Activity drivers are events or activities that affect the overall cost of a product. Analysts use them to determine the cost of a product and reduce costs to make it cheaper. They also analyze activity factors to uncover overhead costs and estimate untraceable costs to ensure a profitable price. Managers and analysts find ways to reduce price without reducing quality or quantity. Software is used to control the cost of cost analysis.
An activity driver, also called a cost driver, is any event or activity that has a substantial effect on the overall cost of a product. This is used to help companies determine how much each product should cost in order for the company to make its money back and make a profit. Common activity factors include employee compensation, machine hours, and cost of resources. There are also untraceable costs, but some analysts argue that these costs should be added to the mix. By looking at activities, analysts can help reduce costs and therefore make the product cheaper.
To help price a product fairly—both for the customer and the company—analysts analyze activity factors to uncover the overhead costs of producing a product. Each activity driver is then placed on its own cost object or on a separate measure of each cost. When looking at the driver, the analyst should check the frequency and hourly cost of the activity.
Every product will have at least one activity driver. Common drivers are the costs of hiring employees to create the product; the hours a machine is used, which maintenance entails; the amount of resources and the time spent accumulating the resources; and transport. The more activity factors and the longer each of them occurs, the higher the price of the product.
Other activity costs are thought to be untraceable or not have a noticeable effect on product price. This includes executive pay and pay for anyone not directly involved in making the product. Although these are not clustered in the cost driver distribution, the cost still needs to be overcome to make a profit. Many analysts therefore also estimate these factors to ensure a profitable price is reached.
Along with knowing the activity driver’s contribution to price, managers and analysts try to find ways to reduce price without reducing quality or quantity. For example, if fewer employees are actually needed to manufacture the product, or if the company can obtain resources cheaper from another supplier, this will reduce the contribution of the activity driver. At that point, the company will lower the price of the product or reap the extra profit.
If a product cannot meet its activity cost, the company will find a way to lower its price or stop doing so. On the other hand, if a product is doing exceptionally well, the company will allocate more resources to ensuring that the product meets consumer demand. To help control the cost of cost analysis, software is often employed so that analysts can work more quickly.
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