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## The budget equation

The basic budget equation states that:

Income – Expenditure = Profit

To determine an initial amount for your budget, there are three main areas to consider; your business’s sales income, including all possible income streams, the total business expenditure for the budgeted period, and your estimated profits.

#### Expenditure

Your business’s overall expenditure for your budgeted period will include all fixed and variable costs, and may also need to take into account inflation and other adjustments, depending on the length of time your budgeted period covers.

#### Fixed Costs

Your business’s fixed costs are payable amounts that will not change by any significant amount throughout the time allotted by your budget, regardless of how your business is performing. Costs such as rent for office space and equipment are fixed for a specified period by the terms of the rental agreement and cannot vary within the agreement period. These can be estimated accurately based on such agreements.

#### Variable Costs

Costs that will change significantly within your budgeted period are your variable costs. It is more difficult to estimate variable costs, as they can change based on a number of factors. Some examples of variable costs are your business’s product stock, which can vary greatly depending on your sales and on market prices for materials, transport costs, which will also vary based on your sales, and utility bills. A realistic estimation of these costs should be based on previous payable accounts and predicted sales.

#### Inflation

If your budget is covering a period of one or more years, you will need to take into account the rate of inflation when estimating your variable costs. The price of goods and services, such as stock and transport, can increase based on annual inflation rates. Therefore it is important to consider these rates when budgeting to ensure your costs are estimated as accurately as possible.

#### Profit

Using these concepts and the basic budget equation, you can estimate your budget for a specified period and plan how to manage your business’s finances, allocating funds appropriately and estimating profit, in order to determine whether or not your business goals for the future are achievable. When setting your budget, remember that it is always safer to over-estimate costs and under estimate profits.