DECEMBER 2007 BEACON
Do You Know Your A, B, C's?
Own more than one company? Your financial future may depend on how well you know your A-B-Cs!
If you have a custom installation business that spun off from your retail operation...or you added a distribution company to your sales representative firm...then you need to know all about A, B, C - or rather - Activity Based Costing.
According to Wikipedia, activity based costing is defined as:
...a method of assigning the organization's resource costs through activities to the products and services provided to its customers. It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominately been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.
In pragmatic terms, you use ABC to determine your product and company profitablity based on a full accounting of the total actual cost of delivering that product or service to your customer. It sounds difficult and tricky but it really isn't.
Let's say, for example, that you own a sales representative company and a distribution company. In the past, you may have blended your companies financials together. This is quite common as in many cases one company grew from the other to begin with. Not only that, but you most likely have significant shared resources between the two companies including manpower, facilities, and capital.
Up until now, you have been happy with your total sales and profits...even if you haven't necessarily known precisely how they were generated by your blended operations. However, now you are considering selling one of the companies. Which would be the best one to sell? The only way to truly determine your best option is to use ABC to "split" your financials and determine which company has the greater profitability.
In our overly simplified example, you would take each shared resource and determine the percentage of utilization for each company. Take for example your time...let's say you spend 70% of your time running the rep firm and 30% of your time running the distribution company. If your salary was...say for the sake of simplicity in this example...$100,000 per year, you would "charge" the finanacials of the rep firm $70,000 and charge the financials of your distribution company $30,000.
You then do the same for all of your other cost items and resources. As you look at each item in your financials and assign them to their respective companies you may see a picture emerge that was quite different than what you saw in the past. You may discover for example, that one company was only marginally profitable...or even losing money. You didn't know this because the profits from your other company hid the loss.
In any event, you are now well on your way to sorting out the reality of your business and can make more informed decisions about taking corrective courses of action. So when you want to know how you're really doing...check your ABCs!