Hello everyone! I hope you will be good. Today I am here to participate in Steemit Learning Challenge of @yolvijrm about the Costs for entrepreneurs - Budgets. It is really an interesting and knowledgeable contest. There is a lot to explore. If you want to join then:
What is budgeting and how does it relate to costing?
Budgeting is a process of creating a detailed plan for the allocation of the resources. In this plan the financial resources are allocated for a specific time period. We estimate the income and the expenses. The funds will be used effectively to achieve specific goals within the available resources.
Budgeting is very important and it helps in planning and controlling. We can monitor financial activities to avoid overspending. We can also detect financial mismanagement with the help of proper budgeting.
Costing is on the other hand is the process for the determination of the actual cost to produce products or giving services. In the costing we calculate all the expenses such as material costs and labour costs. In the costing overheads, direct and indirect costs are also included which are used for the production of the product or to deliver a service.
Relationship between Budgeting and Costing
Here are some aspects which explain the relationship between the budgeting and costing:
Foundation for Budgets: Costing provides accurate data about the expenses. It is used for the preparation of the real budget.
Resource Allocation: Budgeting uses cost data to allocate resources to the different projects as well as activities.
Financial Control: Costing helps to track the actual expenses against the budget. This helps to the control the finance.
Decision Making: The data collected from the costing helps in decision making. It allows the business to adjust the budgets. In this way the owners and the managers can make good financial decisions.
Performance Evaluation: Comparing budgeted costs with actual costs identifies variances and helps improve efficiency.
So costing provides the data needed for effective budgeting, and budgeting uses that data to allocate resources and manage finances efficiently.
Explain the importance of budgeting in determining costs.
Budgeting plays an important role in the determination of the costs. It offers a well organised framework for the estimation and planning as well as expenses. Here are some points which gives the idea why budgeting is important in the determination of the costs:
1. Accurate Cost Estimation
- Budgeting helps to identify and estimate the costs of the activities, projects or products before execution. It ensures that all the expenses are calculated such as fixed, variable, direct and indirect costs.
2. Resource Allocation
- Resource allocation is important for different elements in the business. If the organisation sets a budget then that business can allocate the resources effectively. It helps to prioritize the necessary activities. It ensures that the availability of the funds cover all the necessary costs.
3. Cost Control
- For the better selling price it is very important to control the cost of tg products or services. In this regard budgeting sets a financial boundary. It makes it easy to track and control the costs. It helps to avoid overspending. It helps in the identification of those areas where it is possible to reduce the costs.
4. Variance Analysis
- The comparison of the budget costs and actual costs allows for the identification of the variances. In this way we can adjust the spending and can improve the process.
5. Decision Making
- A well prepared budget provides a clear picture of the anticipated costs. It also helps in strategic decisions. We can decide whether to undertake a project or invest in the new resources. We can decide whether to outsource activities or not.
6. Financial Planning
- Financial planning plays the role of the backbone for the business. Good financial planning leads the business to do well. It ensures that costs align with the available funds. It avoids cash overflow problems. It ensures sustainability over time.
7. Performance Measurement
- Performance measurement is another important factor of any business. Budgeting also helps in the performance measurement. It provides a way For the evaluation of the efficiency and effectiveness of the cost management. It helps the organisations to measure if they meet their financial goal or not.
Budgeting not only helps in the estimation and management of the costs but it also serves as a vital tool for the financial control and strategic planning.
Prepare the budget as explained, for the preparation of cakes. Consider a 4% adjustment.
In order to prepare a budget for cake preparation with a 4% adjustment I will follow a similar approach as it was used in the bread example.
Let us suppose that I want to make 40 cakes. So the budget for the prepartion of the cakes is given below:
Step 1: Calculating Direct Costs
| Costs | Required for 40 cakes | Unit value (in PKR) | Total amount |
|---|---|---|---|
| Flour (grams) | 20 kg | 500 per kg | 10,000 |
| Sugar (grams) | 10 kg | 600 per kg | 6,000 |
| Eggs | 120 units | 12 per egg | 1,440 |
| Butter (grams) | 5 kg | 1,200 per kg | 6,000 |
| Milk (liters) | 10 liters | 50 per liter | 500 |
| Cake boxes | 40 units | 20 per box | 800 |
| Work (labor) | 4 days | 15,000 per day | 60,000 |
| Total Direct Costs | 84,740 |
The total direct costs are 84,740.
