Determining Expense Budgets

Determining Expense Budgets

Budgets for each expense must be established, considering both external and internal factors, as in sales forecasting.

In determining expense budgets, the following would be considered internal factors:

  •  Corrective actions planned to bring excessive expenses in line.
  • Policy changes such as new commission plans.
  • A commitment such as equipment purchases, leases on new facilities, or professional service contracts.
  • Planned salary increases.
  • Planned changes in benefit programs.
  • Additional personnel.
  • Promotional plans.

 External factors could include the following:

  •  Inflation and its effect on price increases from suppliers.
  • Tax rate increases including payroll taxes, local property taxes, inventory taxes, and so on.
  • Utility rate increases.

 Additionally, the interrelated effects of expense increases must be considered. For example, payroll increases will increase payroll taxes and, possibly, employee benefits. Rent on larger facilities can also involve additional utilities expense.

 Reevaluating the Plan

Once an initial plan has been established, it is often useful to review it in order to identify areas of further improvement.

Getting Started on Budgeting

Getting Started on Budgeting

Your first budget will be the most difficult to develop – but it will be worth the effort. The budget will help you analyze the results of your advertising. By your next business year you’ll have a more factual basis for budgeting than you did before. Your plans will become more effective with each budget you develop, don’t delay in getting started on budgeting.

 Developing Expenses Budgets

 After a realistic forecast has been developed for sales and gross profit, expenses for the coming year must be estimated in order to establish expense budgets and to determine expected operating profit.


As with the forecast of sales and gross profit, expense estimating begins with a review of the current year’s performance based upon comparison with the following indicators:

  • Performance in prior periods
  • Industry averages
  • Objectives established for the current year

For purposes of comparison, it is often useful to express each expense as a percentage of total sales.

Comparing Variable Expenses

The use of percentages as a basis of comparison and forecasting is particularly applicable when analyzing variable expenses. Variable expenses are those that tend to change as a result of changes in sales volume. For example, if salesmen’s commissions are based upon a percentage of sales, the total dollar amount of commissions earned would increase as sales increase. If sales in a month were 20% higher than expected, commissions paid would also increase 20% as a direct result of the higher sales volume.

Comparing Fixed Expenses

On the other hand, fixed expenses are not directly affected by short-term variations in sales volume. Therefore, a 20% increase in the dollar amount of any fixed expense such as salaries or rent would normally be considered unacceptable even if sales for the period increased by 20%. When comparing fixed expense levels with objectives or from one period to another, it is more realistic to make comparisons in absolute dollars rather than in percentages.

A business has sales and rent expense in January, February, and March as follows:


                                               Rent expense

Month                 Sales                        $            % Sales


January            $100,000                 $1,000              1.00

February              80,000                   1,000              1.25

March                125,000                   1,000              0.80


As a percentage of sales, rent expense was high in February and low in March. However, this does not indicate that control of this expense was more or less effective in either month. It simply reflects the changes in sales volume. In all three cases, the actual rent expense was 1,000.

Long-Range Considerations

Despite the shortcomings of using percentages to evaluate fixed expense control within the business from month to month, they can be useful when making long-term comparisons or comparisons with industry averages. These averages normally express expenses as percentages of sales, regardless of whether they are fixed or variable.

For example, assume that a business found that its rent expense as a percentage of sales was 2% compared with an industry average of 1%. This differential would have to be offset by better than average performance in gross profit or other expense classifications if the business expects to realize net profit equal to its industry average. Perhaps the reason for the high percentage is due to an exorbitant rental expense, or it may be caused by inadequate sales. In either case, certain questions must be answered. These could include the following:


  • Are we renting more space than we need?
  • Is our space too expensive for our requirements?
  • Could a less elaborate facility be located that would be adequate for our needs?
  • Would a less costly location be sufficient?
  • Is our space utilization inefficient?
  • Will expected sales increases be handled without renting additional space? Will this bring our rent expense percentage in line with the industry?
  • Can the terms of our lease be re-negotiated?


Similarly, when comparing long-term performance with prior periods, the use of fixed expense percentages can be helpful. For example, if you found that warehouse salaries jumped from 2% of sales to 4%, a number of important questions would be raised. These could include the following:


Are we now using too many warehouse personnel?

Are warehouse personnel less efficient?

Has ineffectiveness crept into the warehouse layout or operating procedure?

Are warehouse workers overpaid?

Is warehouse supervision inadequate