As a CEO or CFO of a forging unit, you’re constantly battling market pressures. But what if your internal tools are making the fight harder? Many Indian MSMEs still rely on absorption costing, a method that might be silently eroding your profits. It’s time to expose its flaws and understand why Activity-Based Costing (ABC) offers superior visibility and true profitability.

The Hidden Trap of Absorption Costing

Traditional absorption costing allocates all manufacturing overheads (fixed and variable) to products. It seems logical. However, it often uses simplistic allocation bases like direct labor hours or machine hours. This approach worked when factories produced a few standardized products and overheads were less complex.

Today, forging units handle diverse product lines, varied batch sizes, and intricate processes. A blanket allocation method distorts true costs. For example, a low-volume, complex forging requiring multiple setups and quality checks might absorb the same overheads as a high-volume, simple one. This leads to misleading product profitability. You might think you’re making money on all products, but some are actually losing you money.

Real-Life Flaws in Action: Two Indian Examples

Example 1: The “Profitable” Automotive Component

A mid-sized forging unit in Pune was consistently quoting low prices for a complex automotive component, believing it was highly profitable due to high volume. Their absorption costing method spread all factory overheads evenly. However, this component required frequent die changes, specialized heat treatment, and extensive quality inspection due to tight tolerances.

When they shifted to ABC, they discovered the true cost was 15% higher than calculated. The overheads associated with die changes, specific heat treatment furnace utilization, and dedicated quality checks were disproportionately absorbed by this one product. They were selling at a loss for years, masked by seemingly profitable simple forgings.

Example 2: The Underquoted Railway Part

Another forging unit in Jamshedpur specialized in railway parts alongside general industrial forgings. They often lost bids for simpler railway components, believing their competitors were simply more efficient. Their absorption costing showed low margins on these parts.

However, the simpler railway parts often used existing dies, fewer setups, and required less specialized post-forging operations compared to their complex industrial components. When they applied ABC, they found that these simpler parts were actually absorbing too much overhead from the more complex operations. By reallocating overheads based on actual activities (like setup time, specific machine usage, quality checks per batch), they realized these simpler parts were far more profitable. This allowed them to bid more aggressively and win contracts they previously missed.

Why Absorption Costing is Obsolete

Only a small fraction of MSMEs (around 15-20%) use modern costing techniques. This leaves many vulnerable. Absorption costing fails because it:

• Hides True Costs: It averages out overheads, obscuring which products genuinely consume resources.
• Distorts Pricing: Leading to under-pricing profitable items and overpricing unprofitable ones.
• Misleads Strategic Decisions: You might expand product lines that are cash drains or discontinue truly profitable ones.

The Power of Activity-Based Costing (ABC)

ABC costing offers a paradigm shift. It identifies key activities that drive costs (e.g., machine setup, material handling, quality inspection, engineering support). It then assigns overheads to products based on their actual consumption of these activities.

Imagine:

• Knowing the exact cost of each die change.
• Understanding the true expense of a specific heat treatment cycle.
• Pinpointing the overheads associated with a particular quality check process.

ABC provides this granular visibility, enabling you to:

• Accurate Pricing: Quote prices that truly reflect your costs and desired profit margins.
• Profitability Analysis: Identify genuinely profitable products and those draining resources.
• Strategic Decisions: Make informed choices on product mix, process improvements, and investments.
• Cost Control: Pinpoint areas of excessive cost and implement targeted reduction strategies.

Upgrade to Smart Costing: A Path to Profitability

In today’s competitive forging market, clinging to outdated costing methods is a strategic misstep. Upgrading to ABC isn’t just about achieving accounting accuracy; it’s about unlocking profitability and securing your unit’s long-term financial health.

Understanding your true costs is the first step towards smarter pricing, better decision-making, and ultimately, a more profitable future for your forging business. Don’t let your costing method kill your profits. Embrace modern costing techniques and lead your unit towards sustainable growth.

Proactive Solutech: Your Partner in Costing Clarity

At Proactive Solutech, we specialize in helping forging units transition to robust ABC costing. Our tailored audit engagements provide rapid clarity on your true cost structures. We work closely with your team to implement practical ABC models, revealing hidden profits and empowering you with the precise data needed for strategic pricing and informed decisions. Don’t let your costing method kill your profits any longer.