How Activity-Based Costing Can Help Small Businesses Boost Profits in 2025

 

Introduction

In today’s competitive marketplace, small businesses face a constant challenge: how to keep costs under control while delivering quality products and services. Traditional accounting methods frequently combine costs, making it hard to differentiate between them, to see where the money is really going. This is where activity-based costing (ABC) comes in.

In this guide, you’ll discover what ABC is, how it works, the benefits it offers, and how to implement it without affecting your budget or operations.

What is Activity-Based Costing (ABC)?

Activity-based costing is a method that assigns costs to products and services based on the actual activities and resources they use. Instead of just spreading overhead evenly, ABC digs deeper to link each expense to the specific task or process that caused it.

Example:
Imagine you run a bakery. Traditional costing might spread the rent and utilities across all your products equally. ABC, however, will show you that wedding cakes require more labor hours, more expensive ingredients, and more electricity than cookies—helping you price them more accurately.

In 2025, small businesses are increasingly turning to ABC because it is compatible with modern tools like cloud-based accounting software and AI-powered analytics, making cost tracking accurate and easy to maintain.

How Activity-Based Costing Works

Here’s a simple, step-by-step breakdown of how ABC works:

1.    Identify Activities

Identify all the major activities in the production of your commodity or the delivery of your service-e.g. procurement, production, packaging, or customer support.

2.    Link Costs to activities

Exclude all labor related costs, material costs, utilities and overhead costs to know the cost of each activity.

3.    Identify Cost Drivers

Identify the reasons that make costs increase or decrease. Costs may be driven by machine hours, labour hours or deliveries, as an example.

4.    Products/ Services Allocation of Costs

Allocate the expenses to individual products or services in terms of quantity that they utilize every activity.

Mini Example:
Let’s say your small clothing brand makes both T-shirts and jackets. Jackets require more stitching time, more fabric, and more quality checks than T-shirts. ABC will reveal that jackets cost significantly more to make, even if both sell for similar prices—helping you adjust pricing or marketing accordingly.

Benefits of Activity-Based Costing for Small Businesses

1. More Accurate Product Pricing
   ABC ensures each product’s price reflects its true cost, reducing the risk of underpricing or overpricing.
2. Identification of Unprofitable Products
   It’s easier to spot products or services that aren’t covering their costs and decide whether to improve, reprice, or discontinue them.
3. Improved Decision-Making
   Data from ABC gives you a clear picture for resource allocation, expansion plans, or process changes.
4. Waste Reduction
   By identifying cost-heavy activities, you can streamline operations and eliminate unnecessary steps.
5. Better Budget Control
   Knowing exactly where your money goes helps you forecast expenses more accurately.

Case Example:
A small coffee shop that used the ABC found out that their “specialty iced beverages” were way more expensive than just ordinary coffee because of increased ingredients and long preparation time. They were able to boost their profit line by 15 % by changes in the recipe and the preparation process.

Implementing Activity-Based Costing in 2025: A Step-by-Step Plan

Applying the Activity-Based costing structured approach is necessary for small businesses' step-by-step costing:

Step 1: Identify the key activities.

Identify every necessary step in creating products or providing services.  Marketing, customer service, packaging, and buying are a few examples.

Step 2: Assign costs to the activities.

Group costs into activity-specific cost pools. Make sure each pool covers all direct and indirect costs for that activity.

Step 3: Determine Cost Drivers

Identify what causes each activity to incur costs. For example, packaging costs might be driven by the number of items shipped.

Step 4: Obtain activity data.

Measure the track data of every cost driver over a certain time. It requires accurate information to obtain the cost of products.

Step 5: Assign Costs to Product or Services

In order to obtain the cost per unit, the total cost of an activity should be divided by the voluminous cost driver.  Then, multiply by how many units of each good or service are used.

Step 6: Analyze and Calculate

Check the results and look back at the inefficient activities, use less, and be more profitable.

Conclusion

Activity-Based Costing isn’t just for big corporations—it’s a game-changer for small businesses aiming to grow profits in 2025. By clearly linking expenses to the activities that drive them, ABC gives you the insight to price smarter, cut waste, and make strategic decisions.

As a fresh university graduate in business who has just started the first business or a mature business player, adoption of ABC may be a chance ahead of other market players who are using traditional costing. The quicker you take action, the faster you are going to have the benefits.