Managing Cash Flow

152 Cost Reduction Analysis Procedures
ACTIVITY BASED COSTING PRINCIPLES
ACTIVITY BASED COSTING IDENTIFIES
OPPORTUNITIES FOR IMPROVED RESULTS.
Activity based costing (ABC) is a cost accounting methodology for assigning costs
of resources to cost objects based on operational activities. In an operational cash
management study, such costing can then be used to make comparisons, identify
critical areas for review, and develop recommendations for cost reductions and
elimination so as to improve both profitability and cash flow. Using ABC methods,
it is the activities, not the products or services (as in traditional cost accounting
systems), that cause the costs. The ABC approach to cost accounting recognizes
the causal relationship between cost drivers, resources, and activities. ABC defines
a process, which could occur in the providing of a product or service or in production
or the office, in terms of the activities performed, and then develops costs
for these activities. ABC does not, contrary to traditional cost accounting techniques,
develop costs by organizational cost centers but in terms of the activities
performed. In addition, ABC assigns overhead based on the activities (cost drivers)
that cause the overhead to occur, rather than allocating overhead via some
arbitrary allocation base such as direct labor hours or dollars. As costs are developed,
each activity is appraised as to its necessity and its extent. As activities are
reduced or eliminated, their attendant costs are also reduced or eliminated driving
these cost savings directly to the bottom line and to positive cash flow.
Many organizations are struggling with better methods for product/service
costing and resultant pricing strategies, together with overall cost management,
performance measurement, return on investment, and so on. In this context, ABC
is only one of the tools for effective survival, competitiveness, and growth and
prosperity that challenge organizations today in an ever-changing business environment.
ABC methodologies, if implemented correctly, can be the central core
that provides the elements of an effective organization-wide cost and cash management
system that enables the company to identify opportunities for improvement
and make recommendations to enhance positive cash flow.
A summary of Activity Based Costing objectives is shown in Exhibit 5.8, a
summary of cost accounting decisions affecting positive cash flow is shown in
Exhibit 5.9, a list of cost reduction targets is shown in Exhibit 5.10, and a list of
areas for improving activities and cash flow is shown in Exhibit 5.11.
Organizational Concerns
ABC concepts have evolved greatly in a relatively short period of time. Originally
conceived as a methodology for product cost improvement and accuracy, ABC is