Learning Your ABCs

Activity-based costing is the new buzzword around our industry. Everyone is talking about it, but what is it really and how can it help you?

If you look at that new Dell computer you got such a great deal on and wonder how they can sell their computers for such a low price, the answer is as easy as ABC, or activity-based costing. Dell knows exactly how much the company spends at every step of the process.

How do they do that? Well, being a multi-billion-dollar corporation with a huge accounting department helps, but Dell started just like every other company — small. The main difference between their business and yours (other than the obvious industry differences and that billion-dollar range) is that Dell knows exactly, to the penny, how much each computer, monitor and mouse costs and, therefore, exactly what the company must charge for those products to get its desired level of profit.

The company is also able to identify areas that can be improved or eliminated and still be able to deliver a great product and service. They monitor these costs constantly and adjust processes, and occasionally pricing, to achieve the profit level they need.

Basically, activity-based costing allows you to simplify your business and improve its processes by modifying or eliminating anything that is not necessary or does not add to profit.

You will first need to define your company's activities. These are the processes, functions or tasks that occur over time and have recognized results, like services, events or information. Activities also use up assigned resources to produce products or services. Understanding these activities is crucial in order to perform activity-based costing, since activities are the building blocks of any business process.

Make sure you include your employees in this process, as they are the ones carrying out these activities every day. Ask them to describe what they do and how they do it. Evaluate what they tell you and make sure you are not duplicating processes here. This step alone can help identify any problem areas in your company that you may not even be aware are occurring

Once the activities have been identified, make a list of them — in laymen's terms — that will allow all employees to understand what each is and see why each has a cost associated with it.