What is Activity-Based Budgeting ?

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Activity-based budgeting (ABB) is a system that records, researches, and analyzes activities that lead to costs for a company. Every activity in an organization that incurs a cost is scrutinized for potential ways to create efficiencies. Budgets are then developed based on these results.ABB is more rigorous than traditional budgeting processes, which tend to merely adjust previous budgets to account for inflation or business development.

Definition

Activity-Based Budgeting (ABB) is a system for recording, researching, and analyzing activities that lead to company costs. Each cost-generating activity within an organization is reviewed to find potential ways to create benefits. Budgets are then developed based on these results.

Origin

Activity-Based Budgeting originated in the 1980s as an improvement over traditional budgeting methods. As the demand for cost control and efficiency increased, ABB became widely adopted.

Categories and Features

The main feature of ABB is its detailed analysis and cost allocation of activities. It typically involves several steps: identifying activities, allocating resources, calculating costs, and developing budgets. The advantages of ABB include its accuracy and deep understanding of cost drivers, but it can be complex and costly to implement.

Case Studies

Case Study 1: A manufacturing company used ABB to identify bottleneck activities on its production line and successfully reduced production costs by reallocating resources and optimizing processes. Case Study 2: A service company used ABB to analyze customer service activities, discovering redundant processes and improving customer satisfaction and operational efficiency by streamlining processes.

Common Issues

Common issues include the complexity and high cost of implementing ABB, as well as accurately identifying and analyzing activities. A common misconception is that ABB is only suitable for large enterprises, whereas small and medium-sized businesses can also benefit from it.

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Activity Ratios

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Accounting Profit

Accounting Profit, also known as Financial Profit or Book Profit, is the net income of a business for a specific accounting period, calculated according to accounting standards. It is derived by subtracting total expenses from total revenues and is typically reported in financial statements, particularly the income statement (profit and loss statement). Accounting profit includes all realized revenues and incurred expenses but excludes unrealized gains or potential losses. It reflects the financial performance and operational results of a business and is a crucial indicator for assessing profitability. Accounting profit differs from economic profit, which considers opportunity costs and implicit costs, whereas accounting profit is based solely on actual transactions recorded.

Accounting Method

An accounting method refers to the rules a company follows in reporting revenues and expenses. The two primary methods of accounting are accrual accounting (generally used by companies) and cash accounting (generally used by individuals).Cash accounting reports revenues and expenses as they are received and paid through cash inflows and outflows; accrual accounting reports them as they are earned and incurred through sales and purchases on credit and by using accounts receivable & accounts payable. Generally accepted accounting principles (GAAP) requires accrual accounting.

Accounting Ratio

An Accounting Ratio, also known as a Financial Ratio, is a ratio derived from data in financial statements used to analyze and assess a company's financial condition, operational efficiency, and profitability. Common accounting ratios include the current ratio, quick ratio, debt-to-equity ratio, gross profit margin, net profit margin, and return on assets. These ratios help investors, management, and other stakeholders understand the financial health and performance of a business. For example, the current ratio measures a company's short-term liquidity, while the net profit margin indicates its profitability. Accounting ratios are essential tools in financial analysis, aiding in making more informed investment and management decisions.

Back-End Ratio

The Back-End Ratio refers to the percentage of a person's monthly gross income that goes towards paying all of their debts. This ratio includes housing expenses (such as mortgage, insurance, and taxes) as well as other debts (such as credit cards, car loans, student loans, etc.). The Back-End Ratio is a key metric used by lenders to assess a borrower's ability to repay a loan. Generally, a lower Back-End Ratio indicates a stronger ability to manage debt, making lenders more willing to extend credit. Typically, lenders prefer a Back-End Ratio that does not exceed 36% to 43%, depending on the type of loan and the lender's policies.

Headline Earnings

Headline earnings refer to a method of reporting corporate earningsbased entirely on operational, trading, and capital investment activities achieved during the previous period. Excluded from the headline earnings figure are profits or losses associated with the sale or termination of discontinued operations, fixed assets or related businesses, or from any permanent devaluation or write-off of their values.