Components of an Operating Budget for a Small Business – When it comes to a small business’s day-to-day operations, budgeting is one of the most important financial management duties. A business’s master budget is an overall financial planning document that includes two budgets: an operating budget and a financing budget.
A business’s operating budget is an anticipated, or predicted, financial statement of all expected revenue and expenses over a specific time period, such as a quarter or a year. The operations budget is often split down by revenue category for each product that the company sells. It’s also split down by the many types of expenditures it makes on each product. The majority of businesses divide their operating budgets into fixed and variable costs.
In the several budgets, or schedules, that make up the operational budget, anticipated numbers are used. These projections are based on historical data, sales force input, and other sources. The pro forma, or predicted, income statement for the firm for the defined time period is the product of the operating budget preparation.
The following is a fictional example of how a small firm, Masks and More, LLC, develops its operating budget.
The majority of firm owners and managers employ a “bottom-up” sales forecasting strategy. In other words, they ask field salespeople for sales data because they are the ones who are most likely to know what sales will be in the future. These sales figures are then merged with data from other sources to create an overall sales prediction.
The general state of the economy, pricing policies, advertising, competition, and other factors all factor into the sales prediction. After it has been changed according to management’s objectives, the sales budget may differ slightly from the sales projection.
The sales budget for Masks and More, LLC is as follows.
|Quarterly Sales Budget|
|Unit Selling Price||x $10||x $10||x $10||x $10||x$10|
Following the development of the sales budget, the production budget is the next phase in the development of the operational budget. The owner of Masks and More, in our example, has to know how many masks to create throughout the budgeting period.
The formula for calculating the amount of production required for each time period is as follows:
If we assume 25 units in beginning inventory and 50 units in ending inventory for Masks and More, LLC, and the sales budget shows that 1000 units are expected to be sold in the first quarter, the production budget would be 1,000 + 50 – 25 = 1,025 units.
The only budget that is expressed in units rather than dollars is the production budget. The production budget is converted into dollars by the direct materials purchases budget, direct labor budget, and overhead budget.
After all of the computations, the product comes to a total cost of $9.00.
By doing the arithmetic, the first time period’s production expenses are $9.00 X 1,025 = $9,225.
Direct Materials Purchases Budget
The direct material acquisitions budget covers the raw materials required for the company’s manufacturing process. It specifies the quantity and cost of each type of raw material required. The amount of raw materials maintained in inventory is determined by the company’s inventory policy.
The budget for Masks and More, LLC’s direct material purchases is calculated as follows:
If the cost of raw materials is $2.00 per unit sold, the direct materials purchase calculation would be: 1,000 + 50 – 25 x $2.00 = $2,050, based on the production budget for the first time period.
As a result, the total cost per unit is $2.00.
Direct Labor Budget
The link between labor and production determines the allotted hours for direct work. Assume that one worker at Masks and More, LLC is paid $7.50 per hour and that one unit of the product takes 0.50 hours to complete. In such a situation, the direct labor budget for the first time period would be calculated as follows: 1,000 x 0.5 hours x $7.50 = $3,750.
The cost per unit, on the other hand, is $3.75.
Everything left over from production that isn’t covered by the direct materials and direct labor budgets is included in the overhead budget. The overhead budget is usually driven by the direct labor budget. Rent or lease payments, as well as utilities, are examples of overhead. Each time period, the overhead for Masks and More, LLC is $6.50 per item.
Selling and Administrative Expenses Budget
Selling and administrative expenses make up the non-manufacturing portion of the expected budget. These costs are made up of both fixed and variable costs. Sales commissions, for example, are changeable and based on sales volume. It’s possible that utilities will be repaired. The sole overhead item in this scenario is utilities, which cost $300 per month.
Ending Finished Goods Inventory Budget
The ending finished goods inventory budget is critical because it provides the data required to compute the per-unit cost of a product. The information from the direct materials purchases budget, direct labor budget, and overhead budget is used to compute the per-unit cost.
The total cost of direct materials per unit in this scenario is $2.00. The total cost of direct labor is $3.75 per unit. To figure out the total cost of overhead per unit, multiply $6.50 by 0.5 to get $3.25.
This comes to a total of $9.00 per unit. Because 50 units of the product were not sold in the sales budget in Step 1, your completed goods inventory would be $450.00.
The Bottom Line
The concern is whether Masks and More, LLC can cover their production costs by selling enough items. The corporation plans to sell $10,000 in the first time period, according to the sales budget. The production budget for the first time period is $9,225 in the next step. In the end, the company will be able to meet its production costs with $775 left over.
An operating budget should be used rather than filed away because it is a dynamic document. If your manufacturing costs are higher than your sales, and 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 expenses.