Crises often occur without warning. But this time the scenario is different. With an unprecedented economic and social context, experts predict a worsening instability in the world economy.
The expectation in 2020 was that economies would improve as we recover from the Covid-19 pandemic. However, the prognosis for the global economy through 2024 is not encouraging.
The projections reveal a slowdown in growth even in developing countries (which generally have better rates), with expansion well below expectations. The most recent Global Economic Prospects report from the World Bank indicates a probable global crisis in the face of high inflation, equally high-interest rates, and reduced investments.
High inflation, falling economic growth
World Bank projections indicate that the global economy will grow by 1.7% this year, and by 2.7% in 2024. These numbers reflect a generalized situation that will impact markets on all continents, with low growth expectations for 95% of the first-world economies and approximately 70% of developing economies.
It is estimated that the global economy in 2024 will grow 6% less than the forecasted rate for 2020, the year before the Covid-19 pandemic exploded. In a more alarming context, this data highlights a significant concern for companies around the world: with such a weakened outlook, any adverse event can start a recession.
An increase in Covid-19 cases, military tensions between countries, or banking fragility with the collapse of banks like Silicon Valley Bank and the bailout of Republic Bank and Credit Suisse could be the push that’s needed. Events such as these can cause GDPs to plummet, real incomes to fall, unemployment to rise, and industries to become idle, with companies in various segments experiencing severe crises or even going bankrupt.
Inflation above pre-pandemic levels
Although on a downward trend by the end of next year, inflation will remain above the rates obtained before the start of the Coronavirus pandemic. High inflation, coupled with projections of low economic growth in 2024, is expected to lead to decreased demand for emerging economies’ exports and depreciation of their currencies. Advanced economies are expected to have their growth slowed from 2.5% in 2022 to 0.5% in 2023.
In the last 20 years, declines of this magnitude preceded global recessions (in 2009 and 2020). For the US in 2023, for example, the worst economic performance out of recession periods in 53 years is forecast.
What Experts Say
However, some believe that the crisis is inevitable, with or without major global unforeseen events. Tom Simons, an economist specializing in the financial market, predicts that we are entering a period of classic recession.
According to Simons, the rise in inflation and interest rates should lead to a significant drop in organizations’ profit margins, resulting in cost cuts that should begin with a reduction in the workforce. Simons believes that this worsening of the crisis will start from the middle of this year, affecting both advanced and developing economies.
On the other hand, opinions are beginning to split among scholars. The abnormalities of the current economic context may imply a different market behavior, leading to unexpected developments. Mark Zandi, Head of Economics at Moods Analytics, states that the simple expectation of a recession can lead to unexpected results.
According to Zandi, with everyone foreseeing and preparing for the crisis, an unprecedented phenomenon, the picture may develop differently, leading to a cooling of inflation and even a possible drop in the unemployment rate.
The certainty we have is that the crisis is here, after all, levels of economic growth like the current ones historically point to the emergence of another global recession. However, it is difficult to say what the extent of the damage and the impact on the different markets will be.
Thus, managers can only watch interest rates and carefully analyze how economic instability will affect different aspects of their business: from supplier relations to customers’ purchasing power. Only then will it be possible to take specific actions to help preserve margins without compromising production and market positioning over the next two years.
Managing 230,000 hectares of agricultural land across 6 different business operations in 3 countries is no easy feat. This is why Adecoagro turned to MyABCM for solutions to optimize management, control costs, and increase profitability.
Expanding a history of growth through cost management
With over two decades of experience, Adecoagro cultivates more than just raw materials for different markets; it also cultivates a long history of growth. The company, which was founded in 2002, started its operations with 70,000 hectares of agricultural and livestock production in Argentina.
In 2004, it expanded its plantation by incorporating new lands outside its country of origin, reaching Brazil and Uruguay. In 2005, the company increased its product line by implementing the production of sugar, ethanol, and energy. With its great evolution, in 2011 Adecoagro was listed on the NY Stock Exchange (NYSE). A major achievement that reaffirms the company’s enormous value.
