Budgeted Cost

What is a Budgeted Cost?

A budgeted cost is a forecasted future expense that the company is expected to incur in the future. In other words, it’s an estimated expense that management anticipates will be incurred in a future period based on projected revenues and sales.

Budgeted costs are future costs, for transactions and operations expected to take place over the coming period, based on forecasts and established goals. Fixed costs are budgeted differently than variable costs. For example, if sales volume is forecast to increase by 10 percent, variable costs will definitely increase accordingly, but fixed costs may or may not need to be increased to accommodate the volume increase.

Purpose

Costs or expenses are elements of your business that cut your profits, but these costs enable you to provide services or manufacture items. The crucial thing to consider is the kind and level of costs you should incur. The budgeting process enables you to identify and clarify your expenses. It forces you to think of ways to control these expenses and identify the expenses you need to prioritize to meet your objectives. It helps you determine what your work costs and what limitations there are so that you make realistic plans. Cost budgets also helps you avoid waste because you can see where you spend your money.

Performance Measurement Tool

For a cost budget, you’ll estimate and pre-decide the costs you will acquire over the next year or quarter. When the period ends, you need to compare the costs you actually incurred with the budgeted costs. Any variances between these will tell if you spent more or less than your budgeted amount. You then need to explain these variances. For example, you might spend more than you budget for energy costs if gas prices increase after you prepared your budget. With these variances and explanation available, you can evaluate whether your business is performing efficiently and where you need to trim spending.

Budget Setting

To set your budget, you’ll first need to identify your costs. Your bank statements are a good place to start because you can see exactly what you paid out each month. For example, if you run a restaurant, you can pull amounts for things like wages, food items, rent and overheads such as electricity, phone and water from your bank statements. Next you’ll estimate these costs for the coming period, combing information from your bank statements with billing statements. For example, when you set a budget for electricity overhead, analyze past bills and assess the units you consumed for each month. Also, consider the expected changes in rates charged per unit. Based on this, get the average amount you spent and apply that expense to each month over the entire period to set your budget.

Example

The budgeting process consists of two main steps: estimating future revenues and the expenses that are associated with meeting those revenues. Most budgets start with current year figures and adjust them for trends. For example, management might think that demand might increase 10 percent next year, so they take the current sales figure and add 10 percent in the budget.

Next management must figure out what expenses are associated with producing this amount of product. These estimated expenses are considered budgeted costs. They are estimated and can vary greatly from the actual costs incurred during the production process.

Take ordering inventory for example. Management might estimate an increase in inventory costs of 10 percent, but because of the explosion in steel prices, inventory costs have risen 35 percent. The actual costs are much different than the budgeted costs. In rare circumstances will this actually affect the accounting of these expenses, but this discrepancy will affect the way the following year’s budget is created.