost Management

Cost Model Structure:

Cost Model is used to assign specific activity costs and as a “tool” for management decision making. BOM Routers Costing Model for Business Decisions Cost Model Structure Product, Customer, Business Unit Cost Analysis Monthly Snap-Shot Activity-Based Cost Management

Labor Analysis :

Determine your “Fully Loaded” Labor Costs: Labor Analysis Activity-Based Cost Management

Equipment Analysis :

Establish a Cost / Hour for all Primary Equipment: Equipment Analysis Activity-Based Cost Management

Department Cost Allocations:

Allocate your Financial Data by Department, Cost Center, Etc. Department Cost Allocations Activity-Based Cost Management

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Step 3: Determine Costs

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Example . . . Contractor - Cost & Profit per Job Analysis

Example Project . . . Do we stay or do we go? - Food Distributor - In Business since 1967 - 11 delivery trucks - Next Generation Mgmt. - Breakeven - Where’s the future?:

Example Project . . . Do we stay or do we go? - Food Distributor - In Business since 1967 - 11 delivery trucks - Next Generation Mgmt. - Breakeven - Where’s the future? Breakeven $121.19/Drop Profit per Drop

ABC/M Objective . . . Profitability by Customer:

0% 60% 70% 80% 90% 100% 10% 20% 30% 40% 50% Cumulative Profits (% of total profits) Refine Processes to Improve Profitability Convert or Disengage Most Profitable Customers Least Profitable Customers Profit Distribution Curve 0% 20% 40% 60% 80% 100% 120% 160% Cultivate and Grow ABC/M Objective . . . Profitability by Customer Activity-Based Cost Management

ABC/M Objective . . . Profitability by Customer:

Identify and eliminate the unprofitable . . . Up to 30% of products, services or customers may not be profitable: - Determine how resources will be allocated - Understand the implications of “Elimination” - Manage the remaining costs . . . . Do Not Transfer! 30% to 40% of products, services and customers are marginally profitable or marginally unprofitable Know w hich Products, Services, and Customers that drive profitability at your company Activity-Based Cost Management ABC/M Objective . . . Profitability by Customer

Next Step . . . . . . Mobilize :

Next Step . . . . . . Mobilize Definition: To make mobile or capable of movement. To assemble, prepare, or coordinate for a purpose. Implement actions to shift to controllable revenues where unpredictability is the greatest. Maximize revenues for existing customers: Mobilize your Sales Force . . .Position for Strategic Partnerships Examine the value chain to increase revenues that can be earned from existing customer. Look for Sustainable Cost Reductions verses Short-Term Cost Savings. Activity-Based Cost Management

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What’s our Market Position? Develop a strategy to recognize merger, acquisition and potential market growth opportunities. Position your company to understand current and future market segment, areas for growth, etc. Options: Stay as you are in your business and market nitch Initiate a diversification strategy / program Explore and initiate mergers and/or acquisitions Identify and source resources overseas Provide a strategic platform for foreign companies Prepare to Transition & Position Activity-Based Cost Management

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78 million workers will leave the workforce over the next 16 years. There are only 48 million new entrants: Look within for Critical Skills and Knowledge Key Questions to Ask: Which segments of my workforce create the most value? Which areas of our organization will be most impacted by retirements? What skills do we need now? What skills will we need in the next 5 years? Are we actively developing workforce plans? Establish a Labor Force Strategy Activity-Based Cost Management

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Lean Manufacturing ISO 9001:2008 Six Sigma Activity-Based Cost Mgmt. Balanced Scorecard Toyota Production System Business Improvement Tools Resource Utilization Problem Resolution Market Intelligence Process Control Cost Management Business / Financial Metrics Goal: To provide you and your management team with high-quality data and business information. Objectives: 1. Timely Decisions 2. Value-Added Insight 3. Maintain Control 4. Efficiency and Profitability Incorporate Productivity “Tools” & Methods Activity-Based Cost Management

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ABC/M Road Map Activity-Based Cost Management

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Diversification Strategy? “ Would you tell me, please, which way I ought to go from here?” asked Alice. “That depends a good deal on where you want to get to,” said the cat. “I don’t much care where,” said Alice. “Then it doesn’t matter which way you go,” said the cat. Lewis Carroll, Alice’s Adventures in Wonderland Activity-Based Cost Management

In Conclusion . . .:

In Conclusion . . . Incorporate a SMART Edge: Strategy - make sure your long term costing strategy remains intact and focused. Message and Measure - it is vital that your key people understand your cost strategy and know where you are heading. Accelerate - the world is changing quickly and you have to change even quicker. This is the time to gain market share. Reinvest – Look for opportunities, cost controls, process improvements, etc. Talent - is a critical key to achieving and sustaining your business goals and objectives . Activity-Based Cost Management

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Questions? THANK YOU! Alan Lund UHY Advisors, Inc. Farmington Hills, Michigan 48334 (248) 355-1040 Alund@uhy-us.com

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