5–11. Use Activity-Based Budgeting

For many organizations, the existing budgeting system simply does not yield adequate results. Management can fiddle with the numbers all they want, but working within the existing structure of revenues by product line and expenses by department is so rigid that there is little room for improving operating results. Only by using outlandish assumptions, such as inordinate price increases or cost reductions, can any reasonable profit improvement be attained. As the new budget year progresses and everyone realizes that those absurd assumptions are not attainable, some of the blame is put on the budgeting process, resulting in a loss of credibility. This problem is especially common in old, established industries, where competition is high and low profits are the norm.

Activity-based budgeting is the best solution for companies in this quandary. To use it, the existing budget model must either be scrapped or used alongside a new model, which pools all costs into cost centers, assigns these costs to activities, and charges the activities to products and customers. By using this new approach, one can see much more clearly the products on which a company really makes (or does not make) money, and margins on all customers, based on the services they demand from the company. With this better information, management can target cost reductions in those areas where there is little return on the money invested, while targeting expense increases if there is ...

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