A business without a budget leaves its day-to-day spending to spiral into guesswork — and a business running on guesswork is likely to collapse at the first hint of an economic downturn. A budget acts as the skeletal framework on which crucial business activities, including resource allocation, cost control, and growth planning, rest.

These days, traditional budgeting methods, which rely heavily on historical data and past spending patterns, struggle to keep pace with dynamic markets. Rather than assigning budgets based on outdated data and assumptions, activity-based budgeting (ABB) focuses on the costs incurred by specific business activities and allocates budget according to their weightage on the activity. This makes ABB efficient in meeting dynamic business goals.

How Does Activity-Based Budgeting Work?

You cannot transition from a traditional budgeting method to ABB overnight. Using a structured approach, with a phased transition, can help you align the method with your business objectives.

Step 1: Identifying Business Activities and Their Cost-Drivers

Activity-based budgeting focuses on specific business activities and their costs. You begin by identifying activities that are crucial to your business objective and the costs incurred in fulfilling those activities. For example, for a manufacturing business, procurement of raw materials and machinery, machine setup, quality checks, and product packaging are the main activities. Each of these activities has primary costs, such as

1. Procurement: Commodity price volatility, freight and transportation costs, order volumes

2. Machine setup: Labour costs, training costs, setup duration, calibration, repairs and maintenance

3. Quality checks: Testing, sampling, technology costs for testing equipment, compliance validation.

Each expense contributes to the execution of specific business activity and should be considered while planning the budget.

Step 2: Separating Value Add and Non-Value Add Activities

With changing market patterns and customer preferences, some activities considered vital tend to become defunct over time. For instance, digital marketing has made print advertising outdated and less efficient. However, if not regularly monitored, such activities can stealthily eat up a large chunk of your financial resources.

ABB helps analyze whether all your business activities actually add value to the business, such as quality checks, customer onboarding, and other activities that enhance the product and customer experience. Any redundant activities and costs, including unnecessary approvals, overproduction, or excessive storage or inventory, are cut down or scrapped to channelize resources to their optimum capacity.

Step 3: Estimate Activity Volume and Calculate Cost per Activity

The next step is to estimate how often each activity will take place in the upcoming business cycle, so as to make budgetary provisions for them. Unlike traditional budgeting that relies on past performance, ABB’s estimate or projection is based on planned or desired production volumes, future sales forecasts, or strategic targets.

For instance, if you run a ride-hailing service and your business target is to increase long-distance rides. For this, the three main activities you need to focus on are: fuel cost per km, driver cost per km, and maintenance/vehicle cost every 1000 kms.

Here’s how your ABB will work.

The business objective is to deliver 100,000 Kilometers of long-distance rides across Canada.

1. Identify activity and cost:

• Fuel: $0.20 per km
• Driver: $1.10 per km
• Maintenance: $250 every 1,000 km

2. Estimate activity volume:

• Fuel Runs: 100,000 km
• Driver Kilometres: 100,000 km
• Maintenance Cycles: 100 service intervals (100,000 km / 1,000 km)

3. Calculate budget provisions:

Thus, you arrive at your total budget by understanding your resource consumption and costs rather than simply applying a certain percentage increase to last year’s budget. Because it is based on realistic, data-driven forecasts rather than assumptions, it also enhances operational efficiency without compromising the quality of the service provided. It also gives you the flexibility to adapt your budget to changing objectives. If the target changes to 200,000 km, you know how much budget you need.

How Organizations Can Adopt Activity-Based Budgeting

ABB’s unique characteristic of focusing on one activity at a time makes it time-consuming. Small businesses can begin by adopting this method for a specific activity or department with defined objectives and significant cost impact, such as increasing sales volume or a marketing campaign for a new product launch. You have to rope in managers and employees who are well-versed in day-to-day operations to help identify cost drivers and estimate realistic volumes, prices, and other factors.

Once a detailed cost breakdown is available, you can set up a reporting system to track these costs, study cost trends, factors affecting them, and variances. A professional accountant and business advisor can help you with tracking, reporting, and analysis.

With detailed data at your disposal, you can allocate more budget to costs that add value and cut down on costs that do not add value. This way you can plan a reliable budget that gives you a fair idea of how much you really need to allocate to the activity to achieve the desired results. You can refine the process with regular monitoring. Once satisfied with the results, you could scale the method company-wide.

Why Small Businesses with Limited Resources Need Activity-Based Budgeting

Usually, ABB works well for start-ups and companies that are looking to expand into new markets, introduce new products, or add new business lines. These are scenarios where historical data is either unavailable or unreliable for budgeting. ABB is also a good fit for businesses with complex or diverse structures or product offerings such as manufacturing, healthcare, or financial services, where changes in operational costs can affect pricing, efficiency, output, and profitability.

ABB works particularly well for small businesses for three reasons:

• Strategic Resource Allocation: Because ABB allocates resources based on actual operational needs, it ensures every dollar is spent constructively towards fulfilling a specific business objective. This helps a small business optimize its limited funds and resources.
• Flexible to Scale Up or Scale Down: Managers can review the main cost drivers individually and their impact on total output, making targeted corrective action and restructuring possible. Moreover, you can adapt the method for a particular high-priority department or activity and scale up later, instead of adopting it to the whole business at once.
• Improve Operating Efficiency: While identifying priority-driven activities and their cost drivers for ABB, you automatically identify unnecessary costs that are leaking funds. Small businesses can remove redundant activities and hidden expenses to enhance operational efficiency at the budgeting stage itself.

Seeking guidance from a business consultant can help you identify your main business activities and their cost drivers faster. Their experience equips them to look in the right places for the right data. Plus, data gathering and analysis are time-consuming, so outsourcing it to a consultant can prevent your staff from being overburdened. They can also help you set up systems to automate data collection and report generation.

Contact Ford Keast LLP in London to Help You with Business Budgeting

Talk to a business consultant to help you with detailed cost analysis and actionable insights to improve operational efficiency, budgeting, and forecasting. At Ford Keast LLP, our accountants and business consultants can provide services such as preparing operational reports, budgeting, and forecasting. To learn more about how Ford Keast LLP can provide you with the best accounting and business consulting services, contact us online or call us at 519-679-9330.