Activity-based management

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Activity-based management
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Activity-based Management is the process of using activities to improve process efficiency. Activity-based Management therefore provides managers with goals and targets in areas such as:

  • eliminating or reducing non-value added activities,
  • increasing throughput and
  • process efficiency.

These goals and objectives are important aspects of management performance. Activity-based Management goals and objectives measure the quality of management decisions (embedded in some ABM activities) to achieve desired results. Activity-based Management's goals and targets are not limited to production managers. Nearly every strategic business unit manager in the organization contributes to Activity-based Management's goals. Activity-based Management is seen as an extension of Activity-based Costing[1]. Although ABC is a relatively new innovation in cost accounting, it is being rapidly adopted by other organizations such as corporations, government agencies, institutions, finance, and service sectors across many industries[2].

Traditional Cost Management

Financial accounting information continues to be the primary source of management information in many organizations. However, as Johnson and Kaplan[3] have pointed out, current management accounting information is too slow, too aggregated, and too biased to be relevant to managers' planning and management decisions. This is because Tradtional Cost Management systems focus on cost control through cost-based budgets, standards, and deviations established at the departmental or unit level. In such systems, many volume-sensitive cost factors are added to overheads to ensure proper matching between income and expenses.

This approach tends to overestimate or underestimate the cost of products/services due to misleading measurements that lead to erroneous judgments. Modern organizations must focus not only on performance measurements of quality attributes such as customer satisfaction, reliability, cycle time, flexibility and productivity, but also on process and activity costs.

A key success factor for any organization is ongoing involvement in the management of all activities to ensure that quality services are delivered in the most efficient and effective manner. This means that it is useless to apply generally accepted accounting principles when planning, managing, controlling and directing activities[4].

Activity-based Costing

A growing body of literature claims that Activity-based Costing offers significant advantages to organizations compared to Traditional Cost Management. Although adoption has been slow, Activity-based Costing is now accepted as part of the accounting and control systems of industrial and service companies. Essentially, Activity-based Costing provides managers with more accurate product/service costs, clearer insight into cost causes and cost drivers, and more relevant information for strategic decision-making. In other words, Activity-based Costing focuses on activities invisible to traditional accounting. With this information, managers can make better decisions about[5]:

  • what's going on at the company,
  • who is doing what at the company and
  • how much does an activity cost?.

Activity-based Management, on the other hand, refers to using Activity-based Costing information to understand and make beneficial changes to how institutions do business in an environment of limited resources and growing demand. It is a strategic tool that enables managers to use a common language for benchmarking, view the activity in process view and choose a course of action based on Activity-based Costing information.

Additionally, other management initiatives such as Balance Scorecard and Performance Management leverage the knowledge produced by Activity-based Costing[6].

Implementation Strategy

To implement Activity-based Costing/Activity-based Management, it is implemented in 6 steps.

  • 1. Defining the Purpose and Requirements of the Costing System

Before the actual implementation of ABC/ABM, company management should determine the primary goals for using the costing system. Common goals of costing systems include measuring profitability and controlling costs. Regardless of the primary goal, ABC's underlying goal is to reduce overhead. Examples of overhead costs include administrative salaries, hardware and software maintenance, and employee training. Depending on the goal, the administrator should also select the accuracy level of the cost system. Accurate cost systems may require more sophisticated computer and network infrastructure, resulting in higher costs. In step 1, the manager also has to decide which cost objects the analysis will examine. For example, a company interested in evaluating customer profitability can choose customer as the unit of cost. On the other hand, a company interested in managing costs primarily related to sales may choose to use products or product lines as cost objects. The goals and requirements of the ABC system should align with the overall business strategy of the specific company.

  • 2. Identify the business activities

Next, you should identify the activities (that contribute to overhead costs) and describe them, preferably in "active" phrases [7]. Examples of activities are maintaining a website, processing customer orders, processing inventory, and shipping products. Furthermore, a company can classify its activities as either direct value-adding activities or supporting activities. Direct value-added activities are directly related to manufacturing products, completing orders, or other activities on behalf of our customers. Activities that support these direct value-adding activities are defined as supporting activities that: B. Execution of personnel affairs. This initial categorization of activities helps prioritize the manager's attention when performing her ABM later.

  • 3. Track overhead to activities using the Expense-Activity Dependency Matrix (EAD)

In this step, you track overhead from expenses to activities. The Expense-Activity-Dependence (EAD) matrix relates activities to expenses and helps determine overhead consumption [8][9].

  • 4. Track overhead to Cost Objects using the Activity Product Dependency Matrix (APD)

Next, track overhead from Activities to Cost Objects. The Activity Product Dependency Matrix (APD) is used to properly assign Activities to Cost Objects [10][11]. APD matrices are also used to track overhead consumption for specific cost objects.

  • 5. Calculate Product Costs for Each Cost Object

Estimates of the costs associated with producing a Cost Object (also called product costs) are calculated by adding together direct and indirect costs.

  • 6. Use ABC Analysis for Operational and Strategic Decision Making

After performing the ABC analysis (Steps 2-5), you can perform ABM using the information obtained. In the context of ABM, managers must correctly interpret the results of ABC analysis and take action to improve operational and strategic performance.

Footnotes

  1. Kren, L. (2018), p. 61
  2. Kumar, N., Mahto, D. (2013)
  3. Johnson, H.T., Kaplan, R.S. (1987), p. 1
  4. Ismail, N. A. (2010), pp. 41-42
  5. Mahoney, R.J. (1997)
  6. Ismail, N. A. (2010), p. 42
  7. Johnson, H. T. (1991)
  8. Roztocki, N. (2001)
  9. Roztocki et al(1999)
  10. Roztocki, N. (2001)
  11. Roztocki et al (1999)

References

Author: Sven Korten