Activity and Process Cost Analysis

September 30, 2020

Cost reduction is a critically important goal of every organisation. Decrease in operational costs signifies higher profit margins and a better organisational budget. It is also one of the key measures of success for Business Improvement programs. According to the PEX Network Biennial State of the Industry Report 2015, around 22.2% professionals consider Cost Savings as the primary measure of success for their Process Improvement Programs.

Analysis of cost is essential for crafting a reduction strategy and process analysis is essentially the foundation of it. A process can be analysed in either quantitative or qualitative way. The quantitative aspects of a business process analysis are usually classified as the following:

Through our blog series, we have already shared how you can do value analysis. In today’s blog we are going to focus on Process Cost Analysis.

ACTIVITY AND PROCESS COST ANALYSIS

Analysing the cost of a process is another way to identify cost reduction opportunities; what the cost saving could be if we were to slightly redesign the process. To calculate process cost, there are two costs to consider:

  • Role cost
  • Overhead cost

A process model indicates the activities performed by respective roles. Identify the role(s) and source the annual cost from the Human Resource department. For example, role XYZ has an annual cost of $100,000. Secondly, the business overhead cost must be calculated. An overhead or overhead expense refers to an ongoing expense related to operating a business. Overhead costs include rent, accounting fees, taxes, telephone bills etc. but does not include labour costs, material costs and direct expenses.

An overhead cost is usually expressed as a ratio and this can be sourced from the finance department. For example, the overhead rate is 0.31 or 31 percent, which means that $0.31 in overhead costs is incurred for every $1 in direct labour costs. Hence, if role cost is $100,000 per annum, the overhead cost is $31,000 per annum. Translate the overhead cost and the role cost into minutes. This can then be multiplied by the minutes it takes to do the activity. Hence, the result is a per activity cost. Allocating a different role to an activity can significantly change the cost of the activity.

Following the Value Analysis described above, calculate the annual process execution cost of your process for:

  • Customer Value Adding activities
  • Business Value Adding activities
  • Non-Value Adding activities

Non-Value-Adding activities represent waste in the organisation; hence these costs can be immediately removed to deliver cost savings

Process cost analysis is one of the approaches to analyse a business process. However, it is important that before executing any of the shared analysis techniques, risks and costs are properly calculated to avoid failures and instead get excellent results from the improvement initiatives. Additionally, based on the objective of the analysis, one needs to choose a technique hence, you need to be very cautious while choosing one.

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