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Improving Healthcare Profitability Using Activity-Based Costing

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The fragile economic conditions that are prevalent around the globe has made it difficult for firms to maintain profitability while delivering high-quality services and products. In particular, players in the healthcare industry encounter specific challenges because of the uniqueness of the sector. At least two factors make profitability a difficult achievement by health providers. First, most of these firms operate as non-profit co-operations. Second, payment is usually through a third party, and not the person receiving the services (Gapenski, & Pink, 2006). For many years, organizations have tried to improve profitability by focusing on revenues. However, most cooperations in the health industry have been operating under an unpredictable flow of income and rising costs. These circumstances have resulted in profitability challenges and increased levels of anxiety among managers. A better approach that has received increasing focus in the recent decades is the emphasize on costs rather than revenues. It has enabled health firms to remain profitable without jeopardizing service quality (Hughes, 2011). A costing method that can be a useful tool in increasing profitability within the health industry is the activity-based costing (ABC) mode because it aids in budgeting, making efficient projects, contracting, besides its few limitations.

ABC in Its Context

Cost management is a critical procedure in any organization. It is a useful tool in pricing, budgeting, profitability analysis, performance reporting, and forecasting of cost objects (services, customers, processes, products, projects, contracts, or any other work unit within a firm). It involves gathering, analyzing, and presenting information that helps in the management of expenditure. Cost management is a critical component of financial control. It aids in mitigating budget strains. Many players in the healthcare industry have appreciated the value of cost management in combating foremost profitability challenges. Various cost control methods are available for firms. Each of the techniques has associated benefits and limitations. Among them is the ABC method.

The traditional technique involves allocating the costs using standard criteria such as labor or machine hours. The ABC model, on the other hand, identifies all the undertakings, resources, and cost objects of a firm. It allocates the resources to each of the activities. It then assigns the activities to their cost objects depending on their consumption. Financial managers use the ABC approach for various purposes and with significant benefits. First, it helps in isolating and eliminating non-profitable products and services. Second, the technique is valuable in lowering the prices of overpriced items and raising those that are underpriced. Lastly, ABC assists in eliminating ineffective organizational processes.

Corporate costs can be direct or overheads. In a health setting, direct costs include materials that help in executing services and labor costs. Typical indirect expenses include supervision and quality control (Baker & Baker, 2014). It is easy to isolate direct costs and assign them to associated objects. The traditional approach to costing has been useful in the management of this category of expenditure. However, allocating overheads to products, projects, or services is a complex procedure, and the conventional models have proved to be inconsistent and inaccurate. In recent years, the improvement of accuracy and consistency in the assignment of indirect costs has attracted much attention. One approach to this objective is the activity-based costing. The ABC model aims at addressing the complications that arise when allocating overheads to cost objects.

An Alternative Approach

Despite the potential benefits of the ABC system, it has its limitations. Designing and implementing ABC requires thorough analysis and breaking down of each activity into individual components. The process involves carrying out extensive surveys. It can be time-consuming and is expensive. Another complication arises from data interpretation. Reports from ABC systems contain information that is different from those of conventional methods. Moreover, ABC does not conform to established accounting standards, and therefore some costs may be irrelevant when making some costing decisions. These factors, along with technological improvements, have prevented managers from reaping the expected benefits of ABC and have prompted the development of new models. Among them is the time-driven activity based costing (TDABC). TDABC aims at eliminating the need to conduct surveys associated with ABC. In this way, it reduces the amount of time needed for costing. It also minimizes the amount of resources (including workers) that are necessary for efficient service delivery in healthcare centers (Hughes, 2011). The invention of useful costing models such as ABC and TDABC has made it possible to improve profitability in the fragile healthcare industry.


Due to the delicate nature of the healthcare industry, attaining profitability while maintaining high-quality service delivery is a major concern. Cost management techniques help in addressing this challenge. It involves allocating resources and costs to different organizational objects. There exist various costing models. Each has potential benefits and disadvantages. The conventional techniques have shown inaccuracies and inconsistencies when dealing with indirect costs (overheads). The ABC model can be an important approach to increasing profit margins in the health sector. It removes unprofitable services or products, raise the prices of underpriced products and lower those that are overpriced, and eradicate unproductive processes. Still, it has its limitations and experts are developing other models that can capitalize on the benefits of ABC while reducing the disadvantages.

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