Activity Based Costing (ABC)

Overview

Activity Based Costing (ABC) has been proven to be a significant improvement over traditional costing methods.  Activity time is the principal driver in allocating direct and indirect costs to specific products manufactured or services rendered.

 

Activity based costing has been used as a strategy to price products more accurately, manage costs, and therefore increase profit.  Its application has been used more in the manufacturing sector, however the principles of ABC can now be used in micro finance as well.

 

Why learn ABC costing from MFI Consulting?

The MFI Consulting application of ABC gives MFIs a more accurate way to look at costs and apply them to specific financial products.  ABC will result in information MFI management can use to make changes in credit and savings product pricing.  MFI management can implement pricing changes and be assured that product pricing is not arbitrary.  Tracking the ABC analysis will allow management to address areas of excess cost and optimize net income.

 

The Consulting Process

MFI Consulting will help your organization define products and activities to be tracked, as well as define the basis for allocating expenses among products.  Each employee will prepare a time sheet, noting the time spent on product specific activities or general activities.  These time sheets will be aggregated by MFI Consulting (off site) along with financial and transaction data into a customized financial model.

 

MFI Consulting will present the ABC model with initial conclusions.  Your organization’s management will be trained on the model logic and will be able to repeat the analysis with little or no follow-up from MFI Consulting.  For the process to be most meaningful, the time capture process should be updated twice during the year.

 

Experience:

The ABC exercise is currently in process for two Bolivian MFIs.  One MFI identified 20 different products and over 120 processes for analysis.  Models will be complete early in 2003.

 

Lessons Learned

Organizations implementing ABC costing have been able to identify their most profitable and least profitable product and make adjustments to their pricing structure accordingly.  One MFI learned the true cost of making the first loan to a new client was much more expensive than it realized.  It is now considering providing incentives to repeat borrowers such as discounted rates, preferred treatment, or special consideration in order to maintain the client relationship, after having made a significant investment in recruiting the client.