Activity-Based Budgeting (ABB)

What is ABB?

Activity-Based Budgeting (ABB) is a budgeting approach that identifies and analyzes the activities that drive costs in an organization. Instead of adjusting prior-period budgets for inflation or growth, ABB builds budgets from the ground up by estimating the resources required for each activity and the expected activity levels. The goal is to reveal inefficiencies, control costs, and align spending with business objectives.

How ABB works

ABB breaks budgeting into three practical steps:
1. Identify cost-driving activities (cost drivers) — the tasks or processes that consume resources (e.g., order processing, machine setups, customer support calls).
2. Estimate the activity level — the expected volume or number of units for each activity during the budget period.
3. Determine cost per unit of activity and multiply by the activity level to produce the budgeted cost for that activity.

This produces a detailed, activity-based projection of expenses that can be aggregated into departmental and company budgets.

When to use ABB

ABB is especially useful when:
* Historical budgeting data are unreliable or not representative (e.g., new companies, startups).
* The organization is undergoing significant change (new products, acquisitions, new business locations).
* Management needs more granular control over cost behavior and resource allocation.
For stable, mature organizations with predictable operations, simpler traditional budgeting may suffice.

Example

Company A expects 50,000 sales orders next year. Processing each order costs $2.
* ABB estimate: 50,000 orders × $2/order = $100,000 budget for order processing.
* Traditional approach: If last year’s budget was $80,000 and expected sales growth is 10%, the traditional budget would be $80,000 × 1.10 = $88,000.
ABB can reveal a different funding need by tying costs directly to activity drivers rather than relying on past totals.

Advantages

• Greater accuracy and transparency — budgets reflect actual activities and cost drivers.
• Improved cost control — identifying unnecessary activities enables cost reduction and efficiency gains.
• Better alignment with strategy — resources can be allocated to activities that support company objectives.
• Useful for planning under change — works well when past data are not a reliable guide.

Disadvantages

• Higher implementation and maintenance cost — ABB requires detailed data collection and analysis.
• Time-consuming — establishing activity definitions and measuring drivers takes effort.
• Dependence on assumptions and management judgment — incorrect estimates of activity levels or costs can yield inaccurate budgets.
• Complexity — may be more detailed than necessary for stable, small, or low-change operations.

Key takeaways

• ABB builds budgets from activities and their cost drivers rather than from historical totals.
• It provides detailed insight into cost behavior and opportunities for efficiency, but it is more resource-intensive to implement.
• Choose ABB when granular control and accurate forward-looking budgeting are needed; use traditional methods when operations are stable and predictable.