What does activity-based costing help organizations to understand?

Activity-based costing (ABC) helps organizations gain insights into how costs are incurred based on specific activities that drive expenses within the organization. This approach allows businesses to identify the true cost of products or services by examining the activities required to produce them, rather than using traditional costing methods that might allocate overhead costs more arbitrarily.

By understanding the relationship between activities and costs, organizations can better manage resources, improve efficiencies, and make informed decisions about pricing, product profitability, and process improvements. This granular visibility into cost behavior supports strategic planning and helps pinpoint areas where spending can be reduced or managed more effectively.

While the generation of total revenue, benefits of reducing fixed costs, and profit margins are essential financial metrics and insights for a business, they do not capture the specific focus of activity-based costing, which is centered on the detailed analysis of costs associated with activities leading to product or service delivery.