16th May 2023
If you haven’t even heard of activity-based costing, you’ve probably already conducted this activity in your business.
Activity based costing (ABC) simply means calculating how much it costs you to run a business process.
This is really useful as it helps you do a variety of things, from discovering how much lean waste there is in your processes to providing you with data to build business cases for your stakeholders.
In this blog, we’ll take a look at the fundamentals of activity-based costing and some of the tools you can use in your business to understand your own costs, either by yourself or through software.
Ready to learn more?
Fundamentally activity-based costing is a calculation of the aggregate cost of activities in a process. It considers the total cost of running that process, from materials, to time, people and movement. For anyone looking to understand their company’s finances, ABC produces nearly true costs and classifies them accurately.
Activities are essentially anything that is a cost driver or has a cost, such as purchase orders, machine setups, or training sessions. They are any event or task that has a specific goal. You add up the costs for each to arrive at the total cost. And you’ll find out what you are spending too much on, whether that’s money or time.
Plus, overhead and indirect costs, like salaries and utilities, can be assigned to certain products or services to also keep them in mind when it’s time to calculate costs. ABC also allows companies to have a better idea of their pricing strategy. They want to (at the very least) break even in what they generate versus what they spend on.
To calculate ABC, you must follow these steps:
You can then plug the above information into the following formula:
Activity Cost = (Duration x Hourly Cost of Employee Responsible) + Direct Costs
Why is it important for my business
ABC is important for any business because it helps you to keep track of how much it costs you to run it versus how much revenue you are generating. You don’t want to spend blindly on tools or purchases that are not producing fruit for how much they are costing you.
An example of how this might play out in your business, is an activity that you find is constantly being repeated because it’ is not done properly. There’s a point in your process where it is continuously bouncing back to the previous step because something is missing. These are hours of work from your employees that you are not getting back and could be dedicated to other projects.
In a similar vein, you can also think of automation.
There are a lot of manual tasks that organisations need to do, such as logging appointments, sending out follow-up emails, filling out certain fields in a CRM, that can be easily automated or simplified. Manually passing information from spreadsheets to a CRM to an email marketing tool are all tasks that take up time and slow down the process. This is time that you lose as an organisation leader – and that could be used for other projects or revenue-generating tasks instead.
Conducting activity-based costing helps you find these issues with numerical, hard data. By utilising the formula, you can continuously check the status of your processes and whether you are making revenue or losing.
And you can start thinking of ways to improve it by experimenting with the numbers.
Say you remove a step that is duplicated or automate a certain activity, you calculate how much time you gain back and how much it might cost to automate with different tools.
This makes it a lot easier to convince stakeholders and employees when it’s time to make a change in the process.
Activity-based costing with Spark: Introducing quantity
Liberty Spark is our process improvement solution. Spark’s first mission is to simplify processes for all parties involved and to be a platform solely dedicated to business process mapping. You no longer need to rely on piecing together several tools to map out your process, nor do you need to fear any miscommunication as standardised out platform with Universal Process Notation (UPN).
For ABC, Spark provides you with a collaborative, cloud-based platform to build your processes as they currently exist. It’s easy to involve all relevant team members and have them contribute to the visualisation of the tasks that they do every day.
But mapping out processes is not enough if you want to truly have them impact your organisation positively. It’s great that they’re mapped out, but now it’s time to add data and run some numbers.
Especially if you want to easily calculate ABC and accurately forecast changes, not only immediate solutions. Liberty Spark’s tool Quantify is here to help you out.
Once your process is mapped, you can add details such as how long it’s taking for certain steps to finish before moving on to the next. You can also add the direct costs associated with each step, as well as the hourly cost to the assigned role responsible.
With this data, Quantify will calculate the ABC for you.
On the main dashboard, you’ll find the total cost of the entire activity per week, a breakdown of the fixed cost versus role cost, the most expensive activities and your most expensive roles. More in-depth analysis is available as well. And you haven’t had to do any calculating yourself so there’s no need to account for human error. The numbers are provided to you as soon as you input the necessary data.
With this information, you can then start to use Quantify more readily to explore different options. You can remove certain activities or switch responsible roles to see how they may impact the cost of the process, if at all.
And you can also see the impact that your changes might have in the future, not just in the immediate numbers, so that you can be even more accurate when it comes to making decisions about what to change. While the numbers may not always be accurate, as you are approximating them, especially time spent on tasks, it will provide enough of a general idea to make a more informed call when you’re deciding how best to improve.
Quantify will also help you identify bottlenecks and other areas in your process you can troubleshoot to be more efficient and further optimise your business.
And best of all, if you need to explain to shareholders the reasoning behind your changes, Quantify can help you prepare a business case. It will include all relevant data, calculation and forecasting all presented in a way that can be easily understood to help you get sign-off on the changes a lot faster.
Getting the full picture with activity-based costing
Mapping processes is a great start, but at the end of the day, numerical data is especially important when making the decision to change any part of a process. It provides you with a clear picture of where you might be overspending, be it time or money, and it gets you thinking about how you might be able to save.
Activity-based costing is one way that can easily help you determine where you need to reconsider your spending. And it can be far more nuanced than simply removing a role or not renewing a subscription.
Informed business decisions need hard data that does not take a long time to calculate and accounts for several outcomes. Quantify does just that in a matter of minutes, allowing you to explore all the potential scenarios that removing certain costs will have. It points you in the right direction to find the best option.
If you’d like to learn more about how Spark can help you effortlessly calculate ABC going forward, don’t hesitate to get in touch with our team today.
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Seamlessly and effectively calculate your activity-based cost to make more informed decisions and save cost