Step 2: Calculating Indirect Costs
I am just assuming the cost for the tools and equipment as 15,000. And I have included all the utilities such as electricity, gas and water under the cost of 12,000.
| Cost | Amount (in PKR) |
|---|---|
| Tools & Equipment | 15,000 |
| Utilities | 12,000 |
| Total Indirect Costs | 27,000 |
So the total indirect costs are 27,000.
Step 3: Total Costs
Here in order to calculate all the costs I have combined the direct and indirect costs and the total cost has become 84,740 + 27,000 = 111,740.
Step 4: 4% Adjustment
Here is the 4% adjustment for price changes or unexpected costs in the total cost:
- 4% of 111,740 is 4469.6
- By adding this amount in the actual total cost it becomes 111,740 + 4470 = 116,210.
I have round off the last decimal point to make it a whole number.
Step 5: Cost per Cake
Now we can find the total cost per cake by dividing all the costs by the number of the cakes. As the number of cakes are 40 so I will divide the total cost by 40.
So the cost per cake is 116,210 ÷ 40 = 2,905.25
Final Budget Summary
- Total Cost for 40 Cakes: 116,210
- Cost per Cake: 2,905.25
Now we can set the sale price by adding margin and profitability in the actual cost per cake. So we need to set higher sale price than the actual cost to generate profit.
Prepare the budget as explained, for the hairdressing service. Consider a 3% adjustment.
I will prepare a budget for the hairdressing service by resembling it with the example of massage service. And I will also add 3% adjustment as required in the question. So for the determination of the budget the steps are given below:
Step 1: Calculating Indirect Costs
We know that these are those costs which support the service but these are not directly related to the single haircut. The indirect costs are given below:
| COST | TYPE | AMOUNT (Local Currency) |
|---|---|---|
| Haircutting tools | Indirect | 50,000 |
| Chair and mirrors | Indirect | 100,000 |
| Hair products (annual) | Indirect | 30,000 |
| Utilities (annual) | Indirect | 20,000 |
| Advertising | Indirect | 20,000 |
| Total Indirect Costs | 220,000 |
So the total indirect costs for the hair dressing service are 220,000.
Step 2: Calculating Direct Costs
These are the expenses which are directly related to a single haircut.
| COST | TYPE | AMOUNT PER HAIRCUT |
|---|---|---|
| Shampoo | Direct | 10 |
| Conditioner | Direct | 5 |
| Hair spray/gel | Direct | 15 |
| Work (labor cost) | Direct | 250 |
| Total Direct Cost per Haircut: | 280 |
So the total direct costs are 280.
Step 3: Hourly Rate
If the goal is to earn a monthly salary of 300,000, and the service can be provided for 4 hours daily for 20 working days which become 80 hours monthly:
Hourly Rate: 300,000 ÷ 80 = 3,750 per hour
If each haircut takes 1 hour then the labour cost per haircut is 3,750.
Step 4: Prorating Indirect Costs
I am saying that the service operates 960 hours per year because 80 hours are per month and for the 12 months it becomes 960 hours. Now in order to prorate the indirect costs:
220,000 ÷ 960 = 229.17 per hour
I have divided the total indirect costs per total working hours per year.
Step 5: Sum Costs per Haircut
So in order to sum all the costs I have added direct costs, labour cost and prorated indirect costs.
Total Cost per Haircut:
280 (Direct Costs) + 3,750 (Labor) + 229.17 (Prorated Indirect) = 4,259.17
Step 6: Adjust for 3%
Here is the 3% adjustment for price changes or unexpected costs in the total cost:
- 43% of 4,259.17 is 127.7751
- By adding this amount in the actual total cost it becomes 4,259.17 + 127.7751 = 4,386.95. By rounding the last digit to make it a whole number it becomes 4,387.
Final Budget Summary
- Total Cost per Haircut after 3% adjustment: 4,387 .
This is the total cost for the single haircut and now we need to set the higher service charges than this cost to generate profit.
I invite @ninapenda, @kouba01, @alejos7ven to join this learning challenge.