Knowledge base
ABC (Activity Based Costing) of Management
ABC (Activity Based Costing) of Management
30.09.2016

Piotr Ukowski

How can we reduce costs in a way that does not additionally reduce the potential of the company, and thus revenue and profit? Accurate information about the actual cost of the conducted actions, the separation of processes that consume too many resources, and the processes that are most beneficial to the company’s results are of key importance.

Conducting a generic cost analysis is possible even without the use of advanced Business Intelligence systems. Information on the value of materials, salaries, depreciation, utilities can be collected and processed in accounting. With the right organizational culture, engagement in the right cost description, creation of breakdowns, we can gain knowledge on the result of the basic objects of the enterprise. Traditional controlling settlements usually use cost center structures, dividing the costs according to arbitrary division keys and do not take into account the actual labor intensity of the tasks that are performed for specific groups of products or services.

But is information on the costs, e.g. on the performance of a specific order, sufficient? Does it let us optimize operations?

Let us use a simplified example in a design company. The costs of executing order X are shown in the table below:

Knowledge baseWhat conclusions can be drawn from the above data? Quite limited ones. We know that finding raw materials that are cheaper by 10% will give us only 2.5% savings. It would be tempting to reduce employment, but we do not have enough data to carry it out safely; the above table does not in any way indicate the employee's performance and resources needed to effectively execute the order.

Therefore, we need information not only about what resources of the enterprise we consume but primarily about the manner in which we consume them.

In our example, let’s replace the traditional approach to cost accounting with a procedural approach. Thanks to this, we will obtain information about the types of actions we take to execute the order and about how they burden our resources. The table will look as follows:

Knowledge base

With such an approach, it is much easier to draw very specific management conclusions: the need to extend the production series or to introduce changes in the design and prototyping process, etc. is striking.

The basis for the ABC (Activity Based Costing) method is assuming that the enterprise’s resources are consumed by activities that are part of the economic processes and not by products or organizational units.

Kolejnym krokiem jest powiązanie informacji o kosztach z analizą przychodów, co pozwala na określenie rentowności podejmowanych działań. To z kolei daje podstawy do uszeregowania zleceń czy produktów wg zyskowności i podjęcie działań, mających na celu utrzymanie najlepszych i eliminację najsłabszych.

The next step is connecting the cost information with a revenue analysis, allowing you to determine the viability of the taken actions. This, in turn, provides the basis for classifying orders or products according to profitability and taking actions which aim to maintain the best and eliminate the weakest ones.

But still, this is not all. Paradoxically, getting rid of unprofitable activities may significantly worsen the enterprise’s situation. Such a decision must be supported by knowledge about the degree of resource use (machine coverage, staff productivity, etc.). Even under-cost production is sometimes necessary if it fills gaps in schedules and allows to cover the regular parts of burdens. In such cases, analytical models of what-if type are effective. They let you simulate how the demand for resources and actions change in the event of changing a scale, methods or the manner of implementing the company’s tasks. From here, we are only a step away from applying Activity Based Budgeting, especially in short-term periods as well as in costing and bidding.

The complexity of active cost analysis, presented even by such simplified examples, clearly indicates the need to use advanced IT tools to record information in an appropriate and required structure, as well as to preserve data, generate diverse multi-dimensional analyses, and, most likely, for flexible modeling. Flexible modeling should be understood as a possibility of simple, intuitive reconfiguration of cost allocation and breakdowns which do not require the involvement of programmers, the possibility of using alternative paths of action while maintaining the ability to immediately analyze results of such actions and a possibility to compare various predicted scenarios. The key to the successful implementation of the ABC method is not only the knowledge of consultants of IT tools’ suppliers but primarily the knowledge of the company’s employees who know the specificity of the business and organization of the enterprise.

Vision of a practitioner – Bogusław Cilski’s statement

Business Intelligence systems are intended to process vast amounts of information. At the same time, they have to meet the requirements within the scope of transparency of the presented information, and the ease with which the processed information is obtained by the managers is also of great importance. Our requirements for BI were extended by the possibility of implementing activity based costing.

The assumptions for the project have been developed since 2005. Initially, we expanded the “5” team of the company's chart of accounts in order to associate the costs with the cost center and we introduced the accounting of costs and revenues for individual orders in the “9” team accounts. Then, we conducted quarterly analyses to verify our assumptions and made corrections to improve performance.

During the review of BI vendors, we were surprised to find out how content rich is the "BI system” formulation. There are companies that offer purely reporting solutions, other companies offer solutions closely related only to the ERP system of a particular supplier. Fortunately for us, there are suppliers whose BI systems need to be powered only from existing transaction systems in order to function properly. Data transformation, data warehouse construction, OLAP cube definitions as well as extensive reporting systems are included in these solutions. An agreement for implementation was concluded with INTENSE GROUP on September 18, 2007.

The execution time was divided into two periods: analysis and implementation. As a result, we received a reporting system based on OLAP cubes (sales, purchases, stocks and stock turnover, payments and settlements, trade ledger and ABC cost cubes as well as RCP of machines and workers). Other modules include budgeting (ABB), event logger, electronic document flow, order execution calendars, calendars for MPK.

Thanks to the implementation of the INTENSE Business Intelligence platform, we receive information on the implementation of orders and efficiency of activities, which directly translates into information support in decision-making. The measurement of activities recorded by very different units is correlated with the cost values of these activities, which allows you to assess performance in relation to MPK, activity, product, customer. From calculation, through the execution of the order, to the settlement of payments, we have the ability to obtain multidimensional information from many sources in one application. Reports defined individually for each manager are delivered to the mailbox.

The agreement concluded between the supplier and the BI systems’ recipient includes an expectation going beyond ordinary math, where one plus one equals two. If there is no clear synergy effect, a positive evaluation of implementation effects is at least problematic. In our case, satisfaction with former cooperation resulted in the extension of the scope with additional features, among others, MIS (Management Information System).

The solution implemented in Zakład Poligraficzno-Wydawniczy “POZKAL” was inspired by the need to obtain reliable information on the costs of the executed orders (ex post) and their close link with offers (ex ante). This distinguishes them from many solutions that combine costs with the undertaken and planned activities in a very loose manner.

Drukarnia POZKAL is a factory with good traditions, employing 250 people. From the very beginning of its existence, it attaches great importance to positive relations with society. It is a leader in the implementation of new technologies (CTP, JDF) as well as management methods (ISO 9001:2000, ISO 14001). It specializes in book printing and binding.

Bogusław Cilski has been associated with Drukarnia POZKAL for 30 years. He currently performs the function of Chief Information Officer. A computer scientist and economist by education.