For many a small business owner every penny needs to be accounted for. Creating a budget will give you a clear idea of your expected income and expenses. This article will help you understand how to build budgets and where to get the information to prepare the budgets from.
For your first period you will really need to think about the costs you are going to incur and the income you will receive. You need to be realistic when you are setting your budgets. Begin by looking at the following areas:
Other things you will need to consider to begin with include business rates, rent of office or factory space and advertising costs – are you going to advertise your products yourself on social media for example or are you going to advertise more formally? This will need to be included within your budget. Once again, look at what your competitors are doing.
It is always important to remember when you are starting out, you don’t have to do everything at once. Keep in control of your costs and don’t try and grow your business too quickly. Focus on the quality of your products and your relationships with your customers. Remember, where you are renting premises you will have utilities to cover such as electricity, insurance, rates etc. Would it be possible early on to use a spare room in your house to try and keep costs down? It is also always useful to include a ‘contingency fund’ in your budget to cover any additional costs that may occur that you didn’t initially plan for, say between 5% and 10% of predicted sales volume - e.g if you were expecting sales income of £3,000 this month, a contingency budget would be between £150 and £300 that month to cover unexpected costs.
To help get you started we have created a budgeting template. To download a copy and to read more on budgeting click here.
What types of budgets are there?
Zero based budgeting is the process by which a business creates a budget from scratch each period. All costs have to be justified.
An incremental budget is prepared using a previous periods’ budget as the basis but with incremental amounts added for the new period. The incremental amounts added may be a set percentage across the board or specific amounts covering expected future events such as inflation and interest rates.
A sales budget is a detailed list of a business’ sales expectations for the budget period, in both units and currency. The sales budget is usually reported in either a monthly or quarterly format.
The basic calculation for a sales budget is the number of units the business expects to sell in that period multiplied by the selling price of those units. If the business provides a variety of goods or services then these should be split out and calculated separately.
The projected sales quantity used in this budget can be taken from historic information, but ensure this is adjusted for any changes in the market, business growth or change in demand for those products.
It can fairly difficult to produce an accurate sales forecast for an extended period of time due to changes in the business landscape. Therefore, a sales budget should be frequently updated with revised estimates to ensure the budget is as accurate as possible - perhaps on a quarterly basis but as regularly as is required by your business.
A basic quarterly sales budget is shown below:
If discounts are offered then this should be built into the sales forecast, deducting the expected value of these from the gross sales figure to give net sales.
The quantities used within the sales budget are directly linked to the production budget which then drives the labour and materials budgets, so it is important that figures are as accurate and realistic as possible.
The production budget is produced to identify the number of units that need to be manufactured to meet sales demand and allow for required stock levels to be maintained. The production budget does not include costs, simply the unit quantities required.
The production budget is calculated as:
Forecasted sales units
+ Quantity required in stock
- Quantity already in stock
= Products to be manufactured
In the above sales budget example product A has total sales of 3,800 units. Using this as an example, a business is planning to sell 3,800 units. It already has 600 units in stock (so these don't need to be produced again and can be used for sale) but they also need to ensure they have 400 units in stock at the end of this quarter ready for next quarter (so these need to be made now). The production quantity required in quarter 1 is 3,600 (3,800 + 400 – 600 ). This would need to be recalculated each quarter.
The quantity of stock that a business chooses to maintain can be subject to a variety of factors. If too much stock is held then this may lead to products becoming obsolete and being disposed of at a loss, holding too little stock can lead to lost sales if a customer requires products quickly.
If a business updates their sales forecast regularly, then the impact of these changes need to be reflected in the production budget. As does any change in policy relating to stock levels.
The materials budget is to calculate the cost of purchasing materials to meet the production quantities calculated in the production budget. If a business chooses to keep stock of raw materials then this is also taken into account.
The basis calculation used in budgeting for materials is:
Raw materials quantity required for production
+ Raw materials quantity required for stock
- Raw materials quantity already in stock
= Raw materials to be purchased
This raw material purchase quantity is now multiplied by the purchase price to give a cost of materials.
A basic example of a materials budget, excluding the adjustment for stock levels of raw materials, is shown below:
|Material quality (kg/un)||2.5||2.5||2.5||2.5||2.5|
|Total quantity (kg)||2000||1875||2250||2875||9000|
|Cost per kg (£)||£3||£3||£3||£3||£3|
Note that the units shown in Quarter 1are 200 lower than the sales units in Section 1. This is due to the additional 200 finished units that the business already had in stock, over and above their required stock levels.
When deciding on the level of stock of raw materials to hold a business should consider their supply chain including the availability of the material, speed of delivery, fluctuating prices, etc.
The production quantity is multiplied by the number of labour hours required for each product and the cost of those labour hours to give a total labour budget.
Using the above production quantity example of 3,600 units, if each unit requires 0.5 hours of direct labour time at a cost of £15 per hour, then total labour costs would be £27,000.
|Cost per hour (£)||£15||£15||£15||£15||£15|
A business may also wish to include a number of hours in their labour budget to account for inefficiencies.
If the production of a product requires labour hours from multiple staff and these staff are paid substantially different rates, then this should be represented in the labour budget.
The labour budget can be used for resource planning as it will identify periods when significantly more or less man hours are required to meet demand. A business can use this information to identify when temporary staff may be required.
The overhead budget covers all costs in relation to a business that aren’t included in the materials and labour budget. This will include:
Much of this information can be identified from historic data so analysing business banking statements can help identify all of these expenses.
Some overheads are likely to be fixed such as rent and admin salaries, however some will be variable including travel and supplies. Best known information should be used within this forecast being careful not to underestimate or omit any relevant costs.
Find out more about budgets in this short tutorial. We look at:
Click on the start button below to begin.
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