Definition
Activity Based Management (ABM) is a method of financial management which focuses on managing activities in order to improve customer value and profit. It involves identifying, documenting, and improving the processes that lead to the production of a product or service. ABM pairs activity-based costing, which assigns costs to those processes, with performance measures to evaluate efficiency and effectiveness.
Key Takeaways
- Activity-Based Management (ABM) is a method of identifying and evaluating activities that a business performs, using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organization.
- ABM can be applied to all types of organizations where it provides information to managers who make strategic decisions about product mix, pricing, suppliers’ management, customer profitability analysis, and the implementation of process improvements.
- The primary benefit of ABM is its capacity to reveal the true costs linked to specific activities in the organizational process thus providing valuable information to help management cut costs, improve efficiency, and make more informed decisions.
Importance
Activity Based Management (ABM) is crucial in finance as it enables organizations to make informed business decisions by identifying, describing, assigning costs to, and reporting on agency operations.
It allows companies to understand how and where they are incurring costs, and how these costs relate to the services or goods they are providing.
ABM provides detailed insights into the cost drivers and cost behavior, enhancing profitability by reducing costs, improving efficiency, and promoting strategic decision-making based on accurate and relevant information.
Hence, its importance lies in its role in promoting cost-effective operations and improving overall business performance.
Explanation
Activity Based Management (ABM) is a method of management control that is primarily employed to reduce costs while improving the business operations and processes. These strategic objectives are achieved by focusing on the activities that are key to the organization’s goals and evaluating their performance.
ABM helps companies to precisely identify inefficient processes and determine the root causes of inefficiencies in the operations that consume resources more than required. Once these are identified, the companies can find solutions to improve them, thereby decreasing costs and improving efficiency.
To do this, the organizations implement ABM to work in conjunction with the principles of Activity Based Costing (ABC). They track the cost of operations and use this data to pinpoint the areas of high cost and wastage. What makes ABM unique is the shift of focus from the mere reduction of costs to the improvement of business processes using planning, controlling, and decision-making operations methods.
By addressing the causes rather than the symptoms of high costs and inefficiencies, ABM enhances profitability and improves overall productivity.
Examples of Activity Based Management
Manufacturing Industry: Many manufacturing companies use Activity-Based Management (ABM) to identify high overhead costs within their production process. For example, a car manufacturing company might have separate activities such as designing, procuring materials, production, quality control, and delivery. The company uses ABM to track costs associated with each activity and identify any inefficiencies. They may realize that procurement costs are higher due to a faulty vendor, and they can then explore other vendor options or negotiate better deals to manage this cost.
Health Care Industry: Hospitals can use Activity-Based Management to track the costs associated with specific procedures or services, like surgeries, check-ups, or lab tests, identifying where resources are being excessively used. For instance, by using ABM, a hospital might notice that specific tests are taking longer and using more resources than necessary. To reduce costs, they could then optimize and streamline these processes, potentially by upgrading or replacing outdated equipment.
Retail Industry: A large retail store chain might use ABM to track costs associated with each department, like electronics, clothing, and customer service. In doing so, they might identify that the customer service department is incurring high costs due to a large volume of product returns. With this information, the company can implement new strategies within the other departments to reduce the number of defective products they sell, hence reducing the returns, and subsequently, the costs associated with customer service.
FAQs on Activity Based Management
What is Activity Based Management?
Activity Based Management (ABM) is a managerial accounting technique that aims to identify and eliminate non-value-adding activities to improve efficiency. This management approach focuses on reducing costs and improving the services or goods produced by a company.
Why is Activity Based Management Important?
Activity Based Management helps in cost reduction, process improvement, and product pricing. It provides a more accurate breakdown of direct and indirect costs by associating costs with their true cause. This approach aids in understanding the profitability of specific products or services, identifying cost drivers, and making informed business decisions.
Who uses Activity Based Management?
Generally, businesses of all sizes and types use Activity Based Management. It is greatly valued by organizations with complex products or services, high indirect costs, or diversity among its customer base. Both manufacturing and non-manufacturing firms benefit from understanding their cost structures and improving their processes through ABM.
How is Activity Based Management implemented?
Implementing Activity Based Management requires four sequential steps: Identifying business processes, assigning costs to activities, assigning costs to output, and identifying cost drivers. The focus is to understand activities associated with costs and manage those activities to reduce costs or improve performance.
What is the difference between Activity Based Costing and Activity Based Management?
While both Activity Based Costing (ABC) and Activity Based Management (ABM) focus on cost control and improvement, ABC is more about tracking costs associated with activities whereas ABM takes it a step further by using this cost information strategically to improve business operations and decision-making.
Related Entrepreneurship Terms
- Cost Driver
- Cost Object
- Direct Costing
- Indirect Costing
- Overhead Allocation
Sources for More Information
- Accounting Tools – An online resource providing comprehensive information on a broad range of accounting and finance topics, including activity-based management.
- Investopedia – A leading source of financial content on the web, offering a wealth of information on finance and investment topics, such as activity-based management.
- CGMA (Chartered Global Management Accountant) – A global management accounting designation offering dedicated resources, including content on activity-based management.
- CIMA (Chartered Institute of Management Accountants) – A UK-based professional body offering training and qualification in management accountancy and related subjects.
