Activities Based Management is used to describe the cost management applications of Activities Based Costing. Activities Based Management views the business as linked activities that ultimately add value to the customers.
It focuses on managing the business based on managing the organization’s activities and assumes that such activities consume costs. Therefore by managing activities, costs will be managed in the long term.
Simple, Activities Based Management builds the principle of activities-based costing and activities-based budgeting to improve the profitability of an organization.
It does this by identifying which activities can be performed more efficiently, which activities can be eliminated, how changing the design of a product can lower costs and improve relationships with customers and suppliers.
Traditional budget and control report analyses cost by type of expense at each cost center. In contrast, activities-based management analyses cost by activities and provide management with information on why the cost is incurred and the cost drivers.
Activities Based Management focuses on managing the business on the activities that make up the organization. It is based on the premise that activities consume cost. Therefore, by managing the activities, the cost will be managed in the long term.
The goal of Activities Based Managements is to enable customers to need to be satisfied while making less demand for organization resources.
Before introducing ABM, most organizations have been unaware of the cost of undertaking the activities with the highest cost to be highlighted so that they can be prioritized to detail study whether they can be eliminated or perform more efficiently.
Value-added and Non-value added:
To identify and prioritize the potential for cost reduction using ABM, many organizations found it is useful to classify activities as either value-added or non-value added. By doing so, the organization knows clearly what activities should improve should to eliminate.
Value-added activity is an activity that customers perceive as adding users to the product or service they purchase. A non-value-added activity where there is an opportunity for cost reduction without reducing the product’s service potential to the customer.
Taking action to reduce or eliminate non-value-added activities is given top priority because by doing so, the organization permanently reduces the cost it incurs without reducing the value of the product to customers. However, management should be making sure that the eliminations are not affecting other value-added activities.
To implement an Activities Based Management system, the following stages.
Here are three steps to implement Activities Based Management:
Step 1: Identify the major activities in an organization
In this step, we simply study the activities that happen in the organization or in the specific production process.
First, you probably pick up all the activities and then categorize them into different categories. Remember, at this stage, we select only the important activities in the organization.
Therefore, once we categories the activities, we then select only the important activities for study. For example, the major activities in the organization include:
- Purchase order
- Material handling
- Quality Inspection
- Assembly, and
Maybe there are many other important activities in the organization that is not included here. But, here are all the activities.
So, once we identify the major activities, we then need to assign the costs to those activities. Late see next step,
Step 2: Assigning cost to cost pools/ cost centers for each activity
Now it is time to assign the cost to those activities that we identified above. This is an important stage of activity-based management and probably the most difficult in a real situation.
The cost of those activities is not realistic, or we cannot obtain enough data to assign the cost for those activities as most of the system or accounting records are not classified.
In general, the accounting records are based on the types of staff or material rather than activities. To implement this, we do need a system that could accomplish such kinds of reports. For example, how much is the cost for assembly, and how much does the installation cost?
Now assume you have all of those reports and data.
Let move to the next step,
Step 3: Determining the cost driver for each activity
In this step, you need to find out the cost drivers of each of the activities you find in step 2. For example, Quality Inspect, probably the number of inspections or hours spend for inspection.
This is very important, and you need to figure out this. So once you figure out the cost drivers, you then need to accomplish the number of those drivers spend on each product.
Then you will know which product you spend a high cost and which product you spend a low cost. By knowing this, you could manage the activities by making sure that those activities run more efficiently.
I hope this Activities Based Management help.