Every organization wants to improve its operations performance as this is inextricably linked to its bottom line. An effective costing model is a valuable tool, as managers can use it to view information from different angles and thereby determine which strategies will have the greatest effect on improving the organization’s results.
We enable them to do so by constructing the model in such a way as to create a cause-effect relationship between the components. Most organizations model the activities required to deliver products or services to their customers. Then, they make sure that the modeled activities enable their decision-makers to understand cost behaviour. They structure their activities so that their costs behave according to one of the following patterns:
|Unit-level activities||Occur every time a product is made or sold|
|Batch-level activities||Occur every time a batch of units is handled or produced|
|Time driven||Based on the time required|
|Product and service-level Activities||Occur because of specific product lines|
|Customer support activities||Occur because of clients|
|Facility support activities||Occur to support the entire process|
Constructing a model in this way shows both the costs of a given process as well as the cost of its component activities. We can also give attributes to each of the model components (resources, activities, cost objects, etc.).
For example, if each model component is characterized according to its potential for improvement (low, medium or high), results can be analyzed not only by activity or process but also by the potential for improvement. In other words, management could choose to improve a process in which most of the activities have a high potential for improvement.
This diagram illustrates the logic of a model based on cause-effect relationships and on cost behaviour. The orange squares represent model components, to which a number of attributes can be attached.
Using attributes to characterize model components enables managers to analyze costs in terms of the organization’s priorities. In addition to focusing on potential for improvement, they could also choose to characterize the components according to value (added value, no added value) or according to quality control (prevention and detection costs, costs of internal and external deviations).
These results help managers identify areas that would benefit from performance improvement projects, such as Lean Management or Process Re-engineering. The model also enables them to measure the effectiveness of improvement projects and check whether they have achieved their objectives. Attributes also enable managers to determine whether the cost of non-added-value activities has been reduced.
The costing model also provides support for different optimization programs. For example, users can construct models to facilitate internal or external benchmarking.