by Gwyn Guthrie

Created on: February 28, 2010   Last Updated: August 07, 2011

Activity based budgeting is a planning philosophy that provides for cohesive business operations, streamlined management layers and optimal levels of staffing for the entire company.  Using budgeted expectations for various activities will give the business owner true power that comes from knowing every aspect of the business.  To implement activity based budgeting, the company must begin by identifying all activities of the business and carefully construct the ideal budget for that activity, including revenue to be expected and expenditures for the activity. 

Begin with the basics. Identify each staff function and capture the data for revenues and expenditures related to that activity.  This is a data collection stage. It is easy for the project to become derailed with attempts at corrections and adjustments for pet projects.  Those influences must be set aside for the company to experience success in this endeavor.  After identifying the activities, rank them in order of impact to the customers and profits to the business. Activities that are adding value to the business should continue. Eliminate any non-essential activities from the company process flows.

The goal of activity based budgeting is to uncover opportunities for eliminating unprofitable customer relationships, implement process improvements in production and manufacturing, evaluate alternative product designs for cost savings, and generate capacity for new products for the company.  Evaluate every resource of the company associated with specific activities to identify all resource constraints and excess capacity perspectives.   Use the roster of activities along with expected revenue, personnel costs and non-personnel costs to track variances for each activity for each month and establish trend lines. The budgeted activity may need adjustment until the company fully understands the goal and the cost drivers for a selected activity.  As new activities are added to the roster, incorporate additional detailed activity budgets.

The initial activity based budget will include certain cost driver rates for personnel and for other resources. Review and update the cost driver rates periodically to reflect changes in operating expenses.  Use of quality programs, engineering changes and continuous improvement efforts will result in reduced costs for budgeted activities. The cost driver rates will need adjusting to reflect those cost savings.  Some companies adjust cost drivers periodically (quarterly or annually) while other companies use event-based adjustments that reflect changes to the resource pool or capacity of that pool.  An example of event-based adjustment would be implementing a new software system to eliminate certain steps in the process flow of the manufacturing floor.  At the time of the implementation event, certain resources would become available for reassignment and that would then be a logical time for updating the cost drivers for future analysis.

Activity-based budgeting and activity-based accounting march hand in hand to provide powerful business intelligence.  Additional information on how to implement these programs in your company can be obtained through local accounting seminars and college courses.

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