Pharmacies often face mounting pressure to deliver high-quality services while managing costs effectively. One method that has proven beneficial in achieving this balance is Activity-Based Costing (ABC). By providing a detailed understanding of the costs associated with each service and activity, ABC enables pharmacies to enhance efficiency, optimise resource allocation, and improve profitability.
Understanding activity-based costing
ABC is a costing methodology that identifies and assigns costs to overhead activities and then assigns those costs to products or services. Unlike conventional costing methods, which might allocate costs based on broad metrics like machine hours or direct labour and often oversimplify cost behavior, ABC focuses on the specific activities that contribute to overhead costs. This approach provides a more accurate reflection of the true costs associated with each product or service offered by a pharmacy.
The relevance of ABC in pharmacies
Pharmacies offer a diverse range of services, from dispensing medications to providing health consultations and screenings. Each of these services involves multiple activities, consuming various resources. A cost pool is an aggregate of costs associated with specific business tasks, which is crucial in calculating ABC. Traditional costing methods may oversimplify cost allocation, leading to inaccurate pricing and resource mismanagement. ABC addresses this issue by breaking down each service into its constituent activities and assigning costs accordingly.
Understanding Cost Drivers
Cost drivers are essential components of ABC as they help allocate indirect costs to specific products, services, or activities. A cost driver is a factor that influences the cost of an activity or process. In ABC, cost drivers are used to assign costs to cost objects, such as products or services, based on their consumption of resources.
There are two main types of cost drivers: transaction drivers and duration drivers. Transaction drivers are related to the number of transactions or events that occur, such as the number of orders processed or the number of customers served. Duration drivers, on the other hand, are related to the amount of time spent on an activity, such as the number of labor hours or machine hours used.
Examples of cost drivers include:
- Machine hours
- Labor hours
- Number of orders processed
- Number of customers served
- Number of production runs
- Number of quality inspections
By identifying and using cost drivers, companies can more accurately allocate indirect costs and gain a better understanding of the true costs of their products and services. This precision is particularly beneficial in a pharmacy setting, where understanding the cost implications of various activities can lead to more strategic pricing and resource allocation decisions.
Benefits of implementing ABC in pharmacies
Enhanced cost accuracy
By analysing each activity involved in service delivery, ABC allows you to pinpoint the exact cost drivers. Grouping overhead costs into cost pools improves the accuracy of cost allocation by associating costs with specific activities. This precision ensures you understand the true cost of each service, enabling more informed pricing decisions.
Improved resource allocation
With a clear view of how resources are consumed across different activities, you can identify inefficiencies and areas where resources may be better utilised. This insight leads to more strategic decision-making regarding staffing, inventory management, and service offerings.
Informed decision-making
Accurate cost information is crucial for strategic planning. Understanding fixed costs is essential in this context, as misclassifying them can lead to misguided decisions. ABC provides the data needed to assess the profitability of each service, guiding decisions about which services to expand, modify, or discontinue.
Enhanced competitiveness
In a competitive market, understanding your cost structure allows you to price services competitively while maintaining profitability. This balance is essential for attracting and retaining customers.
Managing Indirect Costs with ABC
Indirect costs, or overhead costs, are expenses that are not directly related to the production of a specific product or service. These costs can be difficult to allocate to specific products or services using traditional costing methods. However, Activity-Based Costing (ABC) provides a more accurate and effective way to manage indirect costs.
ABC involves identifying the activities that drive indirect costs and assigning those costs to specific products or services based on their consumption of resources. This approach helps companies to:
- Identify areas where indirect costs can be reduced or optimized
- Allocate indirect costs more accurately to specific products or services
- Make more informed decisions about pricing, production, and resource allocation
By using ABC to manage indirect costs, companies can gain a better understanding of their true costs and make more informed decisions to improve their profitability and competitiveness.
In the manufacturing industry, ABC can be used to manage indirect costs such as:
- Factory overhead costs
- Quality control costs
- Maintenance costs
- Energy costs
In services, ABC can be used to manage indirect costs such as:
- Salaries and benefits of support staff
- Rent and utilities
- Marketing and advertising expenses
- IT costs
By allocating indirect costs more accurately, companies can improve their performance management and make more informed decisions about resource allocation and cost reduction. This is particularly relevant for pharmacies, where understanding the full cost structure can lead to better financial management and enhanced service delivery.
Steps to implement ABC in your pharmacy
- Identify activities: List all activities involved in each service, such as patient consultations, medication dispensing, inventory management, and administrative tasks. For example, the process of medication dispensing can be broken down into unit-level activities like counting pills and batch-level activities like preparing bulk orders.
- Assign costs to activities: Determine the resources consumed by each activity, including staff time, equipment usage, and facility costs.
- Determine cost drivers: Identify factors that influence the cost of each activity, such as the number of prescriptions filled or the time spent on patient consultations.
- Calculate activity rates: Divide the total cost of each activity by its cost driver to determine the cost per unit of activity.
- Assign costs to services: Multiply the activity rate by the number of units consumed by each service to determine the total cost associated with that service.
- Analyse and act: Use the information gathered to assess the profitability of each service, identify inefficiencies, and make informed decisions about resource allocation and pricing.
Challenges and considerations
While ABC offers numerous benefits, implementing it requires careful planning and commitment. Challenges may include the time and effort needed to collect detailed data, potential resistance from staff, and the need for ongoing maintenance of the costing system. However, with the right approach and support, these challenges can be managed effectively.
Seek advice
Implementing Activity-Based Costing in pharmacies provides a detailed understanding of service costs, leading to improved decision-making, resource allocation, and competitiveness. By embracing ABC, pharmacies can navigate the complexities of modern healthcare with greater confidence and efficiency.
At Diamond Accounts, we specialise in helping pharmacies implement effective costing strategies like ABC. Our team of experts is ready to assist you in gaining a clearer understanding of your cost structures, enabling you to make informed decisions that enhance your profitability and service quality.
Contact us today to learn more about how we can support your pharmacy’s financial health.