Is it true that it is most sensible to start with the sales budget and develop the other budgets (overhead, capital expenditures, direct labor and raw materials) from there, and how should sales revenues be considered when determining other costs?    

Expert Answers

An illustration of the letter 'A' in a speech bubbles

It is sensible to start the complete budgeting process with the sales budget. The sales budget, when done properly (based on accurate research and/or last year's sales figures) is the foundation that helps determine programs in a host of departments. The reason is that the other budgets and company initiatives are dependent on what a company believes will be their revenue for a fiscal year. When they have a good idea of what sales revenue they will take in, they can allocate resources to other areas of the business.

For example, a company that makes the proverbial 'widgets' may budget that they will sell 1 million widgets at $2 each. Therefore, their revenue (projected) will be $2 million dollars. Consequently, this affects the raw materials budget. They will budget to buy enough raw materials for 1 million widgets and a little more, just to be safe. However, in using their resources wisely, they will not budget money to buy raw materials for 3 million widgets. Based on their sales budget, this would be unwise and a waste of resources. They would have too much raw material inventory on hand - up to three years worth; they would incur the carrying costs associated with this inventory. They would not reap all the sales possible from this for almost three years.

Similarly, this sales budget would affect all the other budgets. Direct labor, the human resources used to manufacture widgets would be based on the sale of 1 million widgets. This may require 100 employees working full-time in the year. It would not require, for sake of argument, 200 full-time employees. Therefore, the company can no their direct labor costs based on their sales budget. This applies to overhead and capital expenditures as well - a company may allocate money to upgrade or purchase one machine based on the sale of 1 million widgets. They may think twice about upgrading or purchasing 3 machines, unless they anticipate sales of 3 million widgets or more.

Approved by eNotes Editorial Team