Budgeting Operating Costs

As you develop your budget, you'll be working with the budget equation. The basic budget equation is:

Sales = Total Costs + Profit

This equation shows that every sales dollar you receive is made up partly of a recovery of your costs and partly of profit. Another way to express the basic budgeting equation is:

Sales — Total Costs = Profit

This equation shows that, after reimbursing yourself for the cost of producing your service, the remaining part of the sales dollar is profit. For example, if you expect $1,000 for a specific job and you know that it will cost $900 to market and perform this service, your profit will be $100. Depending on the form of your business (proprietorship, partnership, or corporation), you may keep profits in your business, called retained earnings, or pass them on to investors: yourself, your partners, your shareholders.

Calculations

In calculating an operating budget, you will often make estimates based on past sales and cost figures. You will need to adjust these figures to reflect price increases, inflation, and other factors. For example, during the past three years, a consultant spent an average of $5,000 on advertising costs per year. For the coming year, she expects an advertising cost increase of 10 percent (0.10). To calculate next year's advertising costs, she multiplies the average annual advertising costs by the percentage price increase ($5,000 × 0.10 = $500) and adds that amount to the original annual cost (5,000 + $500 = $5,500). A shortcut method is to multiply the original advertising cost by one plus the rate of increase ($5,000 × 1.10 =$5,500).

How can I track my operating budget?

Systems like QuickBooks (http://quickbooks.intuit.com) and Peachtree (www.peachtree.com) include budgeting tools that not only help establish your business budget, but also can help you track actual income and expenses against your budget to help you manage both.

If your consulting services business is a new venture and has no past financial records, rely on your own experience and knowledge of the industry to estimate demand for and costs of your service. Your accountant or trade association may also be able to help you develop realistic estimates.

Budget Creation

Before you create an operating budget, you must answer three questions:

  • How much net profit do you realistically want your business to generate during the calendar year?

  • How much will it cost to produce that profit?

  • How much sales revenue is necessary to support both profit and cost requirements?

  • To answer these questions, consider expected sales and all costs, either direct or indirect, associated with your consulting services. To make the safest estimates when budgeting, many companies overestimate expenses and underestimate sales revenue.

    Start constructing your budget with either a forecast of sales or a forecast of profits. For practical purposes, most small businesses start with a forecast of profits. In other words, decide what profit you realistically want to make and then list the expenses you will incur to make that profit.

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