Fundamentals: Activity-based Budgeting and Operational Planning

This page is an overview of the basic concepts of operational planning, activity-based budgeting, and full-cost rate setting.

Why are People Interested?

Traditional budgets -- listing cost factors like compensation, travel, and training by group -- cause numerous problems. Two problems are really damaging:

* First, they don't support sound financial decision making, since the full cost of individual projects and services is not known.

* Second, they don't define exactly which projects and services are covered by the budget. As a result, organizations face expectations well beyond their resources, and are blamed when they can't satisfy every request.

Instead, budgets should list deliverables -- the products and services produced by the organization -- and present the full cost of each.

In other words, budgets should describe the total cost of each of your products and services. This is termed "activity-based budgeting" (ABB), distinct from budgeting by cost factors.

Definitions

Activity-based Budgeting (ABB) means presenting a budget in terms of the cost of an organization's products and services, rather than the traditional budget that describes cost factors (expense codes) such as compensation, travel, and training.

"Budget-by-Deliverables (r) is a practical method and tool-kit for ABB.

ABB is distinct from Activity-based Cost Accounting (ABC), which means gathering costs (after-the-fact) by projects and services delivered. Both ABB and ABC involve the principles of activity-based costing. ABB is done before the year begins as a planning process, while ABC is a modification to accounting systems that track costs during the year.

Why it is wise to do ABB before ABC tracking...

In addition to producing a budget, ABB is used to calculate a cost-based set of rates (prices) for all the organization's products and services.

Results of ABB

ABB is a very powerful leadership tool that addresses a number of challenges, including the following:

* Match clients' expectations with available resources.

* Negotiate budgets based on returns on investments, rather than arbitrary benchmarks such as last year's budget.

* Avoid the trap of defending clients' projects.

* Align all work with clients' business strategies.

* Enhance teamwork by funding entire project teams, including support staff (not just the "prime contractor").

* Deal with unfunded mandates without "stealing" resources from other commitments.

* Avoid having to judge clients' ideas in the course of setting your own priorities, which positions you as an obstacle to those you're supposed to serve and undermines customer focus.

* Set aside time and money for critical investments in the organization itself.

* Ensure that rates are fair, transparent, defensible, and comparable (apples to apples) with outsourcing.

With a budget presented in terms of deliverables, the debate during the budget process becomes much more businesslike. Instead of micromanaging you or demanding that you do more with less, client executives -- your customers -- decide what products and services they will and won't buy with the corporation's finite spending power.

With ABB, executives can decide budgets based on the value of the deliverables they receive, perhaps measured by ROI. Thus, organizationwide strategic alignment is automatic.

By the way, we've found that, in this process, clients naturally step forward and defend their needs. Thus, you don't get blamed when their projects are cut, and any necessary cuts are made based on a better understanding of the needs of the business.

When executives fund deliverables, all participants on the project team are given the resources to contribute to the project, and cross-boundary teamwork is enhanced.

MANAGING EXPECTATIONS:

Once an activity-based budget is approved, clients understand exactly what they can expect from your organization. Thus, expectations match available resources. In this way, ABB is one key part of an internal economy that balances supply and demand.

If clients want more, you willingly supply it -- at an additional cost. When clients supply additional funding, internal entrepreneurs can expand supply (e.g., hire contractors and vendors) to satisfy incremental demand, far better than turning clients away. Thus, ABB encourages a culture of customer focus and entrepreneurship.

Integrated With Business Planning

In fact, ABB is more than a financial process. It's an integral part of operational (tactical business planning.

Indeed, it's wise to integrate operational business planning, budgeting, and rate setting into a single process. Here's why:

Fundamental to effective resource governance, and to a functioning market-based internal economy, is the operational planning process that leads to a budget and (if needed) to rates (pricing, e.g., for chargebacks).

Budgeting cannot be separated from operations (tactical) planning. The plan for what business will be conducted and how it will be executed is the foundation for the budget.

Similarly, rates cannot be analyzed separately from the budget. It makes no sense to promise one cost in the budget, then charge a rate during the year that adds up to a different number.

An effective planning process develops an operational plan, translates it into a budget, and then derives rates -- all as an integrated process.

How To

Of course, as with many things, the devil's in the details.

To determine the cost of deliverables, managers must first define all their products and services -- not just client deliverables, but also corporate-good activities, investments in the organization such as infrastructure, and internal overhead services needed to keep the organization running well.

Each group amortizes its indirect costs such as unbillable time, non-project-specific expenses, services from peer groups, and organizationwide overhead.

Then, costs from all groups involved in a given deliverable are aggregated.

Through extensive research and development, we have overcome the mechanical challenges that have made it difficult to implement ABB in the past. Budget-by-Deliverables, is a comprehensive tool-kit with spreadsheets, software, and a clearly documented step-by-step method that guides leadership teams through the proven process.

The budgeting resources listed below explain the process and what it takes to do each step.

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