Construction is an expensive business. Materials keep going up in price, as do many other expenses. As a contractor, you want to use all of your resources as efficiently as possible. When construction jobs run into delays or customers request changes, you want to make sure nothing gets wasted or goes unused. Traditional accounting methods can let you know how much money is coming into and going out of the business, but they are not necessarily the best tools for measuring how efficiently your business is operating on a day-to-day basis.

Costing methods allow businesses to track how much they spend to determine the actual cost of their products or services. Different costing methods work better for different types of businesses. The activity-based costing (ABC) method focuses on components of work performed for customers or clients. This can help businesses in the construction industry. Read on to learn more about the ABC method and how it could benefit your business.

What Is Activity-Based Costing?

A costing method is a process of:

  1. Collecting data about business expenditures; and
  2. Using that data to determine how much a business spends for each product it makes or job it completes.

Businesses that manufacture, distribute or sell goods can use costing methods to determine the cost per unit produced, shipped or sold. While this oversimplifies the process, they can essentially tally up their operational expenses and divide them by their total number of units. For businesses that provide services, including many construction companies, it can be much more complicated.

Service-oriented businesses cannot divide their expenses equally among all units of output. Different jobs or projects require different resources and take different amounts of time. The ABC method allows these businesses to focus on their work processes. It looks at the cost of materials and labor used in each job, as well as some overhead and administrative costs.

An “activity” is anything that helps the business reach its goal of serving the customer, such as working on construction plans, sourcing and ordering materials, setting up equipment and cleaning up worksites. The term may also include any other event that is a cost driver, meaning that it generates a cost or consumes a resource.

You can measure activities in two ways:

  • Transactional: How many times does an activity occur?
  • Durational: How long does an activity take?

The ABC method also identifies five levels of activity, which helps businesses get to the details of how they use their resources:

  • Unit-level;
  • Batch-level;
  • Product-level;
  • Customer-level; and
  • Organization-sustaining.

What Are the Benefits of Using Activity-Based Costing?

The ABC method offers numerous benefits that can help businesses in a range of industries:

  • In industries where other costing methods do not work, particularly service-oriented industries, the ABC method allows you to allocate costs to various aspects of the services your company provides.
  • It offers a more expansive way to categorize costs, grouping them based on specific activities rather than general categories like “overhead” or “operating.”
  • It provides a way to connect many indirect costs, such as depreciation and payroll, to specific activities, projects, jobs or clients.
  • It provides a more nuanced look at cost than measurements of volume, such as total labor hours or machine hours.

These improved metrics can lead to:

  • Higher profit margins, thanks to more detailed and accurate information;
  • More efficient processes;
  • Improved allocation of resources between departments; and
  • Greater accuracy in budgeting, estimates and pricing.

What Are the Disadvantages of Activity-Based Costing?

For all of its benefits, the ABC method is not without its drawbacks. Many of the disadvantages involve the increased cost and effort required both to implement and maintain the system:

  • The initial process of implementing the ABC system can be burdensome. Nearly every person in the organization needs to receive training and contribute to the system.
  • Data gathering is an ongoing process that, as mentioned above, requires input from nearly every employee. The necessary data requires more input than the company’s general ledger. It might be possible to outsource much of the data collection to a third party, but that represents a financial cost rather than an opportunity cost.
  • The potential for inaccuracy grows with each person involved in the process. Employees who must already keep track of the times they clock in and out of work might resent having to keep another set of time sheets. Furthermore, they might not track their time as accurately when it is not directly tied to their paychecks.

How Can I Use Activity-Based Costing in My Construction Business?

You can make use of the ABC method in your construction business in a variety of ways. You might, for example, give it a test run by trying it out on a single project or job. If it works well for you, you can scale it up to include other projects or the entire business.

As for the specifics of how you may do so, it depends on the type of operation you have and how you want to use the method. You might want to implement the system in different ways if you do all of your work on-site, versus if you have your own facilities, like a fabrication shop. The first step is planning, whether you will be handling that yourself or assembling a task force. You can identify the goals you wish to achieve with the ABC method and begin charting the organization’s activities and costs.

We were at the forefront in providing guidance on activity-based costing to our clients. We’ve also implemented company-wide dashboards and/or flash reports, which allows management to keep a pulse on the business and anticipate results long before the monthly financial statements are completed.

Contact our Construction team to learn more about using the ABC method for your business.

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