Why Activity Based Budgeting Is Your Solution For A Cost Efficient Business Strategy.

Activity based budgeting is a modern approach to financial planning linked directly to organizational strategy.

It requires you to establish all activities that incur costs in each function of your business and then define the relationships between those activities.

The information you get will guide your decision on how much resource you should allocate to each activity.

ABB provides you with greater detail, especially regarding overheads, because it permits the identification of value-adding activities and their cost drivers.

This page will demonstrate to you the difference between ABB and other commonly used forms of financial forecasting, and also let you appreciate its strategic role as a cost and management tool, in as far as running your business more efficiently is concerned.

The Traditional Budgeting Approach

Traditional forecasting practices such as Zero Based Budgeting, Incremental Budgeting, are operated on the basis of predetermined maximum spending limits, and are normally characterized by the need to re-write the business plan to fit expenses.

The traditional process focuses on what managers are allowed to spend, and not the resources they actually need to add value to their business. Thus, the traditional budget process fails to identify waste, does not identify the incoming workload, does not support continuous improvement, does not identify cost drivers, and appears to have a general lack of ownership and buy-in.

Other criticisms of the traditional budgeting process are that it is extremely time-consuming for the benefits achieved, it results in arbitrary cost increases or reductions, and it focuses on resource inputs instead of the outputs generated by those inputs.

The true cost of producing a product caused by complex overhead activities such as research, marketing, human resources are simply not captured or measured with traditional methods.Indeed, traditional methods typically under cost low volume but complex products and over cost high-volume products.

In summary, traditional forecasting practices do not appear to serve the needs of modern organizational strategy, whose main objective is inclined towards efficiency and cost leadership.

A case for Activity Based Budgeting

  • ABB will provide opportunities for better communication of strategic objectives throughout your company.
  • It will allow for an optimum utilization of resources by focusing on how best you can continuously improve up on the deployment of your business resources.
  • An effective ABB model will identify the level of resources you need to perform each of your business activities, the relationship between those activities and the resulting output, and how changes in output expectations will affect the required activities.
  • Using ABB management will provide you the opportunity of focusing on questions about why you need to perform certain activities, how often you need to perform them, and their cost.
  • Activity-based information on process and product costs will highlight excess or wasteful activities that you may want to get rid of or reduce and pinpoint potential alternatives to which you could re-deploy resources .
  • In manufacturing, Activity based Costing can enable you quantify decisions such as how a reduction in set-up and machine repair costs will be traded off against the cost of new machinery you may want to investment in.
  • It facilitates detailed analysis of costs, and may also lead you into thinking about why you have been generating certain avoidable costs, or why a particular process within your production cycle is costing you more than it Costs your competitors.

Activity based budgeting in a Strategic Perspective

It is a management methodology defined by Harvard professors Kaplan and Cooper in their 1991 book Cost & Effect, in which they address the distortion problem of traditional costing methods for assigning overhead costs directly to product.

The Harvard professors have stated that ABB measures activities that consume company resources. Activity Based Management (ABM) manages resources to new and more valuable activities. Together, they enable fact based, quantitative management initiatives such as Cost Reduction, Business Process Re-engineering (BPR), Customer Relation Management(CRM),Value / Supply Chain Management and Benchmarking.

Bottlenecks to Activity Based Budgeting

Business acumen and the ability to properly apply powerful transaction-based systems are becoming an all important ingredient in today’s world of modern commerce.

Many companies around the world are undertaking ABB initiatives and are thereby experiencing positive results and solid improvements as a direct result. However, many companies are falling short of the greater goal of moving on to full-scale operational Activity Based Management.

Why is this the case?

  • Without proper understanding of the benefits and implications of the ABM, ABB concepts,projects sometimes are dying from neglect.

    Ultimately, Activity based budgeting is about change management and people often resist change. The processes necessary to develop and implement ABB results are often becoming too difficult to sustain.

  • For ABM to be implemented on a continuous basis, costing must be executed on a regular, monthly or quarterly basis with the results integrated into the company’s overall performance management process.
  • Successful activity-based budgeting relies on the extraction and transformation of diverse operational (or ‘cost drivers’) data that is often not readily available or easily retrievedfrom source information systems on a regular basis.
  • Having a parallel financial reporting system, with the accompanying reconciliation to officially reported results, has also further diluted the viability of maintaining the ABB process.

Activity based budgeting is a fairly complex system to implement and monitor. We highly recommend that you employ or contact a certified accountant for professional guidance. Please don’t hesitate to contact us, for further online support on this subject and more.

Return from activity based budgeting to budgeting.

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