Today, Adecoagro’s main operations include sugar, ethanol, energy, milk, rice, and grain production. It produced 2.7 million tons of agricultural products and more than 1 million MWh of bioelectricity. Throughout its history, Adecoagro’s planting area has increased by over 200% and its focus on growth and excellence in management has led to 2021 revenues surpassing US$1 billion.
Reducing the complexity of a multinational business
Adecoagro continues to surpass its expectations each year. To further drive its growth, the company’s management team has decided to invest in technology to achieve complete transparency and traceability of costs, advanced business simulation capabilities, and most importantly, independence and autonomy!
It is in this scenario that MyABCM will operate. Adecoagro chose our solution to enhance its cost management processes, which were previously performed with difficulty using another tool and could no longer keep pace with the complexities of such a dynamic organization. With full integration with corporate systems, MyABCM will bring several key benefits to the company, including:
Increased clarity in tracking the allocations and cost composition of the company’s different businesses and products;
Ability to perform sophisticated scenario simulations to support the decision-making process and reduce risks;
Making it easier to maintain drivers;
Automation of the main management reports, adding more productivity;
Integration with all the company’s systems;
And much more!
This will provide management with a clearer understanding of how costs are distributed throughout the company’s complex operations, from suppliers and distribution channels to other critical aspects of its business. The result will be much greater decision-making capacity and reduced risks, as well as increased profitability of its operations, paving the way for new investments.
Want to learn more about how MyABCM can provide detailed cost control for companies with highly complex structures? Request a Demo today!
“Today, we have everything tied up with MyABCM: understanding the main business dimensions, analysis of individual targets… I can say that without MyABCM, it would be extremely difficult today to manage the organization with the agility that it demands.”
With 30 years of history, Quatá, a dairy products manufacturer, impresses with its potential and speed of growth. The company, founded in 1990 in the countryside of São Paulo, started its operations with only 16 employees and a processing capacity of 3,000 liters of milk per day. Today, the company is responsible for more than 1,600 jobs and has a production capacity of around 1.1 million liters of milk a day. The industrial plant has expanded and currently six factories are producing the various goods in the industry’s portfolio, which includes dry and refrigerated lines among cheeses, kinds of milk, creams, zero lactose options, and specialty cheeses.
The challenges of a booming business
Growth is undoubtedly one of the greatest goals of any business. However, it is a process that brings with it great challenges. And for Quatá it was no different. The company uses in its management one of the best ERPs available in the market, TOTVS. However, even with all its versatility, the platform proved to be insufficient to offer the level of detail required to control the indirect costs of such a complex industry. Thus, to support the cost management process, Quatá employed in its logistics and distribution areas a costing model partially by absorption and by activities, using Excel spreadsheets.
Even with the association of these resources, the company still had difficulty in visualizing the costs of all the processes accurately and productively. With a varied portfolio and different production methods, one of the biggest challenges was to efficiently measure profitable and loss-making products. In this context, the production of the industry’s refrigerated goods line proved to be particularly challenging. With an almost manual process for manufacturing their specialty cheeses, accurate costing was not an easy task, but it was a must.
The choice of MyABCM to support Quatá’s cost and profitability management
MyABCM has provided Quatá with the possibility of implementing a new cost management model, capable of serving all sectors of the business, integrating smoothly with the ERP already in use. The cost modeling by activities (ABC/M) is now applied from the industrial plant, in the Production area, to the Commercial sector (covering delivery, logistics, and customer service) and also in the back office and the correct allocation of the indirect costs of the business.
The company, which does accounting and management closing every 5th business day, uses MyABCM to extract various dimensions of analysis, which are then published at a very high level of detail. Through integration with Power BI, the findings are quickly made available for viewing by the entire company, which can use the data provided to improve the decision-making process.
Results provided by MyABCM
Quatá is a company that is growing a lot and it is essential to understand where it is making and losing money, so one of the company’s greatest gains was in the diversity of the performance information and its analysis. And the outcome of this process is the empowerment of the management teams, who now have much more control over the business performance, since strategic decisions are taken based on the data provided by the software. Among them, it is worth highlighting the contribution margin analysis, which is now performed by Product, Channel, Customer, Management, Salesman, Representative, and Region.
