Activity-Based Budgeting (ABB)

What Is Activity Based Budgeting?

Activity-based budgeting is one of many budgeting techniques. While not as common as methods, such as traditional budgeting or zero-based budgeting, it can nonetheless be a very useful exercise for many organizations.

Activity-based budgeting is more thorough and rigorous than most other budgeting methods because it involves breaking out the costs associated with every single activity carried out by an organization.

This more detailed method of budgeting allows companies to understand which activities are driving the most profits and how to better manage resources and reduce costs. It is also useful for companies who are undergoing significant changes in their business and need to re-evaluate the impact of every activity.

Activity-Based Budgeting vs. Traditional Budgeting

How does activity-based budgeting differ from traditional budgeting?

When developing a traditional budget, companies will often look at values (such as revenue and expenses) from prior years and then use those values as a baseline when projecting future values. For example, a company might have revenues of $100 million in the prior year and project a 10% growth for a forecasted total of $110 million in revenue for the upcoming year.

In contrast, activity-based budgeting igneous historical values. Instead, activity-based budgets look at all the activities expected to be carried out by a business in the upcoming year and then outlines the cost associated with each activity in detail.

Activity-Based Budgeting

Activity-based budgeting looks at all costs and resources associated with an activity such as:

• Raw materials
• Wages
• Number of expected labor hours
• Returns

Traditional Budgeting

Traditional budgeting involves:

• Reviewing historical costs
• Projecting future costs by increasing or decreasing historical costs

Examples of Activity-Based Budgeting

Company Y expects to receive 10,000 orders for one of their products in their next fiscal. To process each order, it costs Company Y a total of $5.

In an activity-based budget, the costs for processing these 10,000 sales orders would be $50,000.

Now, let’s look at this example from a traditional budgeting perspective, which we know looks at historical costs while activity-based budgeting does not. So let’s say that in the prior year budget, Company Y spent $40,000 on processing sales orders. And in the budget for the upcoming year, Company Y is expecting a 10% growth in sales. In this case, only $44,000 would be budgeted for.

Advantages of ABB

Here are a few advantages of activity-based budgeting (ABB):

• Helps cut costs
• Improves resource allocation
• Increase cross-departmental budget collaboration
• More control over the budget

Disadvantages of ABB

Here are a few disadvantages of activity-based budgeting (ABB):

• More expensive to implement
• More time-consuming to perform

How To Make an Activity-Based Budget

So how do you create your own activity-based budget? There are three main steps involved:

1. Identify Your Activities and Their Associated Costs. Any activity that supports the business or generates revenue counts as an activity. And any expense required to carry out that activity counts as a cost.

2. Compute Baseline Units for Each Activity. What do we mean by units? Examples include the number of staff and numbers of wage hours required to perform the activity.

3. Compute the Total Cost of Each Activity.First, calculate the cost per unit for each activity. Then multiply that number by the activity level.

If you’re looking for templates for your budgeting needs, head on over to our library of free Excel templates.

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