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BEST PRACTICES - Activity Based Budgeting

Activity Based Budgeting is an outgrowth of Activity Based Costing; which defines the "real" cost of providing a product or service (internal to the company or external to the customer) by capturing and analyzing how workers spend their time. Activity Based Costing is often thought of as a highly rigorous approach to allocating costs, and can be used to refine pricing models (especially when price is set based on underlying costs), improve profitability analysis, and so on. Activity Based Budgeting uses these same models, and given projections for volume, provides projected costs.

If Implemented Well If Not Implemented Well
Detailed understanding of an organizations costs.

Increased control over expenditures.

Improved understanding of the linkages between a company's processes & activities and their related costs.

Increases the level of the dialog during departmental budget review sessions, encourages a healthy discussion of issues and cost drivers.
Results can be ignored or dismissed. Allocated costs tend to be hotly debated, even if they have been rigorously developed (as they are with ABB).

Difficult to implement, as Activity Based Budgeting first requires an Activity Based Costing (ABC) system.

Time consuming - a solid Activity Based Costing system (a requirement for ABB) requires workers to record how they spend their time.

Garbage in, garbage out. If workers don't record their time accurately, the value of an ABC system or Activity Based Budgeting can be undermined.

Can this work for my company?
For cost minded companies, Activity Based Budgeting, supported by an Activity Based Costing system can appear to be very attractive. If implemented well, it will help to control costs and help a management team tighten their grasp on the business. But the ultimate success of ABB depends heavily on two factors: management's commitment to act on the data, and worker's commitment to accurately record their time.

There will be some resistance to the allocated costs derived from ABC models, and projected using Activity Based Budgeting. That's to be expected. But if this approach is to be successful, management must support the results. Of course it can't do that without a thorough and complete understanding of how it works (which requires an investment of their time).

If management team does not understand how the budgets and allocations were developed, and fails to support the results, then the entire process can be undermined.

Likewise, if individual workers fail to accurately account for their time, or if their superiors take too many shortcuts in estimating their time, then the resulting allocations and budgets will not prove very useful.

In light of this, you may want to consider implementing ABB if your company meets this criteria:

You have a data warehouse, or have implemented an Enterprise Application System (such as SAP or Peoplesoft).
Management is committed to acting on the information provided by ABB.
There is an incentive system for workers recording their time in an ABC system.
Allocated costs today, without an ABC system, are sometimes thoughtfully challenged but rarely dismissed out of hand.