Many families develop a budget for day-to-day household expenses, such as food, rent, insurance, entertainment and clothing, and to be viable, these expenses must not exceed income. Small businesses operate under the same principles. Their day-to-day expenses must keep the enterprise running smoothly, but within the revenue generated through sales. It is called an operating budget.
Foundation of Operating Budget
The sales budget projects revenue over a time period, usually a year. Small-business owners develop the budget based on past sales performance, current trends, competitive forces and any new products or services planned for introduction. The two main components are pricing and volume, which together determine revenue. A good sales budget details the price and expected volume of each product or service individually, to produce total sales. Sales volumes often vary from month to month, and the budget should reflect the monthly variables, such as historical seasonality. The importance of the sales budget cannot be overstated for a small business, as it not only projects revenue, but also is the basis for the expense plan.
The direct-expense budget forecasts the funds needed to produce the goods and services in the sales plan. These items include raw materials such as metal, wood, chemicals and paper, as well as manufactured parts and components purchased from other firms. This budget also includes labor directly responsible for the product’s manufacture. A small business that delivers a service, such as an insect exterminating business, would include the labor cost of the exterminator, cost of the exterminating fluids, and rental or depreciation for the truck. Labor-related expenses such as insurance would also be included in this category. An important aspect for small business is to allocate appropriate funds to assure product or service delivery to the customer in a consistent, timely manner.
Sales, Overhead and Administrative Budgets
Operating budgets include sales costs, such as commissions. Salespeople often receive a base salary, plus a commission based on volume, and both are considered an operating expense. Marketing activities such as advertising and promotion are also part of the budget. Overhead, or fixed expenses not related to volume, include utilities and taxes. Administrative labor costs, such as executive and secretary salaries, also are included in the operating budget. Machine and computer service maintenance contracts, and accounting services also fall into the administrative expense category, along with rent and office supplies.
Small businesses may also develop a capital budget. Monies from the capital budget are used to purchase office or other work spaces and equipment designed for future expansion, and may involve bank loans and other financial tools. These expenses are not part of the operating budget.
A detailed month-to-month operating budget that forecasts revenues and expenses provides the opportunity to review the operating budget throughout the year, including the company's cash flow. Sales volumes can change, and unanticipated costs can emerge, both easily identified with a monthly variance analysis. Variances may be due simply to timing, but the analysis can spot production or sales shortcomings. Opportunities may also be discovered, such as higher-than-anticipated demand for certain products. Small-business owners can adjust the operating budget to gain sales revenue. For example, an unplanned decision to hire seasonal help to meet higher demand will change the operating budget.
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