With this detailed vision, Quatá has gained an important competitive advantage. The tools of the MyABCM solution are also used for Planning and Budgeting, in addition to providing historical budget data and solutions for scenario simulations that are fundamental in pricing studies and in obtaining sophisticated forecasts.
This is another benefit of great prominence for the organization. With the agility of the market transformations in the dairy segment, being ready for all the possible unfolding of the sector facing economic and supply chain fluctuations put Quatá ahead of the competition. And it is not only in preparing for market fluctuations that the resources for costing, simulation, and scenario forecasting have optimized Quatá’s operations. The industry launches several products every year. As such, the previous studies with the application of target costing techniques produced with the support of MyABCM are a fundamental pillar in the decision-making process regarding these new launches.
According to the Controller Manager, Jullian Soares, who was responsible for the implementation of costing in Excel and later led the MyABCM project at Quatá, “The model has to make conceptual sense for the business. Today, we have everything tied to MyABCM: understanding key business dimensions, individual goal analysis… I can say that without MyABCM, it would be extremely difficult today to manage the organization with the agility that it demands.”
It is also important to note that the support of the MyABCM support team was evaluated by Quatá’s board as fundamental throughout this process. Not only for their experience with the platform itself and its tools but also their knowledge in the implementation of the activity-based costing method and expertise with 100% dedication focused on the topic.
Before the Covid-19 Pandemic, Duke University research gathered 848 financial executives in the United States and asked, “What are your organization’s top three concerns?” The number one concern of these executives was “Being able to maintain margins.”
Another study, this time from Gartner, of 482 executives asked, “What is your biggest technological challenge?” The biggest challenge identified was “Properly measuring Product and Customer profitability.”
In other words: obtaining adequate profit margins has been a difficulty and a widespread concern among companies. In this article, we will shed light on some of the factors that may be causing this problem in your organization, and how you can reverse the situation.
Every customer matters when it comes to improving your profit margin
In fact, we realize that the margins of organizations have fallen dramatically in recent years. This is due to several factors, such as the pandemic itself, pressure from government agencies, logistics problems, competition, and even increasingly demanding customers.
It is common to find companies that do not realize that one of their products is making a loss and continue to sell it below cost out of total ignorance! And in their eagerness to serve customers, organizations are often practically forced to give significant discounts – which in many cases ends up generating a loss-making sales operation, resulting in a significant impact on the overall profit margin.
In this context, it should be noted that those customers who demand a lot of effort from the organization are deficit customers. They are those who make special orders, impose a great logistical challenge of any nature, or require significant post-sales. Now imagine what it is like to sell to such a customer!
And, making matters worse, many of these clients are treated as “key” customers, because they buy a very large volume of goods (or in the case of the services segment, transact a large volume of services), often giving the false impression that they are “profitable” when in many cases they are loss-making!
On the “shop floor” the adversities are equally great. Every process or activity done in duplication, the rework, represents huge costs that the company must bear. Defective products or layout problems and high idleness are good examples.
If we go to the back office, several factors must also be evaluated in order to maximize the company’s profit margin. Is the size of the organization adequate for the challenges of producing, selling, delivering, and after-sales? Is there a way to be more efficient? These are some important questions.
These scenarios are reinforced by a study done at Harvard. The research found that on average, 20% of customers are very profitable, approximately 70% “stall”, and 10% are loss-making. The big challenge is to understand which ones they are and what to do with this information!
Know the results generated by each client and improve your organization’s margins
The issue of controlling profit margins is urgent for companies in all sectors. A pre-pandemic survey by Exame magazine pointed out that the average net margin of organizations in the last 10 years was 2.54%.
This means that a transaction made outside of compliance, or some additional discount offered to a customer is often the difference between profit and loss for the company.
From the moment we can measure costs and results properly, we can make the best decisions. Discount policies, salespeople commissioning, process outsourcing, exporting or not, opening new divisions, etc., are just some of the possibilities when we have true information for this decision-making.
