Activity based cost management
A key aspect of managing any organisation, whether commercial, not-for-profit or local or central government, is to understand the full cost of products, services, outputs or outcomes.
Understanding the costs of delivering services is a key element of price or fee setting decisions and for monitoring the level of profitability or cost recovery that each service contributes to the organisation.
Activity-based Cost Management is a decision support tool that provides such information about the costs, prices and profitability of services. Activity analysis also provides information about the effective use of resources to deliver services across the organisation – particularly useful in times of economic change when restructuring or when looking to improve process efficiency.
Financial accounting systems are not typically designed to provide this information. And the cost modules of ERP systems or the popular “slice and dice” software add-ons are still only as good as the related data structures and analytical capability of the user.
Activity-based Cost Management applies costs to services or outputs based on the organisation’s resources that are consumed in producing and delivering each service or output (refer to Figure 1 below).
Figure 1 Concept diagram of activity based costing
Having developed the full cost of a service or output, it is an easy step to determine the “contribution” made to the performance of the organisation.
Because Activity-based Cost Management highlights the resources consumed by each service or output, management can better understand the allocation of resources across the organisation and focus on efficiency, cost reduction, pricing or the appropriate setting of fees and charges. Information about activities, services or outputs enhances performance reporting and keeps the focus on cost effectiveness and delivery of services.
The following diagram (Figure 2) illustrates how Activity-based Cost Management is applied by attributing information into cost pools based on cost drivers and the consumption of resources.
The mechanics aside, Activity-based Cost Management is really about applying cost of services information to manage organisational performance and improvement. At an operational cost level, for example, it can be used to identify non value added costs that can be removed. At a strategic level, it can be used to provide decision support for in-house vs. outsourcing decisions or to support the preparation of a business case or the public sector comparator in PPP evaluations.
And it becomes very powerful when combined with techniques such as the Balanced Scorecard to provide dashboard reporting for monitoring achievement of strategic initiatives.
