Updated July 25, 2023
Definition of Activity Based Budgeting
Activity-Based Budgeting is a process of creating a blueprint or financial plan in advance which will act as a yardstick by addressing individual activities which are to be carried out given the limited amount of resources in an organization using research tools and allocating the resources accordingly as per their priority in form of a budget specifying expected costs that are required to be spent.
Components and Process of Activity Based Budgeting
Components and Process of Activity Based Budgeting are given below:
- It starts with identifying activities that revolve around resource consumption and these activities are mainly classified as main activities and secondary activities which denotes the degree of involvement and importance of an activity to the organization as per their priority, therefore, main activities are activities which are directly related with the objectives and are essential.
- Secondary activities are those activities that create added value to the customer and change its preference in the organization’s favor which may involve a significant amount of resources.
- After defining the activities the next task is to identify how to distribute the costs or resources accordingly among the activities which are done with the help of inducers which are factors defining the level of consumption in different activities.
- Mainly three such inducers influence such decisions which are time which depicts the duration for the processes, amount of resources required by each activity, and lastly the number of times an activity is repeated after getting all these facts the appropriate costs can be calculated.
Example of Activity Based Budgeting
Following is the example budget for the first quarter of the year 2020 of company A ltd based on the activity:
Advantages and Disadvantages of Activity-Based Budgeting
Advantages and Disadvantages are mentioned below:
The various different advantages related to Activity-Based budgeting are as follows:
- Activity-Based Budgeting takes up a forward-looking view rather than looking at previous activities which is a common feature under traditionally based budgeting i.e. it asks questions like what needs to be performed and where can we make improvement rather than what was done earlier and sort of just allocation of costs according to that.
- Activity-Based Budgeting sources its budgets based on activities and resources allowing better insight on inefficiencies in processes and sources of imbalances which will help the managers find areas of improvement making them more efficient in their jobs.
- Activity-Based Budget has a more practical approach in a dynamic environment and makes it easier for the employees and managers to communicate and execute the activities in a time-bound manner as well as to evaluate performances of the same by fixing accountability of specific activities.
- Activity-Based Budget leaves scope for making changes as per the changes in the climate and current situation as opposed to what was initially planned as it allows tools to trace resource consumption which allows identifying capacity issues so they can adjust in a timely manner.
The various disadvantages related to Activity-Based budgeting are as follows:
- Activity-Based Budgeting is a lengthy and comprehensive process that requires a considerable amount of time and resources on an entity and spending too much on analyzing may prove to be counterproductive.
- It requires a well-groomed talented team of individuals who are experts in finding gaps and are equally competent in reporting and use of the necessary software as it is a complex process on which the direction of the company is dependent.
- While preparing an Activity Based Budget it is possible that the axis of focus may shift to immediate and short-term results and the bigger picture may be ignored causing damage in the long term.
- It is based on forecasting with the use of historical data and future expectations which may sometimes prove to be unreliable if the situations or scenarios planned do not come out to be what was expected to lead to problems that can hamper the entity and its resources.
- Activity-Based Budgeting provides only supplemental information.
Important Points of the Activity-Based Budgeting
- It is simply put getting a detailed analysis of all the costs associated with activities. A tool that enables the managers to gain control ensuring timely and quality delivery while cushioning them for an unforeseen future as it is a flexible approach and promotes innovation which is a great advantage to have compared to the traditional system of budgeting. However, it is much more complex and difficult to manage as compared to traditional systems as its emphasis is on the added values that activities bring to the product.
- Activity-Based Budgeting has helped not just private institutions to run smoothly but also has its impact on drawing major public policies and government spending. Various institutions like schools, universities and non-governmental organizations have also been using this technique to make decisions, enable transparency and fix accountability of work creating a better environment overall of efficiency and brilliance. The format and syntax of the budget may vary for different organizations there is no uniform format.
It is a detailed, lengthy, complex, and continuous process that requires a significant amount of resources and time which an entity may not necessarily have. Further Activity Based Budgeting may cause more confusion rather than become a solution if not handled properly. It is a very unique approach to look at things from a different perspective enabling better decision making hence improving the internal processes within the organization. Therefore Activity Based Budgeting is better suited to those who are willing to innovate and want to be quick to make changes, identify and correct mistakes in a time-bound manner which are those organizations that have a significant amount of resources and a resolution to excel at any cost.
This is a guide to Activity-Based Budgeting. Here we discuss the introduction and components and process of activity-based budgeting along with advantages and disadvantages. You may also look at the following articles to learn more –