abm project

8/13/2019 Abm Project

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The activity -based Management can be useful also in SME

Cojocaru Cornelia Alexandra

Mihalcea Margareta

Abstract

This study examines the activity based Management method (ABM) , a procedure that originated in the 1980s for

analyzing the processes of a business to identify strengths and weaknesses. Specifically, activity-based Management

seeks out areas where a business is losing money so that those activities can be eliminated or improved to increase

profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead and other factors in

a business to determine and allocate activity costs. In this study we will analyze the steps which can be followed in

order to implement it.

Key words : activity-based Management; overhead; activity; value-added or non-value-added;

costs.

I. Introduction

In any organization, customers represent the force.

In order to create and improve the processes to

increase customer and shareholder value is the primary goal of managers in these new

organizations. To reach this goal, they need

relevant, defensible and transparent information.

So we can say that Activity-Based Management is

a mean of providing useful information for

Management decision-making and organizational

advancement.

Steel, there are many techniques and

methodologies used to measure and adjust

organizational performance, such as: total quality

Management, just in time, business process

reengineering, balanced scorecard, business

excellence model and shareholder value added,

according to Plowman (2001; XVI).

The Activity-Based Management if is correctly

applied, places the organization which uses it, in a

more favorable position to achieve its objectivesand goals and, it assures improved outputs, higher

quality, improved cycle time, improved service

and profitability. ABM identifies the key activities

performed in an organization, providing a

defensible and transparent measure of their

associated costs and causes. ABM uses value

analysis, cost driver assessment, and performance

measurement in order to initiate, drive, and

support improvement efforts and to enhance

decision making. Focused on shaping the future,

not explaining the past, ABM incorporates

opportunity cost analysis into the standard set of


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estimating tools used by the finance professional.

Lately the number of companies and organizations

which have embraced Activity-Based

Management has grown significantly.

Nevertheless, companies use this method with

different results, suggesting the successful

application of ABM requires the mastery of new

management tools and techniques as well as a

management mind shift. Analysis, not control,

must become the focus of managers using

financial and non financial information in a

process-driven, customer- centered organization.Defining, measuring, and improving the ability of

an organization to create value has to become the

stimulus shaping management information

systems, as well as the actions and decisions they

support. Achieving this goal lies at the heart of

ABM.

The remainder of this paper is organized in five

sections. The following section reviews related

literature and develops our hypotheses. This is

follow by a section that discuss the research

method and presents results.Finally, a summary

of our results and limitations to our study are

discussed.

II. Literature review and hypotheses

There has been extensive literature proposing the

importance of ABM, and according to Miller

(1996:1), the purpose of Management information

system to provide information about work

processes and activities of an organization has

falling behind the needs of its managers. The

author states further that Activity-Based

Management fills this information need by

providing activity, cost and operating information.

In addition to accurate information about activities

and related costs, ABM also provides useful

information about value analysis, cost drivers and

performance measures to initiate, drive and

support effective management decision-making

and organizational improvement.

The authors, Kaplan and Cooper (1998), organizeABM into operational and strategic: so the

operational ABM is about doing things right,

using ABC information to improve efficiency.

Meaning those activities which add value to the

product and that can be identified will be

improved. And, on the other hand, activities that

do not bring value are the ones that need to be

reduced to cut costs without reducing product

value.

Further, we observe that strategic ABM is about

doing the right things, using ABC information

to decide which products to develop and which

activities to use. This can also be used for

customer profitability analysis, identifying which

customers are the most profitable and focusing on

them more.

But, in spite of all the benefits brought by this

method, a risk with ABM can be that some

activities have an implicit value, not necessarily


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reflected in a financial value added to any product.

For instance a particularly pleasant workplace can

help attract and retain the best staff, but may not

be identified as adding value in operational ABM.

A customer that represents a loss based on

committed activities, but that opens up leads in a

new market, may be identified as a low value

customer by a strategic ABM process.

Managers should interpret these values and use

ABM as a common, yet neutral, ground this

provides the basis for negotiation (Kennedy, T.,

& Bull, R. (2000). The great debate. ManagementAccounting,78). ABM can give middle managers

an understanding of costs to other teams to help

them make decisions that benefit the whole

organization, not just their activities' bottom line.

In the next section, the details of the analysis of

activities are discussed. The analyses of activities

involve: (i) Identification of value-added and non-

value-added activities;

(ii) Analysis of critical activities; and (iii)

Comparison of the performance of those activities

with that of benchmarked.

III. Identify value-added and non-value-

added activities

From the moment the activities are specified and

the cost of each activity is calculated, the next step

is to identify value-added and non-value-added

activities. A non-value-added activity is often

defined as an activity that can be eliminated with

no deterioration of product attributes (e.g.

performance, functionality, quality, perceived

value) (Miller 1992).

