Budgeting allows companies to estimate their revenues and expenses for a specific period in the future. It provides them with a standard or benchmark against which they can measure their actual output. In most cases, budgets are crucial in keeping companies on track through their income and expenditure. This process can involve several steps and a comprehensive understanding of finance.
Budgets can apply to all entities, including individuals, businesses, companies, organizations. The process usually involves making a comprehensive list of expenditures and expected income. While entities can budget manually, several tools are available that make this process online. However, budgeting does not involve complying with strict rules and standards. Instead, it provides a benchmark for operations.
Budgeting can be significantly crucial for various reasons. Primarily, it helps entities understand their expenses and incomes better. This way, they can estimate their future performance or position. However, it is crucial to select the best type of budget that suits an entity’s needs. One of these types includes the activity-based budget, which can have several benefits.
What is Activity-Based Budgeting?
Activity-based budgeting is a process used to budget for the future. However, it does not involve a similar process as traditional budgeting techniques. Instead, it uses activities to allow companies to create a more precise budget. Activity-based budgeting involves basing the budgeting process on “activities,” which can lead to significant efficiencies.
An activity-based budget helps companies record, research, and analyze their activities. In essence, business activities include any operations that a company engages in to earn profits. Generally, this term refers to any activity carried out by a company during its operations. These activities may fall into various categories, for example, operating, investing, financing, etc.
Activity-based budgeting does not require traditional budgeting techniques. Most other budgets use a base, which usually comes from past operations. Once that information is available, it involves using increments or decrements to adjust the budget for future use. In most cases, these increments consider information or business development needs. While this technique works for some companies, it may not always provide efficient results.
However, activity-based budgeting estimates a company’s activities. Based on that information, it calculates a budget for expenses and income. Usually, activity-based budgeting does not consider historical information or costs when devising a budget. This process is more rigorous compared to the traditional budgeting techniques.
Overall, activity-based costing is a budgeting technique where companies analyze their activities to predict operations. While this process may be lengthier compared to traditional budgeting methods, it can provide more accurate results. However, it also involves more work, which can lead to significantly higher costs. This process can lead to higher efficiencies.
How Does Activity-Based Budgeting work?
Traditional budgeting methods use historical budgets to use as a base for modification. Based on these budgets, the company uses estimates to increase or decrease the budget. Usually, companies adjust their existing budgets for inflation and come up with a new one. For some companies, this process leads to an incremental budget. However, it can also produce inaccurate results.
Instead, activity-based budgeting requires companies to use activities to create a budget. Usually, this process involves thoroughly recording, researching, and analyzing various activities within a company. This process may lead to significantly higher work compared to the traditional budgeting techniques. However, it can also allow companies to understand their operations better.
The first step when creating an activity-based budget is identifying relevant activities. Usually, this involves establishing various cost drivers. These are items that contribute to a company’s revenues or expenses. The identification of cost drivers is significantly crucial for setting a base for this budget. Usually, an activity may have single or multiple cost drivers.
The next step for activity-based budgeting involves establishing the number of units associated with each activity. These units relate to the costs drivers identified in the first step. Once companies determine these numbers, they can use them as a baseline for their calculations. For each cost driver identified, the number of units and basis will differ.
Lastly, the activity-budgeting process involves accurately calculating the cost per unit of activity. This step is crucial in getting a base for future calculations. Once companies establish the cost per unit, they can use the result to multiply with the activity level. This way, they can create an overall budget based on the total expected activity level.
What Are the Benefits of Activity-Based Budgeting?
The most significant benefit of activity-based budgeting is that it provides a more accurate budget. By recording, researching, and analyzing activities, companies can understand their operations better. Based on this information, they can build a more precise budget compared to other traditional methods. Usually, the more effort they put into the process, the more accurate the budget will be.
Similarly, by understanding their operations better, companies can break down their costs more efficiently. This way, they can determine what factors contribute to its costs. Therefore, activity-based budgeting leads to a more precise budget. On top of that, it also allows companies to understand their operations. This process can provide better insights into inefficiencies in processes and any wastages that may exist.
Activity-based budgeting also provides an alternative method to budgeting compared to traditional ones. While those methods may produce consistent results, they may not be as accurate. On top of that, activity-based budgeting takes a forward-looking view rather than fixating on historical performances. This way, it can provide a realistic budget compared to other techniques.
In most modern companies, activity-based budgeting can provide better results. These companies operate in a dynamic environment where changes transpire regularly. By using this budgeting method, they can adjust to any deviations that may occur. It can also lead to more accountability within a company since the cost drivers and activities are available.
What Are the Drawbacks of Activity-Based Budgeting?
Aside from its benefits, activity-based budgeting may also have some drawbacks. The most crucial of these is the process involves preparing these budgets.
As mentioned above, activity-based budgeting involves various steps. Each stage within this process requires significant effort and time compared to other budgeting techniques. Therefore, it can complicate the process and make it unnecessarily lengthy.
Due to this complicated process, companies may also suffer more costs. Companies need resources to complete the activity-based budgeting process. As mentioned, this process involves recording, researching, and analyzing activities. Each step within this process requires time and effort, all of which can lead to higher costs. For some companies, the benefits from this process may not exceed those costs.
On top of these, activity-based budgeting also requires experience. Most traditional budgets involve incrementing existing figures for inflation. However, activity-based budgeting includes more. In most cases, this technique requires experienced staff that can complete all stages within it. On top of that, the staff must be experts in finding inefficiencies and compensating for them in the budget.
Activity-based budgeting may also focus on short-term objectives rather than long-term goals. Similarly, it uses forecasting with historical activity data, which may lead to unreliable results. It occurs when the plans do not meet the actual results. This way, it can lead to issues and create unnecessary stoppages.
Activity-based budgeting is a technique that relies on activities for budgets. It goes against traditional budgeting techniques, which adjust historical figures for inflation.
Instead, it uses three steps to create a more reliable budget. The benefits of activity-based budgeting may vary from one company to another. However, it may also have some drawbacks, as listed above.