In today’s competitive business landscape, understanding and managing costs effectively is paramount for enhancing profitability. One strategic approach that has proved effective is activity-based costing (ABC), a method that assigns company expenses to products and services based on their consumption of resources.
But what is ABC really, and how can it make a difference in your operations? In this blog, we’ll explore what ABC is and how activity-based costing can improve profitability.
What is activity-based costing?
Activity-based costing or ABC is used to more accurately assign costs to products and services. Unlike traditional costing methods, which broadly allocate overhead costs based on volume metrics such as labour hours or machine usage, ABC focuses on the activities that incur costs. By identifying and evaluating these activities, companies can understand how and where resources are consumed, leading to more precise cost assignments.
This method involves several key steps, including identifying the major activities that take place in an organisation, assigning costs to these activities and allocating these costs to products or services based on their consumption. The result is a more accurate picture of profitability by product, service, customer or channel, enabling businesses to make informed strategic decisions.
How activity-based costing can improve profitability — five core benefits
Here are five key ways ABC can boost profitability within your business:
- Enhanced cost control — By providing a detailed breakdown of costs associated with specific activities, ABC enables businesses to identify areas of high expenditure and potential inefficiencies. This detailed insight allows for targeted cost-reduction strategies, such as process improvement or renegotiation with suppliers.
- Informed pricing strategies — With a clearer understanding of the costs incurred by different products or services, companies can set prices more effectively. This tactic ensures pricing strategies are aligned with the actual costs, potentially increasing profit margins.
- Improved decision-making — ABC offers a data-driven foundation for decision-making. By understanding the cost drivers and their impact on overall costs, businesses can prioritise investments, discontinue unprofitable products or adjust resource allocation to maximise profitability.
- Customer and product profitability analysis — Not all customers or products are equally profitable. ABC helps identify which products generate the most profit and which may not be worth the investment. This can lead to a more strategic approach to customer relationships and product portfolios.
- Strategic resource allocation — By highlighting the most resource-intensive activities, ABC guides companies in allocating resources more effectively, ensuring that efforts and investments are directed towards the most profitable areas of the business.
Final thoughts on implementing ABC in your business
Adopting ABC requires a shift towards a data-driven culture, where decisions are based on detailed analysis rather than intuition. It involves identifying key activities, determining the cost drivers and applying this methodology consistently across the organisation. While implementing ABC can be complex, its insights are invaluable for strategic planning and operational efficiency.
Maximise your business’s earnings by partnering with CFO On Call
As businesses strive for efficiency and profitability in a competitive market, adopting ABC can be a pivotal step towards achieving those goals — and the team at CFO On Call can help you achieve this and more. CFO On Call specialises in providing expert financial services that align perfectly with the goals of ABC. Our team of experienced CFOs can guide your business through the ABC implementation process, ensuring you gain deep insights into your costs and profitability.
Coming on board with CFO On Call exposes your business to unmatched expertise to help you make informed strategic decisions, optimise your pricing strategies and ultimately, drive your business towards greater financial success. To learn more about our services, please contact us today.
