Measure Production Expenses Using Activity Based Costing
By Mike Stevens
Managing expenses is crucial to running a small business. Being able to focus on specific input costs can provide business operators with the information they need to effectively manage the production process.
Activity based costing, commonly referred to as ABC, takes into account all the costs associated with making a product. Costs are analyzed at the unit, batch, product, and global level.
You can use ABC to further assess exact expenses incurred to produce products. The following list comprises some basics on how to calculate unit cost using the ABC approach:
- Materials costs: This is a simple external cost to calculate; it is the price that businesses pay suppliers. When calculating material costs, be sure to include acquisition and handling costs.
- Unit cost: In order to calculate unit costs, an accurate measurement of labor and machine hours is needed. Barcode-based systems, where workers scan a unit at the beginning and end of a task, are very accurate. If this is too costly, business managers should personally monitor the time production takes to produce varied amounts of products or services. This should be done several times to get an accurate average.
- Batch cost: Depending on the nature of the product line, other expenses, such as engineering, may need to be added in to batch costs. If setup costs are $1,000 and 20,000 units are manufactured, setup adds 5 cents per part.
- Product cost: For standard products, costs are measured in development hours.
- Global costs: Overhead costs, such as utilities and payroll. Global costs may need to be specially defined in the activity based costing approach. For example, if engineering costs are included at the batch or product level, they should not be included in the indirect cost figure.
When conducting a pricing exercise, either for a bid or for a product line, add up all these costs and divide by the number of units.
Use of ABC
Activity based costing is ideal for businesses who want to take a detailed look at all the costs along the production chain. Switching to ABC requires a transition as to how a business accounts for costs.
Charlie Alter, a Toledo-based management consultant to small manufacturing companies for more than 20 years, says that the biggest obstacle to implementing activity based costing is mobilizing accountants. “The hardest thing is to get the accountants out of their chairs and onto the factory floor,” says Alter. Once that is accomplished, transitioning to the activity based costing method is feasible.
If a small business is seeking margin improvement, or is having trouble managing costs in the production process, activity based costing could be the solution. At its core, the activity based costing approach seeks to align pricing with reality.
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