Want to find out what is causing your company’s profit margin to drop and reverse this process? Contact our experts!
Extended Planning & Analysis (xP&A) is an evolution of the traditional FP&A, widely known and employed in organizations. In a scenario where technologies have developed to the point of allowing the collection, relationship, and integration of large amounts of data, this deployment of analysis and financial planning is an expected phenomenon.
After all, why ignore departments whose activities impact the financial results of the business, if it is now possible to understand how their actions at a specific level have repercussions on the overall picture of the company?
Want to understand better? Then continue reading to learn about xP&A!
What is xP&A?
The simplest definition is that xP&A is an FP&A that broadens the view of the financial sector. And as we have already mentioned, it is a natural result of the advance in management software, which is now able to fluidly interrelate information from all sectors of a business.
In other words, the xP&A differential is the proposal to centralize the data from the company’s various departments and manage them in a single interface. It allows the different cost centers of a business to be identified and correctly considered in the organization’s financial analyses.
When integrating the needs and operations of the different sectors of the company, it is easy to create information silos that isolate departmental data and prevent the finance team from understanding its origins and validating its acuity. With tools that allow the organization to adopt xP&A, managers can observe how the various sectors (marketing, human resources, distribution, production, technology, research, etc.) contribute to the generation of costs and results.
In short: xP&A creates a real map of the inflow and outflow of resources within the organization.
Main xP&A Benefits:
Holistic view of financial performance
xP&A allows the visualization of costs and financial allocations at the sector level. As such, it allows the identification of cost sources and bottlenecks, improving the decision-making process regarding the application of resources.
Harmonization of data
Here we are talking about a unification of data within the company. Financial, sales, marketing, HR, etc. All within the same platform with a unified model in data collection and presentation, making the information more consistent and reliable.
Advance in business alignment
By connecting information, xP&A opens the door for the creation of integrated planning. This way, we have the company working more like a uniform gear, where everything is connected and working coordinated.
Companies that adopt xP&A can have much more agility when it comes to planning and projections. This impacts all niches, but especially those that deal with greater economic uncertainty and volatility.
More accurate forecasting
Visualizing the origins of costs and the way resources flow through the organizational structure guarantees much more predictability regarding the results and the impacts of actions.
Facilitating the identification of opportunities and risks
This last benefit is the result of the union of all the others. Thanks to all the visibility promoted by xP&A, decision-makers can be more efficient in seeing improvements, opportunities, and risks. Scenario modeling can simulate situations and anticipate changes, preparing the company to act strategically.
However, one must keep in mind that not just any software is suited for the adoption of xP&A. Traditional ERPs, as well as less sophisticated accounting systems and financial solutions, traditionally are not able to integrate information at such a detailed level.
To obtain all the benefits of this methodology, it is indispensable to count on a solution that can manage and update in real time a high volume of information, as well as collect data from the various sources fed by each department.
MyABCM was tailored to provide this level of detail in the analysis, in a flexible model that adapts to the most diverse segments and business models.
Want to know more about MyABCM? Contact our consultants using the form below.
Active in the property, personal and life insurance market since 1971, Assurances du Crédit Mutuel (ACM) is one of the large European organizations that rely on MyABCM to manage their costs and profitability.
The challenges of Assurances du Crédit Mutuel
The organization is one of the most important insurers in France, and has a portfolio of services that is not limited to the French territory. The insurer also distributes part of its portfolio in Luxembourg and Belgium, and has financial participation in products that serve the Canadian and Tunisian markets. This large coverage brings together in ACM’s customer portfolio more than 12 million people insured by its different products.
To meet all this demand and manage its diversified portfolio, the organization employs more than 3,800 employees. With these numbers, in 2021 the company was responsible for more than 35 million insurance contracts on various fronts.
Managing all this information is undoubtedly a great challenge. For this, the corporation used the SAP PCM (Profitability and Cost Management), but with the removal of the tool’s support, the board chose to migrate to the MyABCM system.
This choice was guided by the need for a solution that not only offers complete features for cost management and business profitability, but also provides the necessary support in its implementation and daily use.
