159159
See also: Play by the rules 120–23 ■ Profit versus cash flow 152–53 ■ Good and bad strategy 184–85 ■ The value chain
216–17 ■ Product portfolio 250–55 ■ Benefitting from “big data” 316–17
MAKING MONEY WORK
should about their costs. They
may be relatively clear about
direct costs, but vague about
the overhead costs that should
be attributed to specific products.
The commercial consequence of
this is that a business may allocate
marketing spending to a product
that is not very profitable. In the
long run, a business that makes
wrong decisions like this will
struggle to keep up with its rivals.
Activity-based accounting
Ideally, an accounting system
measures every aspect of every
transaction and decision related to
a particular product or service. The
most effective way of achieving this
is through activity-based costing.
Whereas traditional accounting
systems estimate the overheads
(perhaps by assuming that every
unit produced at a factory should
have the same share of the total
overhead bill), activity-based costing
is much more precise: it breaks
down the overhead costs to find out
which activities create which costs.
This allows the company to realize
that the cost of making a chocolate
product, for example, is not “about
65 cents,” but exactly “59 cents.”
This level of accuracy tends
to be especially important when
considering nonstandard products,
such as the completion of a special
order of merchandise for the Brazil
Olympics in 2016. Activity-based
costing might show that the costs
associated with this special order
are higher than they would be for
standard products. This would help
the business to set the right prices
for the Olympic items.
To perform effective activity-
based costing, a company needs
to: first, identify all the direct and
indirect activities and resources;
second, determine the costs per
indirect activity; and third, identify
the “cost drivers” for each activity. A
cost driver is a factor that influences
or creates costs. For example, a
bank teller has many activities—
when measuring the cost driver
of an activity such as handling
incoming checks, the bank should
figure out how long the teller spends
on this task alone. From these threecalculations, a company can
calculate the total direct and
indirect costs for a product or
service. By dividing these costs
by the quantity produced, an
accurate unit cost can be obtained.
The company can then establish
reliable break-even points, identify
the products with the profit margins
that make them worth backing (with
advertising support, perhaps), and
allow clear comparisons for making
sound investment decisions. ■Frederick Winslow
TaylorBorn in 1856 in Philadelphia,
PA, F. W. Taylor trained as a
mechanical engineer. He later
became famous for his study
of “Scientific Management,”
which was based on the idea
that effective management is
a science with clearly defined
laws. Taylor was also known as
the “father” of cost accounting.
In the late 19th century, he
established new accounting
systems involving the “monthly
determination of unit costs.”
He highlighted the value of cost
data as information that managers
could use to set prices anddecide what to produce. His
belief was that if accounting
information is to be valuable,
it must be useful, timely,
and formed into comparable
statements, so that progress
(or decline) can be identified
quickly. F. W. Taylor died of
pneumonia in 1915 at 59.Key works1911 The Principles of Scientific
Management
1919 Two Papers on Scientific
Management: A Piece-rate
System and Notes on BeltingKeeping of costs with
a reasonable degree of
accuracy can be made a
matter of very great profit
to the company.
F. W. Taylor