To run your business successfully, you need to manage all your operating expenses. (Essentially these are the costs of carrying on business on a day-to-day basis.)
To manage these, you need an operating budget.
But to be accurate and effective you need to make sure your operating budget contains all the right information. Otherwise, it won't help you at all.
That's why you must include these seven elements in your operating budget...
Make sure these seven elements are in your operating budget
Study your company's peak and low seasons to forecast what your sales will be. If you don't, you'll under-budget and won't be able to cover costs. Also identify any items that aren't likely to recur, like special sales, accidents, etc.
It's important to forecast sales using your previous year's figures. If you're starting a new business, use industry insiders to give you a framework for the sales you'll achieve.
2. Cost of sales
Forecast the cost of sales by using the previous year's figures. This forecast depends on your industry.
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3. Gross profit
This is the total amount you expect to bring in from your total sales before you deduct anything.
4. Variable costs
Make sure you budget enough for variable expenses such as labour and material. Calculate if you'll need to hire more workers this year or if you'll need to increase stock.
Use the figures in your direct material budget
, direct labour budget and sales expense budget. These budgets will show you where you can save money on these costs. They'll also help you calculate the cost per unit.
5. Fixed costs
Fixed costs are regular costs that don't vary with output, such as your rent. Your general and administrative budget shows how you could save money on these particular costs. It also helps you calculate the cost per unit.
If you use your previous year's figures as a reference, your current fixed costs will increase because of inflation.
6. Net profit/loss
Determine your profit/loss for the next 12 months by deducting the cost of sales, variable costs and fixed costs from your total projected sales.
7. Payment and income
You need information about when payments and income actually come in for your cash flow budget, not just how much you can expect.
When you draw up these elements, you must use your supporting documents. This bases your operating budget on past experiences and will help you create a realistic budget.
If investors ever ask for reasons for your operating budget, you can also show them your source documents to explain why you budget the way you do by showing them the patterns and trends you experienced in the past.
And remember, your budgeting job isn't finished once you include these seven elements.
There's one other thing you have to do after you create your operating budget
According to the Master Budget Series
, once you create your budget, you must go back and reassess your forecasting. After all, if the budget comes out as a possible loss, you need to change your forecasting to ensure that doesn't happen.
You must constantly reassess your forecasts and budget to make sure they're accurate.
You can find a template for your operating budget, as well as nine other budget templates, in the Master Budget Series.