Activity-based costing

Assigning overhead to customers or products by the activities they consume, each at its own rate per cost driver.

DefinitionAssigning overhead to customers or products by the activities they consume, each at its own rate per cost driver.

Activity-based costing (ABC) assigns overhead by what each customer or product actually uses rather than by a blanket share of revenue or labor hours. Overhead is split into activity pools such as order handling, picking, delivery and support, and each pool is charged out at a rate per unit of its cost driver.

How it is computed

For each pool: activity rate = pool cost / total driver volume. A customer's cost = sum over pools of rate x the driver volume that customer used.

Example

An order-handling pool of $120,000 covers 4,000 orders, a rate of $30 per order. Customer A places 400 orders and is charged $12,000; Customer B places 40 and is charged $1,200, even if both buy the same dollar volume.

Where it goes wrong

Too many pools, kept up by hand, so the rates go stale; or drivers chosen because they are easy to count rather than because they cause the cost. The full guide is activity-based costing.

Articles that use this term

Finance metrics and formulas

Activity-based costing: a worked example against traditional allocation

Activity-based costing assigns overhead by the activities each product or customer uses, rather than by revenue or volume. This page sets out the four steps, builds activity rates for a distributor's four cost pools, charges four customers both ways, proves the charges reconcile, and covers when ABC changes the answer and when time-driven ABC is the simpler route.

Oct 1, 20267 min read Finance metrics and formulas

Fixed vs variable costs: the difference, examples, and how to split a mixed cost

Fixed costs stay the same in total as volume changes; variable costs move with every unit. This page sets out the difference in one table, gives business examples of fixed, variable, semi-variable and step costs, and splits six months of a packing operation's costs with the high-low method, checked against Excel's SLOPE and INTERCEPT.

Oct 1, 20266 min read Finance metrics and formulas · SaaS

Unit economics: the per-customer P&L, with LTV, CAC and payback worked for three segments

Unit economics is the profit and loss of one customer: what it pays, what it costs to serve, what it cost to win and how long it stays. This page builds the per-customer P&L for three segments of one software company, ties CAC, payback and LTV together, caps the lifetime so low churn cannot inflate it, and shows the same method for businesses without subscriptions.

Oct 1, 20268 min read