Activity-based budgeting (ABB) is a comprehensive budgeting system that links operational activities to the organization’s financial objectives. This system accounts for the internal resources used in activities and the external resources obtained from a variety of sources. It can be used to allocate resources, assess performance, forecast costs and plan for future activities. ABB can be used to identify potential cost savings and to allocate resources efficiently in order to reach the most profitable areas of the business.
Overview
Activity-based budgeting (ABB) is an analytical tool which helps managers plan and assess the investments they make in the firm’s activities. It identifies the relative profitability of each activity in relation to other activities, allowing managers to identify and invest in the most profitable activities. Furthermore, it helps to identify cost and efficiency savings by providing detailed data for managers at the activity level.
ABB uses cost drivers – such as direct labor, materials, overheads, and capital – to identify the cost of each activity. Through this approach, managers can understand how each activity contributes to the bottom line. It also provides the information necessary for managers to make rational decisions to modify activities or identify cost savings.
Activity-based budgeting often involves the use of several different techniques, such as activity-based costing (ABC), cost-volume-profit analysis, and capital budgeting. By providing a more comprehensive view of the business, ABB can be used to identify areas of cost savings or opportunities for improvement.
Benefits
The primary benefits of activity-based budgeting include:
– Improved decision-making: ABB provides managers with detailed cost information for each activity, allowing them to make more informed decisions.
– Enhanced cost savings: By uncovering cost savings opportunities from within the organization, businesses can reduce costs and improve efficiency. This can result in an improvement of the bottom line.
– More accurate forecasts: By understanding cost drivers and identifying the most profitable activities, businesses can develop more accurate forecasts for the future.
Example
A business that manufactures cars may choose to use activity-based budgeting to identify potential cost savings and allocate resources to the most profitable activities. The business might use ABB to compare the cost of producing new models of cars to the cost of producing existing models. It could then use this information to identify potential cost savings and allocate resources accordingly.
For instance, the business may find that producing the new model is less expensive than producing the existing model. As a result, the business can redirect resources to focus on producing the more profitable model. This may result in cost savings or increased profits for the business.
The use of ABB can be extended to other areas of the business as well. For instance, the business can use it to compare the cost of obtaining materials from one supplier versus another. This could lead to cost savings or better terms with the supplier.
Conclusion
Activity-based budgeting is a powerful budgeting tool that can provide businesses with detailed cost information, helping them to identify cost savings and allocate resources to the most profitable activities. By using ABB, businesses can improve their decision-making, identify cost savings opportunities, and develop more accurate cost forecasts. It is a useful tool for businesses looking to maximize their efficiency and profitability.