The most important activity in every business, be it small or big, is creating a budget. For businesses, a budget is an overview of the financial planning for the quarter or the year, and this budget is usually divided into:
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Financial Budget
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Operating Budget
A financial budget includes the company's inflow and outflow of revenue, including liabilities, sources of funds, and balance sheets.
An operating budget deals with the predicted expenditures of a company across a stipulated time. For example, the cost of raw materials required would be covered under this budget. An operating budget is usually broken down into fixed and variable costs, commonly created at the year-end.
Let’s take a deeper look into the components of an operating budget in small businesses:
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1. Sales Budget
This budget includes the sales figures for the given period. This budget is predicted by consulting salespeople in the same, or similar industry that would generate an aggregate predicted sales figure. This budget also takes into consideration factors like the state of the economy, competition, the marketing strategies of the business, and the management of the company.
This budget documents the products or services your business will sell for the given period and would provide a calculated estimate of the revenue that would be generated. A sales budget also considers the sales of the previous year or the time period being considered. It estimates if there is a need for any increase or decrease in any product or service pricing. These estimates are then added, and the new budget is modified.
2. Production Budget
A production budget estimates the unit production required for the specific period to cater to client demands. In addition, the business has to consider the expected units of product to be sold and refer to previous sales reports.
The production budget is the second step after a sales budget, as the sales budget helps you create an efficient production budget. This budget would be stated in terms of the production units and not in dollars like the rest of the budgets under an operating budget.
3. Direct Material Budget
This budget involves the raw materials the business would need to produce the products it is selling. It is easy to create a direct materials budget after creating a production budget, as a direct materials budget uses the units produced to create an estimate. A business inventory would help with creating a direct materials budget. This budget takes into consideration the cost of every raw material the company requires.
4. Labour Budget
A labor budget involves the number of hours you will require each laborer to work for. Once you calculate the hours based on the demands, you can estimate labor costs as well. The formula used to calculate this budget is:
Total Direct Labor Hours = Units to Produce X Direct Labor Hours Per Unit.
5. Overhead Budget
This budget estimates the overhead costs for the calculated period. An overhead budget includes variable costs. It comprises components such as rent, utilities, and lease payments. These costs vary on a monthly basis. This budget covers all the costs of the production budget that are not covered in the direct material budget or the labor budget.
6. Administrative Expenses Budget
This budget involves costs that are not concerned with manufacturing. It comprises fixed and variable estimates. Also, the general administrative costs are added under this budget for the given time period.
7. Finished Goods Cost
Finished goods cost includes the cost for every finished product. Therefore, an estimate is required to understand the final cost that contributes to a completed product. This estimate is calculated by considering readings from the labor budget, overhead budget, and materials budget.
An operating budget is an essential aspect of developing a small business that ought to be effectively utilized and not just recorded and put away. You can use an operating budget to reveal where you can reduce costs if your production expenses are more noteworthy than the sales. This budget plan can be as detailed as you would want it to be, and these details will help you reflect upon all the necessary costs.
In addition, an operating budget can be used to study the data about sales and production and understand the possible errors that can be rectified. This becomes extremely integral when dealing with small businesses, as the study and development of such a budget would ensure a smooth financial run for the required time.
In conclusion, budgeting is always a good idea, so it becomes necessary to take calculated risks to ensure minimum losses when it comes to setting up a business. Hopefully, these components of an operating budget will help you create one for your business.