Making non-value-added cost visible is one of the

major benefits of ABM, but also the most difficult

to achieve (David and Robert 1995). Of course

defining these topics in contrast can be very

difficult. The definition value-added and non

value-added activity can be often confused and

misunderstood.

To be more specific there are few examples ofnon-value-added activities in an organization.

Equipment setup is a non-value-added

activity (as the machine is not producing

anything while being setup).

The logistics in the organization is another

non-value-added activity (moving a

product does not make it more valuable). Inspection is a non-value-added activity.

Making the same work again can be one of the

non-value-added activities that can be found in

any industry. Nevertheless, this activity is a value-

added activity for an operator who performs

rework on a job because he/she increases the value

of a product by rework. Therefore, all aspects of

an organization should be considered while

identifying value added and non-value-added

activities.


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An alysis of cr iti cal activi ties

Generally speaking, in a small company, the

number of activities may range from 10 to 200. It

is not possible to analyze all of them at once due

to limited time and resources. The key is then to

focus on the most critical activities that will add

value to customers or help the effective operation

of the business. Moreover, these are the activities

that provide the significant opportunities for

improvement.

IV. Activity-based management at PaideiaImage - a case study

Paideia Image (PI) is a small company with 0.5

million euro annual turnover. It employs about 20

people and is located in India. The main products

of PI are four types of machines (viz. sander,

splitter, shaper and foliar) for the picture framing

industry.

The foliar and sander machines are produced in

different numbers of heads varying from 1 to 6.

They produce machines in standard specifications

and according to customers requirements. The

company manufactures only 22% of parts of the

machine in-house and purchases 78% of parts

from subcontractors and suppliers.

The assembly of all these parts is the main activity

of the company. The company works in a

traditional way and all activities are performed

manually.

Information provided by an ABC system is used to

find the opportunities of improvement in

organization at the activity level. The analysis of

activities involves classification of activities into

value added and non-value added, and then

compare these with that of the world class

company or the best practices. Benchmarking with

the best practice offers avenues for improvement

in value-added activities. This also explains how

Management can use the cost drivers as the

performance measures and control the volume of

cost drivers. The ideal cost object is `products that are sold to customers. The cost of all activities

is calculated in a similar way to that of parts. The

total cost of a four-head foiler is shown in table 1.

Marketing. The annual cost of marketing

is 23 330 which is divided equally

between four types of machines. Then, this

amount is divided by eight because theannual sale of a four-head foiler is eight

machines. Therefore, the marketing cost

for this product is 729.06.

Inventory carrying cost. The cost driver

for inventory carrying is the stock value.

The total stock value in PI is 20 000. For

a four-head foiler, the stock value is

1600. Hence, the inventory carrying cost

for this machine is 491.20.

Engineering support. The cost driver for

this activity is the time spent by the

engineering support staff s for a particular


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product. For this machine, a total of 80 h is

spent by the engineering staff and hence

the cost of engineering support activity is

1480.

Assembly. The assembly of the machine is

performed manually. The cost driver for

assembly activity is the labor hours and the

volume of the cost driver is 82 h. This

leads to the total assembly cost as

886.42.

Table 1 The cost of a four-head foiler

Activity Cost driver Cost driver rate Cost driver

volume

Cost

Assembly Labor hours 10.81 82 h 886.42

Material

handling No. of movements 0.2 1020 movements 204

Inspection No. of inspection 0.41 450 inspection 184.5

Purchasing No. of orders 20.65 16 orders 330.4

Marketing No. of product 729.06 1 729.06

Inventory Stock value 0.307 1600 491.2

Engineering

support

Staff hours 18.5 80 h 1480

Personnel Labor hours 0.64 470 h 300.8

Misc. overhead Labor hours 1.6 520 h 832

Manufactured

parts

1306.88

Direct material 9773.0

Total cost 16518.3

An alysis of activiti esABC provides detailed information about the

company and its activities. This detailed

information can be used by the Management to

initiate improvements and decision- making. The

percentage cost of all activities is shown in Figure

2. This shows that engineering support activitiescarry 22.21% of the total cost of all activities.

Once the cost of each activity is calculated, the

next step is to identify the value-added and non-

value-added activities. According to the definition

of a non-value added activity (an activity that can


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be eliminated with no deterioration of product

attributes), all activities are non-value added

except activities, e.g. assembly, machining and

engineering support. Activities, e.g. marketing,

personnel and purchasing do not add value to the

product, but these are necessary and cannot beeliminated.

Figure 2 The percentage of cost activities from (Assembly

to the last Direct material)

Therefore, there are three non-value-added

activities, viz. inspection, material handling and

inventory.

If we compute the percentage of value-added and

non value-added activities, it indicates that non-

value-added activities are 16.18% of the total cost

of activities. These activities can be eliminatedwithout deterioration of product attributes, e.g.

quality, performance and function.