Efficient cost management with full support
Other factors were also decisive for the MyABCM system to be chosen as the ideal solution for ACM, out of other renowned software available in the market.
Among them, it is worth mentioning the fluid integration with the ERP used in the organization and its ability to add powerful and flexible cost and profitability analysis tools, capable of processing the robust volume of data coming from its operations.
Let’s recapitulate some trivial points that underlie “Activity-Based Costing”.
Control associated with direct and indirect costs;
Allocation criteria respecting a cause-and-effect relationship
Robust data analysis;
Identify all activities related to services / products, customers and channels;
Traceability of expenses;
Accurate information for decision making;
And much more.
If you are already familiar with the term, let’s go ahead and discuss why ABC (activity-based costing) has the power to increase your profitability.
What is the main objective of the ABC method?
Let’s get right to the point.
The focus of the ABC method is to have maximum control over the indirect costs (also called overhead) as well as the direct costs associated with a product, service, customer, or channel.
Through a costing system using drivers that respect a cause-and-effect relationship and aiming to bring an advanced analysis of the costs per activity within the operation.
And with this dense range of data, intelligently filter the numbers and transform them into strategic decisions.
Data-driven decision making
The first step comes from what we call “data-driven culture”.
This is the natural habit of ALWAYS making decisions based on collected data and not on a gut feeling.
It all starts by identifying the main KPIs (key performance indicators), which are our key performance indicators.
Do I need KPIs?
If you intend to make decisions based on data and not just intuition, yes.
Performance indicators make it possible to measure how much a strategy is generating the expected result or not.
It is important to mention that KPIs are always measurable and concrete.
My data is not conclusive, now what?
Analyzing data is something automatic in large companies, however, not always creating strategies and defining next steps is provided by a study on top of what has already been collected and digested.
The ABC costing method is useful for companies that already have this data-driven culture and are looking for optimizations through detailed data analysis.
The more knowledge you have about how much and where your resources are being spent, the more precise your improvements associated with cost management will be.
And that is what we at MyABCM offer.
The ABC method results in an advanced costing analysis based on each activity involved in producing some product, providing some service, or serving some customer or channel.
This is where pricing comes in.
One of the biggest challenges within a business can be made easier by applying the ABC method.
Keep in mind that failing to calculate your total costs can result in sub-optimal pricing, resulting in an unfavorable profit margin for the company.
With all the control of segmented expenses in the palm of your hand, pricing becomes clearer and effectively correct. The consequence of this is the real impact on negotiations with customers, discount policies and commissioning of salespeople, resulting in the end in greater profit for the company!
1. Reliable and accurate data throughout the value chain
The option of being able to precisely manage all the organization’s costs. This opens up the possibility of making more assertive decisions about where to act to reduce costs, invest, and even serve the best channels and customers from a profitability standpoint.
2. Associate overhead costs with the products, services, channels, and clients that actually consume it
Instead of associating the same cost to all products, services, customers, and channels, you can allocate the fair value consumed by each.
This also helps identify costs that apply to more than one segment, making this feature more valuable because it potentially eliminates distortions in cost calculations.
3. Evaluate production efficiency and apply improvements
The ABC method makes it possible to assign value to overhead costs by working the data as if it were direct costs. By breaking down overhead costs and assigning them by activity, we can look for breakthroughs with precision.
In the same way, we can make processes more efficient and correctly monitor the key KPIs for each activity in the organization.
4. Accurate data to obtain the desired profit margin
Having accurate data will directly impact a leader’s decision making. It opens up the possibility to reduce or shift production costs and apply effective pricing strategies to obtain an adequate profit margin.
5. Unique Benefits
Other methods cannot cover what the ABC costing method provides.
Directly related to the particularity of activity-based costing, it can measure expenses related to activities, however small they may be.
How do I know if I should use an ABC system?
All the questions below must be answered with a yes.
Do you have a diversity of Products and Services?
Diversity of Customers and Channels
Diversity of Processes?
Your overhead costs are high, and you have difficulty in allocating them correctly to products, services, customers, and channels?
Do you notice that your margin has been falling in recent years, often even though you have higher revenues?
