Learning the ABCs of Cost Analysis

Bradley S. Litt

Until recently, corporate accounting was the last place an operational manager would look for help in accessing the health of a business process. Over the past decade, as the complexity, variety and diversity of business has escalated, the cross-functional behavior of business processes and the shifting patterns of cost have left traditional approaches to process and cost/benefit analysis distorted and grossly inadequate. In addition, traditional accounting systems generally exist to satisfy external reporting requirements, not internal project metrics, and usually fall short in helping project managers detect process-related problems or potential solutions. 

ADVERTISEMENT

Trending Articles

The Cost of Time

by Andy Jordan

For career-minded project managers, balancing progression with experience is critical…but how do you do that? Is it better to build a track record of success even if that delays career progression, or is it better to look to move up when an opportunity presents itself--even if that means leaving things undone?

Topic Teasers Vol. 63: New Manager No-Nos

by Barbee Davis, MA, PHR, PMP, PMI-ACP

Question: I have recently been assigned to manage a group of project managers. Unfortunately, I have no background or experience in project management, let alone the training and certifications they hold. In addition, I really have little experience in business at all…just a tangential college degree. What can you tell me about managing PMs that will help me survive in this new position?
A. Immediately get a book on project management and read up on this profession. A general overview will allow you to see that all projects are so similar that implementing your own new procedures can be equally beneficial for all the projects in progress when your start date occurs.
B. You are in a perfect position to manage project managers because you will have a fresh outlook and not be influenced or limited by what has been happening before you came. Make as many changes as you can in the first few months before you are dragged down into how things have been done in the past.
C. This is a more common situation than you might think. The best thing to do is familiarize yourself with the most common new manager mistakes and at least avoid making these. Lay low until you can figure out what is going on.
D. You should never have been hired. There is no way that a person who is not a project manager can successfully supervise those who are. Contact your boss and ask if you can be moved to a department that has people with more generic skill sets. You can be successful there.
Pick your answer then Test Your Knowledge!

As businesses have become more complex, the elements of cost/benefit have shifted and become mixed. Overhead costs are replacing the direct costs of labor and purchased materials. These overhead costs increasingly comprise technology and the specialists who are needed to sustain the gains in productivity and manage the complexity of production. As managers attempt to understand and manage cross-functional business processes, organizations are finding that traditional approaches for managing these costs are ineffective. So how do you get decent cost analysis?

Activity based costing (ABC) is an accounting technique that utilizes cost attachment rather than cost allocation to determine the actual cost of products and services. While not a new concept, ABC is quietly changing the way organizations view and manage their business. Although ABC is only data, it has the ability to clearly define the critical attributes of today’s business processes. Through data, ABC is able to act as an enterprise-wide change agent, enabling organizations to build awareness, make better decisions and effectively support enterprise-wide improvement initiatives.   

The real beauty of an ABC model is that it forces organizations to adopt a cost management paradigm that focuses on understanding their processes.  Once an organization accepts this paradigm, they soon recognize that their products or services are produced through cross-functional business processes and not functional silos.  These processes contain a wide variety of activities that not only define the process, but more importantly, reflect how effectively the process performs. It is these activities that actually consume organizational resources (cost).  They are the central focus and foundation of ABC.  

Without an effective focus on activities, ABC would be just another cost accounting system.  Focusing on activities rather than departments or functions makes it possible for ABC to provide the information necessary to not only effectively manage business processes but also to improve them.  Ensuring a smooth running business process is critical in maximizing the perceived and actual value your customers receive.   As a result, it's not uncommon for organizations beginning an ABC implementation to simultaneously be involved with improvement initiatives centered on defining and measuring core business processes and related activities.

Another way ABC adds value is that it avoids two significant problems associated with traditional cost allocation methods: 1) misallocation of cost and 2) the masking of the true drivers of cost. Within an ABC implementation, business processes are mapped to ensure that the appropriate boundaries for each process are defined.  Through this mapping process, activities and associated drivers are identified and their relationships tested. This verification process ensures a concise attachment and not an allocation of cost to processes and products.

While ABC can be complex and confusing, organizations can reduce the complexity by building a strong process orientation through the definition and mapping of core business processes prior to introducing ABC.  Studies have found that companies with a strong cross-functional process orientation tend to experience fewer false starts and less anxiety with their ABC implementation.  Not only are the implementations more successful, but the organization as a whole is better prepared to understand the basic structure of ABC.

From a strategic perspective, ABC’s value lies in its ability to correct product-cost distortions. Once product-cost distortions are corrected, organizations can better understand which products are actually profitable and adjust pricing and product lines accordingly to maximize profitability.

From an operational perspective, ABC’s value can be found in its ability to link up-to-date financial metrics of resource-cost consumption to improvement processes.  Managers who understand ABC realize that accurate, relevant cost data enables them to identify and achieve innovation and continuous improvement.

The strength of ABC is its ability to measure and organize data at an extremely fundamental level where the resource consuming activities are actually performed.   ABC also makes it easier to understand variable cost behavior and cost-of-quality for activities and processes.  Finally, ABC can provide project managers with accurate cross-functional cost data ensuring reliable cost related decisions and consistent monitoring throughout their projects. 


Related Content

Comments (1)

Please login or join to subscribe to this item
Network:0
Wow...long winded and useless. This guy really likes himself.

ADVERTISEMENTS

"There is a theory which states that if ever anybody discovers exactly what the Universe is for and why it is here, it will instantly disappear and be replaced by something even more bizarre and inexplicable. There is another theory which states that this has already happened."

- Douglas Adams

ADVERTISEMENT

Sponsors