Your small business cannot survive without budgeting. Budgeting is a very crucial aspect of your business finances. Every business needs a master budget that includes two other budgets, the operating budget, and the finance budget.
Your operating budget consists of all your expected revenue into your business and your expected expenses over a specific period of time, it could be 3 months or a year. The operating budget consists of the expected revenue each product or service brings into the business and the expected expenditure each product or service makes. It can further consist of the fixed and variable costs of the business.
Every business is different and operating budgets may differ depending on the type of business and the industry the business is in. However, there are elements that are general and apply for most industries.
Revenue or Sales budget
This covers all the items that drive revenue into the business. It shows a projection of how many products or services your business is expecting to sell and how much revenue these sales will bring.
Projecting your business’ revenue can help you plan and manage your expenses. Make a list of all your products or services before creating the revenue budget. It’s also important to consider your previous sales as you make your projections.
There are several factors that affect your revenue you might need to consider as you make the projections. Consider the current economy, market (pricing policies, competition), etc.
This is explanatory as it is. This budget lays out all your production costs showing you how many units you need to make for each product in order to meet your sales and inventory needs.
Your production budget links with your sales/revenue budget. As you make your production budget link it to your sales budget, for example, the units you expect to sell within your planned time and how much you expect to make from these sales.
Consider the following when putting together your production budget:
- Number of units expected to be sold (based on last year’s data)
- Ending inventory must be at a certain level.
- If you have any, the number of units in your initial inventory.
Calculate how many units you’ll need to make each product:
Expected Unit Sales + Ending Inventory Units – Beginning Inventory Units = Units to Produce
Other components of your operational budget, such as direct materials, direct labor, and overhead budgets, are influenced by your production budget.
Direct Materials Budget
The quantity of units of raw materials your company needs to purchase for its manufacturing process is determined by your direct materials budget. This could include fabric, leather skins, etc. The budget lays out the cost of each raw material needed.
Cost of Raw Materials Purchased = Units To be Produced + Ending Inventory – Beginning inventory ✕ Cost of Raw Material
A direct materials budget specifies the price and quantity of each raw material that a company requires. Each type of raw material should have its own direct materials budget.
Direct labor budget is very important and it comes after determining your direct material budget. A direct labor budget shows the number of direct labor hours and the labor cost.
Take the number of units you want to create (from your production budget) and multiply it by the direct labor hours per unit to get the cost of direct labor for a certain period (how long it takes to produce one unit). Then multiply that sum by how much it costs you to produce one unit every hour (e.g., how much it costs in labor).
Units to be produced X time X cost per hour = direct labor
Your annual overhead budget comprises both variable and fixed costs or another period.
Variable costs are subject to change depending on your sales activity (e.g., commissions and direct labor). If sales are high, your variable costs will rise. Your variable costs are bound to change from month to month.
Regardless of sales, fixed costs remain constant and they are the costs that you must incur in order to manage your business (e.g., rent, insurance). Unlike variable costs, fixed costs are usually consistent month to month.
As you create your overhead budget, remember to include your business’ variables and fixed costs.
General and administrative expenses budget
This budget includes the fixed and variable operating expenses for the general and administrative elements of your business.
List your general and administrative budget’s fixed and variable costs. Utility bills and salaries are examples of fixed cost, while direct supplies and sales commissions are examples of variable cost.
If your production costs are higher than your sales, an operating budget might help you figure out where to decrease expenditures. The operating budget can be as precise as you want in terms of revenue and spending.