Do you use data to make decisions?
Do you have pricing problems?
Then you are prepared.
To be clear, there are not only advantages.
But it is the solution to a number of complex problems for those seeking cost optimization through a robust system.
After you have finished reading this post, you certainly have the clear answers as to how ABC cost management can increase your profits.
Meet another one of MyABCM’s great customers in Latin America! Arca Continental is a company that operates in the production, distribution, and sale of beverages under the brands owned by The Coca-Cola Company, as well as the snacks brand Bokados in Mexico, Inalecsa in Ecuador and Wise and Deep River in the United States.
The corporation has more than 96 years of history and is part of the largest Coca-Cola bottlers in the world. With this, Arca Continental supplies the brand’s products to more than 125 million people in several Latin American countries.
The company’s challenges
In charge of manufacturing several brands and integrated with several other divisions, Arca Continental deals with a large and complex operation. Thus, the company needed a solution that could keep up with its production pace and aggregate information from multiple sources into a single platform.
The choice for the MyABCM solution was motivated by the system’s ability to handle a large volume of data and provide a detailed view of cost sources and profitability indexes for each brand in the company’s portfolio. Another determining factor was the smooth integration with ERP and other systems already in use at the organization, and the ability to perform multidimensional modeling and visualize how resources are actually consumed in day-to-day operations
Therefore, the investment in the system will support the decision-making process and create the basis for an assertive and profitable management.
Find out how MyABCM solutions can help your company too!
São Paulo — July 14, 2022 — Abcosting Produtos e Servicos LTDA, doing business as MyABCM, today announced that its MyABCM – Cost Management and Profitability solution is now available on SAP® Store, the online marketplace for SAP and partner offerings. Integrated with SAP HANA®, MyABCM delivers state-of-the-art technology to manage cost and profitability.
“As our customers mature in their deep experience of cost and profitability, the importance of integrating with SAP cannot be overstated,” said Andre Sanseverino, Global VP Sales and Marketing with MyABCM. “Together with MyABCM’s expertise and market leadership, businesses that use SAP technology will now have access to a complete modern package for cost and profitability modeling and analysis, providing customers with strategic decision-making tools.”
MyABCM has helped transform how companies experience cost and profitability management by providing powerful real-time tools that impact the day-to-day work of over 1,000 companies in more than 50 countries. Customers also have access to sophisticated decision-making tools, what-if simulations, and more. The solution is available on-premise or in the cloud in just a few clicks. Apply for a free trial on SAP Store.
The integrated solution enables customers to:
Understand the profitability of products and services
Increase profitability with powerful analysis tools
Improve cost drivers and assignments that include indirect expenses
Perform sophisticated what-if simulations and planning analysis
Provide a management solution integrated with SAP
SAP Store, found at store.sap.com, delivers a simplified and connected digital customer experience for finding, trying, buying, and renewing more than 2,000 solutions from SAP and its partners. There, customers can find the SAP solutions and SAP-validated solutions they need to grow their business. And for each purchase made through SAP Store, SAP will plant a tree. MyABCM is a partner in the SAP® PartnerEdge® program. The SAP PartnerEdge program provides the enablement tools, benefits, and support to facilitate building high-quality, disruptive applications focused on specific business needs – quickly and cost-effectively.
ABCosting Produtos e Servicos LTDA, doing business as MyABCM, is a global organization that offers solutions for controlling costs and optimizing profits. Our main mission is to help companies get a detailed and deep understanding of their costs and make better decisions based on reliable information. The company offers a full range of cost and profitability solutions ranging from prototypes and pilot installations to integrated, enterprise, and global-wide information systems. Visit www.myabcm.com for more information.
SAP and other SAP products and services mentioned herein as well as their respective logos are trademarks or registered trademarks of SAP SE in Germany and other countries. Please see https://www.sap.com/copyright for additional trademark information and notices. All other product and service names mentioned are the trademarks of their respective companies.
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Almost 30 years ago, more precisely in February 1997, the front page of Forbes Magazine featured an article by Prof. Srikumar S. Rao of Columbia University that showed that the lack of control over rising overhead costs could literally kill organizations.
