Activity based costing for small businesses

Key takeaways

Activity based costing assigns overhead to the activities that cause it, such as raising an invoice or handling an enquiry, and then to the customers and jobs that use those activities. A small business can do a simple version in an afternoon. It turns hidden indirect cost into a price per activity.

• Cost per activity = time per activity x loaded hourly cost, plus tools.
• 12 minutes per invoice at £19.81 an hour is about £3.96 per invoice.
• Start with your 5 highest-volume activities.
• Use the result to price jobs, drop loss-makers and compare with quotes.

What is activity based costing?

Activity based costing, often shortened to ABC, is a costing method that identifies the activities a business performs and assigns indirect costs to products, services or customers according to how much of each activity they consume. It replaces a single blanket overhead rate with a cost for each activity.

• The hidden costs of doing everything in-house
• Direct vs indirect costs: what small businesses miss

Why does it matter for a small business?

It matters because support work is not used evenly. One customer places a clean monthly order. Another sends ten changes and phones about each invoice. A flat overhead rate makes them look equally profitable. Costing by activity shows which customers, jobs and services carry the hidden cost.

• What are hidden costs in a business?

How do you calculate a cost per activity?

Calculate it from time, volume and loaded labour cost. If raising and sending an invoice takes 12 minutes and the person costs about £19.81 per worked hour under 2026/27 GOV.UK rates, the labour cost is about £3.96 per invoice. Add a share of software and any correction time to reach the full figure.

• List the activity and count how many are done a month.
• Time a sample of ten.
• Multiply average minutes by loaded cost per minute.
• Add rework: correction minutes spread across all units.
• Add tools: monthly software cost divided by volume.

• Work out your cost per task before you outsource
• Overhead cost per employee in the UK: what to add

What do you do with the numbers?

Use the numbers for three decisions: pricing, customer profitability and sourcing. Add activity costs to job costs to see true margin. Identify customers whose service load exceeds their profit. And compare your cost per activity with an outside price for the same work.

• How to benchmark in-house team performance
• In-house vs outsourcing: which model is more cost-effective?

When is it overkill?

Full activity based costing across every process is overkill for a small business and expensive to maintain. A light version covering the five or six highest-volume activities, updated once a year, gives most of the insight for a fraction of the effort.

What does a worked example look like?

Take a firm handling 300 enquiries, 120 quotes and 200 invoices a month. Timed samples give 6 minutes per enquiry, 25 per quote and 12 per invoice. At a loaded £19.81 an hour, that is about £1.98 per enquiry, £8.25 per quote and £3.96 per invoice. Monthly, the three activities cost about £594, £990 and £792: roughly £28,500 a year of labour in work that was previously one overhead line.

Now it can be asked whether a £150 job that needs a quote, two enquiries and an invoice, about £16 of admin, is worth taking at its current price.

How do you apply it to customers?

Count how many of each activity your top customers consume in a month and multiply by the cost per activity. Subtract the result from each customer's gross margin. The ranking usually changes. A mid-sized customer who orders cleanly can be worth more than a larger one who generates queries, changes and credit notes. The response is not always to drop the costly customer; a minimum order, a service charge or a simpler ordering route may fix it.

What mistakes do small businesses make with it?

The usual mistakes are trying to cost every activity, timing people in a way that feels like surveillance, and treating the result as exact. A figure within 20% is good enough to guide pricing and sourcing. Explain to the team that you are costing the process, involve them in timing the samples, and share what you find.

What does this look like in practice?

A pattern we see when firms cost by activity: small jobs that looked profitable on materials and labour turn negative once quoting, scheduling and invoicing are added, because each job carries the same admin whatever its size. A minimum job value follows.

Across our client work, back-office cost per task has fallen by 42% once the process was written down and run by a managed team.

• See client work
• BPO Solutions for UK businesses

Activity costing checklist

Complete in an afternoon.

• Choose five high-volume activities.
• Count monthly volume for each.
• Time a sample.
• Calculate cost per unit at loaded rates.
• Apply to your top ten customers or job types.
• Review prices and sourcing.

• The hidden cost audit: score your business in an hour
• How to run a cost review in a small business

Next step

Send us your five highest-volume admin activities and rough monthly counts. We will cost them with you in a 30-minute call and show how they compare with market ranges.