Activity-Based Budgeting (ABB)
Activity-based budgeting (ABB) is a method whereby a company's activities are analyzed by weighing them against the cost of the company's products.
Many activities are performed in an organization, and the performance of such activities incurs costs. Also, therefore it becomes important for the organization to analyze such activities and take measures for performing the activities efficiently by considering the company's budget.
Activity-based budgeting is not only important for the efficient performance of the activities of a company, but it also helps in preparing the company's budget or price for retrieved products/services.
One of the best advantages of activity-based budgeting is that it helps the company reduce costs, which ultimately helps the company earn more profits or increase sales.
Working of Activity-Based Budgeting
For any organization, what is more important is to keep the cost to the minimum as it is a way to increase profits. But the management of costs to the minimum should be done effectively, and it should not be excessive as excessive reduction of costs may also harm the growth of the company. Therefore, it should be done in such a way that the company can earn profits and also keep the cost to a minimum while maintaining quality and brand value.
Activity-based budgeting also helps the company in the reduction of activity, which is used to generate sales effectively. Furthermore, it helps the company in cutting many unnecessary costs, which ultimately helps the company to boost its profitability.
Steps involved in Activity-Based Budgeting
Following are the three steps through which Activity-based budgeting can be done-
- The ABB's first step is identifying relevant activities. This step determines what activities the company will perform in the next fiscal year. Examples of activities are ordering, delivery of the items, setting up the machines, etc.
- The second step in activity-based budgeting is the calculation or estimation of the activities that the company will perform in the next year. Here, for example, in the case of a company placing or receiving an order, the number of activities is the total number of orders placed or received by the company.
- The third and last step of Activity-based budgeting is calculating the total cost incurred in performing those activities. It is the calculation of the cost driver rate, which means cost per unit of activity.
Benefits of using Activity-Based Budgeting
Activity-based budgeting focuses on the overhead activities of a company and the costs associated with such activities. According to Activity-based budgeting, the costs of the activities can be controlled if the volume of the activities is controlled in parallel.
The difference between traditional budgeting and activity-based budgeting is that traditional budgeting focuses on input costs, while the activity-based budgeting approach is output (outcomes) based. Activity-based budgeting defines a business as a collection of different activities, and the budget is prepared accordingly.
Precautions in Activity-Based Budgeting
The following points should be kept in mind before implementing activity-based budgeting:
- Activity-based budgeting cannot be done in a short time; it takes a longer time. Therefore, it becomes necessary to consider whether a company has enough time and support to implement Activity-based budgeting.
- The next thing which becomes essential for implementing Activity-based budgeting is whether there are enough resources or software available or not.
- Not only time but Activity-based budgeting requires enough funds, too, as it is costly to implement. Therefore, a company must first check that the costs incurred in implementing activity-based budgeting do not exceed the benefits to the company.
- Activity-based budgeting totally depends on the activities of a company; therefore, for proper implementation, it is important to check first that the company can list all the activities it will perform in the next year. Because if any activity is missed in the implementation of the Activity-based budgeting, then the result of the budgeting could vary from the actual report, which will not be good for the company. And also, as it is expensive to implement Activity-based budgeting, it cannot be done repeatedly.
- The last point that the company needs to consider before implementing Activity-based budgeting is if the company can get buy-in from the operational managers.
Things to Avoid while Activity-Based Budgeting
The following activities should be avoided while implementing the activity-based budgeting approach:
- Companies that are not using Activity-based costing should avoid implementing an Activity-based budgeting approach in their company. If the company is using an Activity-based costing approach, then only it should adopt an Activity-based budgeting approach in the company. Simply put, Activity-based budgeting is best suited for companies that adopt Activity-based costing.
- When implementing activity-based budgeting, it is very important that operations managers are included in the process; the company should not ignore them during implementation. The inclusion of operational managers in the implementation of Activity-based budgeting becomes important because if they are not included, they might struggle to understand the concept of Activity-based budgeting, which can also make the process of Activity-based budgeting more time-consuming.
Example of Activity-Based Budgeting
Suppose a company named ABC anticipates that it will receive 25000 sales orders in the next year, and the cost incurred for every single order is Rs. 140. Therefore in such a case, to calculate the Activity-based budget for this particular activity and the total expenses which are going to occur, the number of sales orders received will be multiplied by the cost incurred per order. Therefore, the Activity-based budget will be Rs. 3,500,000 (25000*140).
- It should be noted that the new companies that do not have access to historical budgeting information can also adopt the Activity-based budgeting approach as it does not need any historical information related to the company for the result.
- Activity-based budgeting is also helpful for companies facing changes in their organization, like the addition of new subsidiaries, significant customers, products, or business locations, because Activity-based budgeting does not require any historical information.