By Mike Stevens
In today's economy, small businesses need to have an effective expense management system to compete. It is critical to choose the right product costing method in order to access the information that small business owners need to make decisions.
Product costing, the system of tracking and analyzing the total cost of production and sale of goods and services, is an integral part of these decisions.
Many companies employ simple accounting practices which can make honing in on specific costs difficult. Let's look at an accounting example using overhead costs and machine hours. If job A involves 100 machine hours and job B involves 50 machine hours, a simplified accounting method would allocate twice the overhead to job A as job B. Alternatively, a comprehensive product costing analysis would more accurately allocate costs to the production process.
This simplistic type of accounting was developed in the old days of mass production when factories churned out the same small set of products day after day. For many smaller manufacturers and job shops, this is not today's reality.
Every business is unique, so accounting for the distinct operations of individual businesses may produce a muddy financial picture. Most production processes have some differentiating factor. A production job might run sporadically, and it could require setup time or special engineering. If a production process uses special materials or components, extra costs could be associated with procurement and handling.
Different factors in the production process could make it difficult for some small businesses to conduct proper accounting. However, there is a unique approach to product costing called activity-based costing, or ABC, that takes these factors into account.
The great thing about ABC is that in order to realize the benefits, small businesses do not have to redo their books, change accounting processes, or hire experts.
The main difference between ABC and traditional product costing is that ABC takes into account the cost of making a product at every level where costs are incurred. These levels include:
Small business owners are able to make informed decisions with access to better information. Activity based costing is one accounting tool that can provide important data of a firm's expenses.
Activity based costing may help small businesses solve the problem of being unable to accurately assign costs throughout the production process. Knowing exactly how much is spent at each point along the production chain enables businesses to wisely invest time and money.