The fact that all businesses incur expenses demands that all who fully manage a business use activity-based costing/activity-based management (ABC/ABM). Why? A fundamental tenet of management is that “if you don't measure it, you can't manage it.”
Most of the expenses (56 percent on average) of a home care enterprise are incurred because people are paid to do things such as sell, deliver, bill, collect, etc. The things people do are called “activities.” If you don't define and measure the activities, you can't manage them.
And if you aren't managing the activities, you aren't managing the majority of your expenses. ABC is the only method of applying costs to activities and, thereby, managing them.
ABC/ABM is fundamental to “sweet spot management,” too. Remember that the primary goal in sweet spot management is to improve profitability by improving productivity, which can be achieved in two ways. One is making more sales of the products that contribute most to the bottom line; the bottom line contribution is equal to revenue minus activity and product costs. The second is making business processes more efficient.
If you don't know the activity costs, you can't determine what any product-payer combination contributes to the bottom line, so you can't direct your sales team to the best referrals. Further, if you haven't performed ABC, you typically can't measure the efficiency of a business process or its activities.
So, how can you calculate your company's activity costs? Follow these six steps:
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Develop an “activity dictionary.” This is a list of processes and the activities that support those processes. For each activity, there should be a description of the tasks that make it up. We typically see 10 to 15 processes and 45 to 60 activities in the dictionary for a home care provider.
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Determine the period to be analyzed. Two consecutive months is a time frame that works well for most companies. Which two months requires some knowledge of the business; the criteria for selection is that they are recent and indicative of the year as a whole.
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Collect two pieces of information for each activity. How many minutes, on average, does it take to perform the activity one time? How many times was the activity performed in the period being analyzed?
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Next, calculate the cost per man-minute. To do that, use your income statements for the two months being analyzed to sum all of the expenses, excluding the acquisition of products. If there is unusual expense, it should be adjusted.
Divide the costs by the total number of man-hours purchased. You can collect that information from payroll reports. When you perform this division, you will know the cost per man-hour. Then, simply divide the cost per man-hour by 60 to yield the cost per man-minute.
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Multiply the cost per man-minute by the number of minutes that are consumed by performing the activity one time. This tells you the activity cost. There is no overhead included in this calculation. We call this the “unburdened” activity cost.
“Overhead” is defined differently for ABC than for other business discussions. For purposes of ABC, overhead is the miscellaneous and non-productive uses of time. Miscellaneous time is that which was not counted in the activities. For example, attending a weekly 15-minute staff meeting may be productive but is generally not counted. Attending to a family matter while on the company clock is non-productive.
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Finally, it's time to apply overhead to each activity. First, multiply each activity cost by the number of times the activity was performed in the period being analyzed. Then, sum all of the extended activity costs. This number represents the cost of all of the time you accounted for.
Subtract that number from the total expenses you identified in Step 4, and now you know the expenses you didn't account for. This is the overhead. Dividing the overhead by the sum of the extended activity costs gives you an overhead factor to apply to each of the unburdened activity costs.
These six steps will help you identify the fully burdened cost of performing an activity one time. It really is simple.
Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at wweeks@weeksgroup.com.
