ABC method

Definition

The ABC method is one of the cost management techniques used to efficiently manage inventory within a company. The ABC cost method aims to accurately allocate the company’s overhead costs to the individual cost items that generated them. The goal of the ABC method is to systematically describe all processes, activities, and tasks within the company and their interrelationships.

How to Apply the ABC Cost Method in Practice

First, customers are divided into three categories:

• Category A: 10% of customers generating 75% of your turnover
• Category B: 20% of customers generating 15% of your turnover
• Category C: 70% of customers generating 10% of your turnover

The ABC cost method is most effective in companies that already have a stable base of repeat customers. The more frequent the purchases, the more accurate the results of the ABC method.

Step 1 – Identifying Processes and Activities

Identify all processes and activities performed within the organization. These can include production, administration, distribution, customer service, or other activities that generate costs.

Step 2 – Determining Cost Drivers

Next, the company identifies the factors that generate costs for each activity, known as “cost drivers.” For example, in manufacturing, a cost driver could be the number of machine hours used for production.

Step 3 – Collecting Resource Consumption Data

After identifying cost drivers, collect data on resources consumed by each activity, such as wages, materials, energy, rent, and depreciation. Based on cost drivers and resource consumption data, the ABC method allocates overhead costs to each activity according to their cost intensity.

Step 4 – Calculating Unit Costs

Finally, the method calculates the unit costs of each product or service, taking into account not only direct costs but also allocated overhead costs.

By applying the ABC method, a company gains a clearer understanding of its actual costs associated with products and services.