Welcome to the world where traditional costing falls short, and activity-based costing (ABC) starts to make sense.
You’ve probably had this conversation before: The P&L looks healthy, but cash feels tight. Gross margins are steady, yet your warehouse team swears every order is a small disaster. The CFO can’t explain why two “identical” SKUs have wildly different profit margins.
The Problem: You Can’t Fix What You Can’t See
Manufacturers and wholesale distributors often live and die by cost accuracy. Yet most still rely on standard costing or a simple overhead allocation that spreads costs evenly across products.
That approach might have worked when your product mix was simple. But as operations scale—more SKUs, custom orders, varying batch sizes—it starts to crack.
We’ve seen it firsthand:
- A distributor with a 20% gross margin on paper… until we traced picking, packing, and returns. The real margin? Closer to 8%.
- A manufacturer pricing its low-volume SKUs like its high-runners, bleeding profits on every “special order.”
- A team that couldn’t reconcile production labor because setup times were lumped into “general overhead,” masking inefficiencies in smaller runs.
In each case, the company thought they had a pricing problem. They actually had a costing problem.
What is Activity-Based Costing?
Activity-based costing takes a more forensic approach. Instead of allocating overhead based on a single measure like labor hours or machine time, ABC assigns costs based on the actual activities that drive those costs.
Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to products, services, or customers based on the actual activities that drive those costs.
Key components of ABC:
- Activities: The tasks that consume resources (e.g., machine setup, order processing, quality inspection).
- Cost drivers: The measurable factors that trigger each activity’s cost (e.g., number of setups, number of shipments).
- Cost pools: Groups of related costs accumulated for each activity.
- Allocation: Assigning those pooled costs to products or customers based on their usage of each activity.
Think of it like this: If your warehouse staff spends three hours a day assembling one custom order and ten minutes on another, ABC makes sure those costs show up where they belong.
The goal is simple: assign indirect costs with the same precision you assign direct materials and labor. Activity costing helps pinpoint which products, customers, or processes are truly profitable.
Why Manufacturers and Distributors Benefit Most from ABC
Activity-based costing isn’t new. It’s just painfully underused. The companies that get it right usually have one thing in common: they’ve reached the point where “close enough” costing no longer cuts it.
Related Read: Inventory Accounting in NetSuite
In manufacturing, ABC helps identify which production runs or work centers eat up the most time and resources. For distributors, it highlights the hidden cost of complexity: small orders, multiple delivery routes, frequent returns, or high-maintenance customers.
When we run a costing review inclusive with our NetSuite for Manufacturers, these are the patterns that jump out every time:
- Products that look profitable but require multiple changeovers per batch
- High-margin SKUs that quietly lose money after accounting for shipping, handling, and returns
- Large customers who appear valuable until you factor in their constant custom requests and credit memos, or customer acquisition costs.
ABC doesn’t just tell you what’s profitable. It tells you why.
Real Activity-Based Costing Results: The “Aha” Moments
Here are a few real-world takeaways from client conversations:
1. Labor costs were there… just hiding in plain sight.
One mid-market manufacturer was running negative margins on their smaller batches. ABC revealed that each setup required three hours of labor, spread across all jobs equally in standard costing. Once they reallocated those hours correctly, they discovered their low-volume runs weren’t profitable at all.
2. The warehouse that worked too hard.
A wholesale distributor’s NetSuite data showed strong top-line growth but weak cash flow. The culprit? Order-level activities like pick-pack-ship were consuming 40% more time than estimated. ABC revealed that small orders under $500 accounted for 60% of those touches. Adjusting pricing and minimums brought cash flow back in line.
3. The “VIP” customer that wasn’t.
A large B2B client had negotiated premium discounts based on volume. ABC exposed that the support and return activity tied to their orders wiped out any profit advantage. After renegotiating terms, the company added 5% back to their bottom line.
4. Stalled NOI
Every founder hits that moment where the numbers stop matching the story.
Revenue climbs. Headcount grows. Capital flows into new initiatives. On paper, the company is “bigger” than it’s ever been. Meanwhile the bottom line refuses to budge. Or worse, slides backward.
That was the reality in a recent conversation with a client who grew from just under $8 million in revenue in 2019 to roughly $11.7 million today. A solid 46 percent increase over 6 years. Millions deployed into people, systems, and complexity along the way.
And yet the business is delivering roughly the same dollars of NOI as it did years ago.
This is the part of scaling that almost no one talks about. Because it feels counterintuitive. Even frustrating.As you grow, your NOI percentage should go down. That’s normal. Overhead needs to evolve. Leadership layers get added. You invest in capital. The founder stops doing ten jobs.But the absolute NOI dollars should go up.
When the percentages drop and the dollars don’t rise with them, that’s not growth. That’s a structural problem hiding inside your financials.
And most companies never see it coming because they’re too focused on their P&L.
The Mirage of “We Just Need More Revenue”
During this meeting, the frustration was clear. They’d doubled staff. Expanded product lines. Made the business more complex. And yet the bottom line hadn’t improved. This led to the existential question that many operators quietly ask when the pressure builds:
“Do we need to get smaller first so we can get bigger?”
Usually, the business isn’t actually “broken.” What’s broken is its visibility.
In this case, the company couldn’t answer basic questions like:
- Which product lines are carrying the business?
- Which are draining cash?
- What does fulfillment truly cost by channel?
- Are we overspending in marketing, and on what products?
- What’s the real cost center structure behind operations?
Even worse, NetSuite contained all the data, but none of it was structured to tell the story. Costs were buried across buckets.
(Take this as your hint you may need a NetSuite consultant).
In this case, the lack of classes and consistent allocation was hiding true costs. Departments weren’t tracked beyond gross profit. Direct labor wasn’t tied to production. Tariffs and shipping weren’t consistently captured. R&D expenses were lumped into random accounts. And marketing? Impossible to read by product.
In short: the team “couldn’t see the forest through the trees.” And the P&L became a blindfold instead of an operating tool.
So we decided to introduce activity-based costing.
Implementing Activity-Based Costing in NetSuite
You don’t need a complete ERP overhaul to get started. If you’re already using NetSuite, you’re sitting on the data foundation required for activity-based costing.
Here’s a practical roadmap:
- Map key activities: Identify what drives your indirect costs (setup, handling, QA, returns, etc.).
- Create cost drivers: Link those activities to measurable transactions in NetSuite (work orders, shipments, cases, etc.).
- Reassign costs and rebuild BOMs: Use NetSuite’s advanced costing and allocation rules to tie those activities to specific SKUs, jobs, or customers.
- Build accountability by department
- Review and refine: Start with a pilot product line or warehouse segment, analyze results, and expand.
If your finance team is still struggling to reconcile reports or explain margin swings, ABC can be your turning point.
The CFO Perspective
The takeaway? Gross margin alone won’t save you. If you want to know where the money really goes, and where you should double-down, activity‑based costing gives you the lens you need.When your costing model is accurate, decisions get easier:
- You know which SKUs deserve marketing spend.
- You can justify or eliminate customer discounts.
- You can optimize production schedules based on actual profitability, not guesswork.
This is where CFOs and COOs start speaking the same language again.
Activity-based costing is to increase visibility. It connects your operational data to the financial story that drives decisions.
Expand your growth.
If your reports look clean but reality says otherwise, activity-based costing might be the missing link.
expandCFO helps companies like yours build costing models that actually reflect the business you’re running, not the one you used to be.
Need a clearer picture of what’s really driving your margins? Let’s talk.
