Operating Budgets for Small Businesses

Learn about the key parts and calculations of developing an operating budget•••Rosemary Carlson Updated March 29 2021

Budgeting is one of the most critical financial management activities when it comes to the day-to-day operations of a small business. A business master budget is an overall financial planning document that consists of two budgets: an operating budget and a financial budget. A business budget is a forecast or forecast financial statement of all income and expenses expected over a specific time period such as a quarter or a year. Operating budgets are typically broken down by revenue category for each product the business sells. It is also broken down into The type of spend it makes on each product. Most companies further segment their operating budgets by fixed and variable costs. An operating budget uses forecast numbers from the different budgets or schedules that make it up. These forecasts are based on historical activity input Salespeople and other sources. The result of developing an operating budget is a pro forma or forecast profit and loss statement for the company for a specified time period. Below is a hypothetical example illustrating the operating budget formulation of the small business Masks and More LLC.Sales Budgeting Most business owners and managers use so-called bottom-up sales forecasting techniques. In other words they solicit sales data from salespeople in the field who typically have the best knowledge of sales over a period of time in the future. These sales figures are It is then combined with other sources of sales information to form an aggregated sales forecast. Other factors that go into sales forecasts include general economic conditions pricing policies advertising competition and other factors. Sales budget may differ slightly from sales Adjusted forecasts based on management’s wishes. The sales budget also shows units sold as well as dollars. 1 Below is the sales budget for Masks and More LLC. Quarterly Sales Budget 1234YearUnits10001200150020005700Unit Selling Pricex $10x $10x $10x $10x$10Budgeted Sales $10000$12000$15000$20000$57000Production Budget Once the sales budget has been developed the next step in developing the operating budget is to put together the production budget. In our example the owner of Masks and More must know how many masks to make within the budget time period. Production The budget tells the business how many units of the product to primarily produce to meet sales needs and ending inventory requirements. The formula for calculating the output required for each time period is: For Masks and More LLC if we assume that 25 pieces are in stock at the beginning of the period and 50 units are required The closing inventory and sales budget show that 1000 units are expected to be sold in the first period and the production budget is calculated as: 1000 + 50 – 25 = 1025 units. The production budget is the only budget dollar expressed in units. direct material Purchasing Budgets Direct Labor Budgets and Overhead Budgets convert production budgets to dollars. To convert the production budget to dollars go to the Ending Goods Inventory step below. After all calculations the production cost of this product is $9.00 So doing the math: $9.00 X 1025 = The first production cost is $9225. Direct material purchase budget The direct material purchase budget is related to the raw materials required for the production process of the enterprise. It states the quantity and cost of each raw material required. of the business Inventory policies help determine the quantity of raw materials in inventory. Masks and More LLC’s budget for direct material purchases is based on the following formula: If the cost of raw materials is $2.00 per unit sold the first cycle is based on the production budget Direct material purchases are: 1000 + 50 – 25 x $2.00 = $2050. Therefore the cost per unit is $2.00 Direct Labor Budget The budgeted hours for direct labor are determined by the relationship between labor and production. Assuming labor pays $7.50 per hour one person needs 0.50 hours Workers research a product unit at Masks and More LLC. In this case the calculation of the direct labor budget for the first time period would be: 1000 X 0.5 hours X $7.50 = $3750. The unit cost in turn is $3.75 Overhead Budget The Overhead Budget is all the remaining costs of production This is not included in direct material purchases and direct labor budgets. Often direct labor budgets drive overhead budgets. 2 Indirect costs include items such as rent or lease payments and utilities. In the case of Masks and More LLC the overhead per time period is $6.50/ unit. Selling and Administrative Expenses Budget The non-manufacturing portion of the forecast budget is selling and administrative expenses. These fees have fixed and variable cost components. For example sales commissions are based on sales volume and are variable. Utilities may be fixed. at this For example utilities are the only overhead item $300 per time period. Ending Finished Inventory Budget The ending finished inventory budget is important because it provides companies with the information they need to calculate the unit cost of their products. This unit cost is The direct labor budget and the overhead budget are calculated based on the information gathered from the direct material purchase budget. In this example the total cost per unit of direct material is $2.00 The total cost per unit of direct labor is $3.75 Calculate the total cost of overhead per unit: $6.50 X 0.5 = $3.25 In this calculation 0.5 equals the time workers spend on the product per hour. This adds up to $9.00 per unit. In the sales budget for step 1 there are 50 unsold units so your finished goods inventory is $450.00 Although it seems reasonable to produce as many products as possible If production is greater than demand by selling items as much as possible the business will end up with obsolete inventory. The bottom line question is whether Masks and More LLC sold enough product to cover the cost of production. In the company’s desired sales budget step Sell ​​$10,000 in the first time period. In the next step the production budget for the first time period is $9225. The bottom line is that the company can cover its production costs with $775. The operating budget is a living document and should be actively used not filed. 3 You can If your production costs are higher than your cost of sales use your operating budget to tell you where to cut expenses. An operating budget can be a detailed report of your desired income and expenses. Use it to perform variance analysis to determine resulting production costs and Budget sales.