How does management use an operating budget? How do they use an activity-based budget? What are the similarities and differences between these types of budgets?
These sites may help you.
http://www.esight.org/View.cfm?x=1036
http://www.investopedia.com/terms/a/abb.asp
Thank you Sue!
Management uses an operating budget to plan and control the financial resources of a company or organization. It provides a roadmap for achieving financial goals by outlining projected revenues, expenses, and profit margins over a specified period of time.
To develop an operating budget, management typically follows these steps:
1. Determine the sales or revenue targets for the period.
2. Estimate the direct costs associated with producing or delivering goods or services.
3. Identify and allocate operating expenses such as rent, utilities, salaries, and marketing costs.
4. Anticipate any additional income or expenditures, such as investments, loans, or taxes.
5. Forecast the resulting net profit or loss.
Management uses the operating budget to:
1. Set targets and monitor performance: The budget provides a benchmark against which actual financial performance can be measured. By comparing actual results to the budget, management can identify areas of overspending or underperformance and take corrective actions.
2. Allocate resources: The budget helps management allocate financial resources effectively by prioritizing expenditures and determining where it is most beneficial to invest.
3. Facilitate decision-making: The budget enables management to make informed decisions about pricing, cost reduction initiatives, production volume, and overall business strategies.
4. Assess and improve profitability: By analyzing the resulting profit margins, management can evaluate the financial viability of different products, projects, or departments. It helps identify opportunities for cost reduction and revenue enhancement.
Now, let's talk about activity-based budgeting (ABB). This approach focuses on allocating costs and resources based on the activities that drive those costs. It aims to provide a more detailed and accurate picture of how resources are consumed within an organization.
Here's how management can use activity-based budgeting:
1. Identify cost drivers: Determine the activities that directly impact costs, such as machine hours, customer orders, or production setups.
2. Assign costs: Allocate costs to specific activities based on their intensity or volume. This process helps management understand how each activity contributes to overall cost.
3. Calculate activity costs: Estimate the total cost of each activity by multiplying the cost rate per unit of activity by the expected volume.
4. Develop activity budgets: Once the costs are assigned to activities, management can use this information to develop budgets for each activity.
5. Monitor and control: Management can track actual activity levels and compare them to the budgeted amounts. By analyzing the variances, they can identify inefficiencies or areas of improvement.
Now, let's compare the similarities and differences between operating and activity-based budgets:
Similarities:
1. Both budgets are used by management to plan and control financial resources.
2. They require analysis of historical data and forecasting future financial performance.
3. Both budgets help management set targets, monitor performance, and make informed decisions.
Differences:
1. The operating budget focuses on overall financial performance, while the activity-based budget emphasizes the relationship between activities and costs.
2. The operating budget provides a broad overview of revenues, expenses, and profitability, whereas the activity-based budget offers a more detailed analysis of costs associated with each activity.
3. The operating budget is based on traditional cost allocation methods, while the activity-based budget assigns costs based on the intensity or volume of activities.
4. The operating budget is typically used in more traditional industries, while activity-based budgeting is often employed in organizations with complex cost structures or diverse product lines.
In summary, while both operating and activity-based budgets serve similar purposes in financial management, they differ in terms of focus, level of detail, cost allocation methods, and suitability for different industries or organizations.