By using different quality assurance methods, e.g.

TQM, ISO9000 and dynamic process control,

quality can be maintained during production and

hence there is no need for an inspection. Similarly,

material handling and inventory-related activities

can be eliminated using different methodologies

and techniques, e.g. JIT. It may not be possible to

eliminate or reduce all non value- adding activities

at the same time. The key is then to focus on the

critical activities which form a major portion ofthe total cost. The inventory carrying cost is

55.81% of the total cost of non value-added

activities. Therefore, activities related to carrying

inventory should be eliminated first.

The cost driver for inventory carrying activity is

the value of stock. The company should not

maintain any stock in order to eliminate related

activities. This could be possible by the

introduction of just-in-time purchasing. At the

same time, the cost of purchasing should be

closely monitored. The purchasing department

will place more purchasing orders to maintain the

minimum stock level. If the company eliminates

inventory-related activities and increases the cost

of purchasing activity, then there are no benefits ineliminating non-value-added activities.

Similarly, the cost of maintaining quality in

processes should be considered in eliminating the

inspection activity.

Material handling activities cannot be eliminated

at the cost that is difficult to justify. Sometime,

non-value added activities can be clearly

identified, but difficult to eliminate completely.

However, it is always possible to reduce the cost

of these activities.

Performance measur ements

In ABM, performance of PI should be measured at

an activity level, and performance measures

1

2

3

4

5


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include both financial and non-financial measures.

The cost drivers are performance measures for all

activities. The volume of the cost driver indicates

the performance level of each activity.

For example, the cost driver for an assembly

activity is labor hours. If labor hours required to perform the assembly activity increases, then this

indicates that the performance of the assembly

activity is poor. If labor hours decrease, then the

performance of the assembly activity improves

which in turn leads to a reduction in the cost of the

product and hence an increase in the profit level.

Similarly, appropriate cost drivers are

performance measures for all identified activities

in the company.

From the analysis of activities, the value-added

and non-value-added activities are clearly

identified. In PI, the inventory carrying activity is

the major non value- added activity which should

be eliminated.

However, it is difficult because the purchasingcost of the present system will increase as the

company places more purchased orders with the

objective to reduce inventories. Therefore, it

indicates that the purchasing activity should also

improve. The comparison of this purchasing

activity with the best practice indicates the scope

for improvements. ABM uses ABC information to

motivate the people in improving and monitoring

the performance of their activities.

V. Conclusions

Management practices and methods have been

changed over the last decade, and organizations

are moving from managing vertically to manage

horizontally.

Activity-based costing and activity-based

Management provide cost and operating

information that mirror the horizontal view. ABC

provides accurate cost information and ABM uses

this information to initiate improvements. ABC

systems produce a large amount of information

that is used by the ABM. The costing at part level

or subassembly level helps the Management in amake or buy decision.

In this paper, an attempt has been made to study

the application of ABM in a small company.

Firstly, a conceptual model is developed to

describe the major components of ABM.

Secondly, a case study is presented to discuss the

application of the model in a real-life small

company. The benefits of ABC and ABM can

only be achieved if it is applied for the whole

organization.

Therefore, PI should use activity-based analysis to

identify non-value-added activities (e.g. inventory

carrying, material handling and inspection), and

then try to eliminate these activities by using the

number of available Management methods andtechniques. Also, there are possibilities to improve

value-added activities. The cost driver of activities

should be used to measure the performance of

activities.


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REFERENCES

1. Armstrong, P. 2002 . The costs of activity-based management . Accounting,Organizations and Society 27 (2002) 99 120.

2. Anderson, S. W. 1995. A framework for assessing cost Management system changes:

the case of activity based costing implementation at general motors , 1986 - 1993.

Journal of Management Accounting Research (Fall): 1-51.

3. Argyris,C., and R. S. Kaplan. 1994. Implementing new knowledge: The case of activity

-based costing , Accounting Horizons (September): 83-105.

4. Gupta, M. and Galloway, K. A ctivity-based costing/management and its implications for

operations management , Technovation 23 (2003) 131 138.

5. Wegmann, G. 2011. Activity-based Management in France: A focus on the information

systems department of a bank, International Conference on Economics, Business and

Marketing Management, March 11-13, Shanghai, China, 2011.
http://scholar.google.ro/citations?user=Ti8HwyYAAAAJ&hl=en&oi=srahttp://www.sciencedirect.com/science/article/pii/S0361368299000318http://www.sciencedirect.com/science/article/pii/S0361368299000318http://www.sciencedirect.com/science/article/pii/S0361368299000318http://www.sciencedirect.com/science/article/pii/S0361368299000318http://scholar.google.ro/citations?user=Ti8HwyYAAAAJ&hl=en&oi=sra

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