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February 6,
2007 Breaking Down Your Activities to Help You Cut Costs Activity Based Costing, also referred to as ABC, is a process in which an organization can assign costs to activities and then assign those activities to specific products or even customers. By breaking down the process by activity, managers are able to get a better perspective on where their costs are coming from and how they can be reduced. When it comes to determining profitability, you must be able to tell where your costs are being incurred to see where your cash flow is being held up. You can do this by first determining your most critical activities and then creating an ABC model.
The pictures above show the general process of what it takes to get a product from your warehouse to the customer. As you can see, the order is taken and then sent, by a pick ticket, to your warehouse where the order is then picked and shipped to your customer. On paper this seems like a very simple and clean process, however, as we all know there are many hidden steps that can cause a setback for you and your business. For this reason, it is very important to know which steps are critical to analyze and which may just cause interference and complexity when it comes to creating your ABC Model. Having too many activities to evaluate can be extremely time consuming and unnecessary while at the same time having too few will not give you sufficient information on how to better your process. In the article, “ABC, 123,” Terrance Pohlen suggests that an ABC model include between 20-40 activities. He also mentions some rules of thumb when it comes to deciding which activities to keep in your model and which are unnecessary. Diversity: It is important to identify which activities can be broken down into smaller more informative categories and which activities are better left at a broad level. Often breaking categories down into smaller groups can give you a more detailed view; however, for some activities it may complicate the process and draw your attention away from other activities more pressing. Simply put, if breaking down the activity does not provide critical, unique information necessary for evaluating your process, don’t do it! Cost: The cost of the activity is critical in deciding whether or not it needs to be included in your model. If you have an abundance of activities to analyze, it’s going to cost you time and will not return much of a benefit as you are not able to narrow down your evaluation. On the other hand, having too little, will also cost you time while not giving you any important information on cutting your cost. Measurement: It would be extremely frustrating to try and break down an activity only to find that it’s impossible to determine which costs to allocate to the activity. Therefore, before you even begin to analyze your activities you should ask yourself which ones are actually worth the time and remove all those that aren’t. Management Focus: Above all, this process is meant to provide management with informative, useful information about activities and their cost. If taking out an activity will prevent you from gaining this much needed information, then it is not worth removing it. Creating an ABC model can be a vital tool when it comes to determining your profitability and cost. Once you have chosen the activities for evaluation, you can then move towards determining where your problems lie. Once these are located, you can then fix the problems and increase profitability. In next week’s article, we will use this process to identify activities pertaining to one of the four practices, as shown in the pictures that will identify the ABC’s of that practice. Decreasing your cost will increase your profitability To Unsubscribe
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