1.2 Basic Budgeting

A budget is an estimate of the revenues and costs associated with a project over a specified period of time. Engineers use budgets to plan the future actions required for a project and their associated costs, and to control the progress of a project by comparing it with the plan over time . This means that budgets are an important part of both short term and long term planning for any substantial financial investment, and indispensable when monitoring and managing engineering projects. Budgeting forces project managers to plan ahead, improves their decision making resources, provides a standard for performance evaluation, and improves communication and coordination on a project.

There are several classifications and styles of budgets, which will be discussed in more detail in Section 1.6. To begin, it is most important to understand the format and function of any basic budget. Budgets list quantities, costs, and revenues based on estimates of future activity, and combine those estimates to predict the total financial situation of a project, department, or company.

To better understand this, let’s look at this basic example of a quarterly budget for a restaurant:

One of the first things to notice is that budget begins by listing its income, which in this case is generated from food sales. Although food costs could be listed as an expense, since they are so closely related to the restaurant’s income they are grouped in the same “sales” section. The “profit from sales” budget line subtracts the cost of sales from the sales revenue and shows the total profit for the business before additional expenses. The second half of the budget lists expenses, broken into payroll for its employees and additional operational costs referred to as “overhead”. (Note: “overhead costs” are be covered in more detail in Section 3.2.) The “total additional expenses” line sums all of the business expenses listed, with the exception of food costs, as previously mentioned. The “net profit” for the business during this quarter is the difference between the profit from sales and the total additional expenses. In this case, the difference is positive, so the restaurant is expected to generate income during this quarter.

Note that budgets combine both known and estimated values, thus they may not be completely accurate. Some values, just as the monthly cost of leasing the restaurant may be known in advance, as it is likely based on a long-term contract. Other costs, such as the delivery and food costs, as well as the expected revenues are likely based on estimates. These should be well-informed estimates however, either well-researched or based on experience, thus are hopefully quite accurate. Yet there is still an element of “guess work” involved, as various factors (many beyond the control of the restaurant owners) can affect the actual values. For example, a new restaurant may open nearby, attracting some of their patrons, thus lowering their revenues, but also lowering food and utility costs as they would correspondingly prepare and cook fewer meals.

We are now familiar with the layout of a basic budget, but to create our own we need to understand how the costs that make a budget are determined and organized.