In the article, Prof. Srikumar cited the real-life example of a giant American company that found a growth opportunity with the bankruptcy of its main rival – but, contrary to what he imagined, it turned into a loss-maker, not a profit maker! Upon investigating a little further, this company incredibly discovered that its “flagship” was actually loss-making, and other products that it thought were loss-making were actually the most profitable products of the organization. And this was due to a misallocation of overhead costs.
Allocate overhead costs
How could such a large and intelligent company make such a basic mistake? It turned out that the organization was allocating depreciation and other overhead costs based on the cost of direct labor; a product that consumed 20% labor ended up taking 20% depreciation and overhead as well. But there is a big mistake here: labor does not depreciate, machines do; where there is a lot of labor consumption, generally less machinery is required. Moral of the story: labor-intensive products should have received less depreciation and overhead (and not the other way around!) – exactly the opposite of what was calculated.
The direct costs are easy to appropriate; it is very easy to know how much we have, for instance, of a raw material in a product or for example of a Bank Cashier. But what about the indirect costs? How to allocate them in a correct and coherent way, respecting a cause and effect relationship?
Great caution is required with any cost modeling that mechanically allocates overhead costs. And remember: depreciation is just one of many indirect items! Overhead can include everything from toilet paper in the bathroom to IT, HR, and support area costs. The “lazy” solution is to allocate them proportionally to production volumes, transactions, or turnover.
To complicate matters, these indirect costs are becoming more and more representative and for several reasons: increased automation, with the clear “exchange of people for machines”, but also with the fact that the increased diversity of products, services, customers, channels, suppliers and machines (i.e. the increased complexity of the business) brings with it, embedded, an increase in indirect costs due to increased “administrative” effort or management of this complexity.
Historically these indirect costs only increase – and consequently raise the distortions caused by arbitrary allocations; it is very common to find in companies situations where a product that they imagine to be the “flagship” in reality are unprofitable; on the other hand products that they believe to be the “ugly duckling” are often the most profitable products of the company and those responsible for still being able to keep the company’s margins in the black.
How to solve the cost allocation problem?
Imagine that three friends decide to go out to dinner. The first one is on a diet and orders a salad with mineral water. The second friend orders a nice steak with wine and the third orders a lobster with sparkling wine and dessert. At the end of dinner, they ask for the bill, which is divided equally among the three friends. These distortions happen every day in many companies all over the world!
Now if you ask for a bill for each friend, where each of them will pay only for what they consumed, we are talking about ABC, the “activity-based costing” that potentially ends these distortions in organizations and gives a proper treatment to these indirect costs as well.
But how to apply ABC in practice?
Take a simple Billing activity: its total cost is the combination of salaries and benefits of the people involved with this activity. This total would traditionally have gone into an “overhead” pool to be allocated arbitrarily. However, with ABC you divide this value by a non-financial measure such as the number of invoices generated. Now you have cost per invoice. Count the number of invoices generated per product, multiply by this value and allocate by product – this is the value of the Billing activity in each of your Products. Besides eliminating distortions, we get an important KPI or performance indicator here for business management that is the value of invoicing per invoice issued – with potential for cost reduction studies, outsourcing possibilities, and even monthly tracking – something that simply would not have been possible before ABC.
Another example: HR activity “Hire Employees”: the cost of this activity is related to the effort of the HR area specifically with the hiring of employees (among so many others like Payroll, Evaluate Employees, Train Employees, and so on). Suppose that in a certain period 5 people were hired for Production, 2 for Maintenance and 3 for Sales; therefore, the costs of this activity “Hire Employees” should be distributed 50% to Production (which will later be allocated to Products, also by activities), 20% to Maintenance and 30% to Sales. Besides being able to allocate the costs of this activity, we gain an extremely important KPI for decision making, which is the cost of hiring employees – this value can be compared with the monthly expenses of the last months, the company’s goal or even the cost of outsourcing this activity.
Now imagine all this potential with all the activities in your company. The possibilities are absolutely endless!
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