How does activity-based budgeting allocate resources in businesses?

Activity-based budgeting allocates resources in businesses by linking them to specific activities that generate costs.

Activity-based budgeting (ABB) is a method of budgeting where activities that incur costs in every functional area of an organisation are recorded, analysed and associated with specific outputs. This method is based on the understanding that not all costs are the same, and different activities consume resources differently. Therefore, it aims to allocate resources more accurately based on the actual consumption of resources by different activities.

The process of ABB involves identifying the various activities performed in an organisation, determining the resources consumed by these activities, and then assigning costs to products or services based on the activities involved in their production or delivery. This approach allows businesses to understand the true cost of their products or services, and make more informed decisions about pricing, outsourcing, process improvement and other strategic issues.

For example, if a company manufactures a product, the activities involved might include purchasing raw materials, operating machinery, quality control, packaging, and shipping. Each of these activities consumes resources - such as labour, materials, and overheads - and therefore incurs costs. By identifying and analysing these activities, the company can allocate its resources more accurately and efficiently.

ABB also helps businesses to identify non-value adding activities and eliminate them, thereby reducing costs and improving efficiency. It provides a clear picture of where resources are being used, and where they might be better allocated. This can lead to significant cost savings, and can also help to improve the quality of products or services.

In summary, activity-based budgeting is a powerful tool for resource allocation in businesses. It provides a more accurate and detailed understanding of costs, and can help businesses to make more informed and effective decisions about resource allocation.