Activity-based budgeting (ABB) is a top-down financial budgeting method focusing on resources allocated to individual budgeting activities instead of departments or products.
With an activity-based budgeting approach, you break down each business activity into tasks and assign costs for each task. This helps you determine the funding needed to support each task performed.
Examples of business activities include:
Breaking these processes down and identifying cost drivers allows for greater control over financial decisions and better visibility into how funds are used.
Activity-based budgeting can also help organizations identify cost drivers and redundant processes to streamline business operations and maximize resource efficiency.
A cost driver is a factor that influences the cost of doing business, from production and manufacturing to marketing and hiring. Examples of cost drivers include:
The more of each cost driver you use for producing an item or a service, the higher the total associated costs with that item.
Breaking down these costs is the first step in reducing the cost of producing goods or providing services.
Resource allocation based on activities, a core principle of Activity-Based Budgeting (ABB), ensures that financial resources are aligned with operational demands within an organization.
Unlike traditional methods, ABB prioritizes resource allocation according to specific activities' requirements, optimizing resource utilization and directing investments towards activities that contribute most to organizational goals.
This approach enhances transparency and accountability in budgeting, facilitating informed decisions and driving efficiency in financial planning and analysis processes.
Controlling costs is imperative to preserving revenue, so companies always look for creative ways to avoid overspending. This is why activity-based budgeting is such an effective budgeting approach.
Understand expenses incurred: Traditional methods of budgeting rely on the previous year’s data to establish the basis for changes. To perform activity-based budgeting, finance analyzes every cost from the ground up. Activity-based analysis occurs without consideration of the previous year's budgeting activities to justify every cost on its merit.
Improve business efficiency: Inefficiency creates a stealthy burden on cash. Using budget analysis to reduce inefficiencies in your process is an excellent way to ensure your business only spends money where it needs to.
Activity-based budgeting is an in-depth approach to planning future spending. It scrutinizes every expenditure at every step of the process to identify places to trim the fat and improve your business processes.
Companies use activity-based budgeting to get a deep understanding of and control costs. By breaking down costs into separate activities, companies can allocate resources more effectively, improve financial performance, and identify redundant or unnecessary activities.
Activity-based budgeting also helps ensure that the most important activities allocate the right budget. It can help uncover opportunities for cost savings It helps managers to track actual spending versus budgeted amounts and compare spending across different departments or locations.
You might consider using activity-based budgeting if:
Companies turn to activity-based budgeting when they need a better handle on spending. This type of budgeting exercise helps young companies manage their costs from the start and established companies bring expenses under control when needed.
Full spend visibility: Activity-based budgeting creates a granular view of every process that crates cost or revenue for the company. This level of detail takes time, but the effort pays considerable dividends in cost savings.
Budgetary control: Making decisions for the budget based on cost drivers enables better control over your spending. It allows companies to understand exactly what drives spend (and budget inflation) for better cash performance.
Competitive advantage: Reducing costs and optimizing processes allows you to produce goods more efficiently and retain more profit. Activity-based budgeting shows you where to improve and what’s essential to your process.
The biggest challenge of activity-based budgeting is when you have many new activities or variables—like new business locations—that you can't account for or that skew your numbers.
Time-consuming: The granular detail of an activity-based budget process requires significant research and analysis and can become time consuming. This budgeting system takes more time and labor investment than other planning methods.
Expensive: The level of research required to complete an activity-based budget means that many stakeholders will invest time in preparing data. This has associated costs not experienced with traditional budgeting. However, the cost benefits of this exercise may well justify the investment.
An activity-based budget breaks down each element of an organization’s spending into its component activities.
This includes:
By breaking down spending in this granular manner, organizations more accurately determine their total budgets for each activity and adjust accordingly.
To build an activity-based budget, use these steps.
Break down each process into its steps. For each step in the process, identify the expense it generates.
For example, manufacturing a product isn’t just “buy materials, make products.” The process is more complicated.
If a company estimates it needs to build 50,000 units of a product (based on its previous year of sales), it must complete each of the above steps for every item. Each repetition of the above steps has an associated cost.
An activity-based analysis looks at each step in this example to identify every cost driver associated with production, including materials, equipment, labor hours, and utilities.
In our manufacturing example, the product requires:
All these factors affect the price of production for each unit you produce.
So, we break down the product example above into its costs:
From here, you can calculate the total and per-unit cost of producing your item.
Once you have the figures for every piece of activity, you can calculate the total cost and per-unit cost of production:
Total cost: $135,000 for 50,000 units
Per-unit total: $2.70 per unit cost
With the above information, the organization can evaluate activity performance to become deeply familiar with its granular costs and use the information to cut individual cost drivers, such as:
This step-by-step analysis is intensive but effective to drive costs down and under control. This process helps organizations reduce costs for any business activity: Manufacturing, sales, marketing, recruiting, etc.
In this section, we'll explore key strategies for achieving success with ABB, from engaging stakeholders to leveraging technology and fostering a culture of collaboration.
Piloting: Start with pilot projects or smaller-scale implementations to test the effectiveness of ABB before scaling up.
Monitoring: Continuously monitor and evaluate ABB processes to identify areas for improvement and make necessary adjustments.
Training: Invest in training and skill development for employees involved in ABB implementation to ensure they have the necessary expertise.
Culture: Foster a culture of collaboration and communication to facilitate the successful implementation and ongoing management of ABB.
Technology: Utilize technology and software solutions to streamline ABB processes and improve data accuracy and analysis capabilities.
Review: Regularly review and update ABB methodologies and assumptions to ensure they remain aligned with organizational goals and objectives.
As you can see, activity-based budgeting can be a powerful strategy.
What about you? Are you going to try activity-based budgeting at your company this year?
If you're wondering about the logistics, like getting all your actuals together, then you should consider Cube.
Cube connects to your source systems (like your ERP) and matches, validates, and de-dupes you data so you fetch it into your Excel spreadsheet in a single click and start budgeting.
Interested in hearing more? Request a free demo below: