A long-term budget looks further ahead. What will your depart- ment be doing for the next five, 10, or 20 years? It may be hard to imagine. But thinking that far ahead is part of being a good manager and making a good budget.
If the copy shop needs to buy new copiers every five to seven years, it would be best to know what years we’re likely to need to do so. That way, we can say, “Three years from now, we’ll need a new copier.” That’s a lot better than not planning ahead. If we don’t plan, we could find that we suddenly need to buy a new copier next month and we didn’t plan for it when we made the budget for the year.
Table 2-2 shows a simplified long-term budget. Take a look at it, and then we will explain the terms and the thinking that helped us look 20 years ahead.
1 Year 5 Years Income
Sales
$15,000 $75,000
10 Years
$150,000 Expenses
Fixed Costs Fixed Annual Start-up Interim
8,925 1,000
—
Total Expenses
$3,275 $13,175 $29,450 Net Income
$11,725 $61,825 $120,550
20 Years
$300,000
$60,500
$239,500 Gross Income
$15,000 $75,000 $150,000 $300,000
44,625 3,000
—
89,250 3,000 4,000
178,500 3,000 6,000
Total Variable Costs $800 $7,200 $12,300 $27,000 Expenses
Variable Costs Annual Project
800
—
4,700 2,500
9,800 2,500
19,500 7,500 Total Fixed Costs $9,925 $47,625 $96,250 $187,500
Expenses
Semi-Variable Costs Fixed Base/Variable
Volume 1,000 7,000 12,000 25,000
Table 2-2. Simple long-term budget
Let’s look at this budget line by line. For sales income, we used the simple solution: we multiplied one year’s estimated income by five, 10, and 20. We’ll look at more accurate ways of forecasting income in the next section.
We broke up expenses by the different ways we might try to calculate long-term estimates. When you do this, ask which of these methods is the best choice for each type of expense:
fixed, variable, or semi-variable.
Let’s take a look at how we estimated each line of the expense budget.
Fixed annual costs. These expenses come from one of two sources. They can be known expenses determined by contract, such as mortgages, service contracts, or equipment leases.
The other possibility is that the costs are actually variable, but neither growing nor shrinking, just varying by month and aver- aging out over a year or two. In our example, we calculated the annual figure from a record of the monthly expenses for the past two years shown in Table 2-3. As you see in the table,
Budgeting for Managers 26
Fixed Cost A cost that does not vary year to year. From an accounting perspective, a cost that does not change even if the amount of production changes.
Fixed Annual Cost A fixed cost that is the same every year throughout the entire budget.
Start-up Cost A fixed cost that appears only in the first year or years of the budget.
Interim Cost A fixed cost that appears during a period in the mid- dle of the budget.
Variable Cost A line item where the cost varies in different years. In accounting terms, costs that vary with the amount of production.
Annual Variable Cost A variable cost estimated as different each year.
Project Cost A variable cost calculated from a project plan.
Semi-Variable Cost A single line item calculated with a combina- tion of fixed and variable elements.
Fixed Base/Variable Volume CostA semi-variable cost that has a fixed component plus a variable component based on volume.
monthly figures varied from as low as zero to as high as
$1,800. But, over time, things average out. We used the aver- age of the 24 months multiplied by 12 (for 12 months in a year) as the figure for our fixed annual expenses for one year.
We then multiplied this by five, 10, and 20 for those columns in Table 2-2. Any one year might vary from the average, perhaps as much as $2,000. But if our assumption that this cost is staying the same overall is true, then our longer-term projec- tions are likely to be on target.
Start-up costs.Our start-up costs were $1,000 a year for just the first three years. We see the $1,000 in the first year. We see
$3,000 in the five-year column because it is a total of what we will spend for that item in all of the first five years. It shows up again in the columns for 10-year and 20-year totals. This illus- trates an important fact: the five-, 10-, and 20-year columns are totals for all those years, not estimates for just the fifth, 10th, and 20th years. As a result, on this spreadsheet, as you move across a row, numbers should never go down. The next column is always the previous column plus any new income or expens- es for the following years.
Interim costs.These are fixed annual costs that will appear for some years in a row and then disappear. In this case, we’re pre- dicting an extra expense of $1,000 per year for six years running, years seven through 12 of our budget. Our office has locations in six cities and the company has announced a plan to renovate facilities one city at a time, from 2009 through 2014. None of this cost appears in the first five years, four years of it are included by year 10, and all six years appear in the 20-year column.
Jan 800 650 Copy costs 2001 2002
Feb 200 1,500
Mar 0 1,200
Apr 750 1,100
May
500 1,250
Jun
600 250
Jul
750 650
Aug 1,150 1,250
Sep 1,500 1,800
Oct 600 250
Nov 200 500
Dec 150 250
Year Total 7,500 10,350
2 Year Avg
$8,925 17,850
Table 2-3. Variable averaging over months
Variable costs.These are costs that change from year to year.
We may just be showing a cost that we think will vary year by year or we may be estimating costs based on a project plan.
Annual variable costs. These are costs that we predict will vary year by year. For example, suppose we manufacture sports goggles and sell them to retail stores. We’ll want to increase our marketing efforts in years the Olympics are held. The summer games will be held in 2004, 2008, 2012, 2016, and 2020 and the winter games will be in 2006, 2010, 2014, 2018, and 2022.
In years without Olympics, we budget $800 for marketing. We add $400 for summer Olympics years and $300 for Winter Olympics years. (Aren’t goggles used more for winter sports?
Well, yes. But people pay less attention to the Winter
Olympics.) Experience indicates that the plan in Table 2-4 is a good one. We show just the first five years, but the spending pattern continues for 20 years. The $800 for year one and the
$4,700 for year five show up in Table 2-2 as annual variable costs. We show the average over years in Table 2-4 to illustrate how a cyclical cost like this averages out over time. We could have just used a 20-year average and entered this as a fixed cost. But, when we know what years will be higher or lower, it’s more accurate to go year by year than to use averaging.
Project costs.This is an example of a project that is expected to take three years, at a cost of $2,500 per year. It’s happening from 2007-2009, so the first year shows up in our five-year budget, but the second and third do not show up until the 10- year budget.
Budgeting for Managers 28
2003 Non- Olympic Annual
2004 Summer Olympics
2006 Winter Olympics 2005
Non- Olympic
2007 Non- Olympic
Total Average
800 800 800
1,200 2,000 1,000
800 2,800
933
1,100 3,900 975
800 4,700
940 Table 2-4. Annual variable costs: marketing budget for goggles based on Olympic years
Semi-variable (fixed base/variable volume).This is a single line item that is the total of multiple elements. Some of the elements do not vary per year (or with quantity of production) and others do. The total costs of any small office are like this. Fixed costs would include rent or mortgage and equipment leases. Variable costs would include supplies. Sometimes, a single line item will be semi-variable. For example, cellular telephone service has a fixed monthly cost up to a certain number of minutes per month and then a variable cost for additional use.
When you prepare a long-term budget, think about each line item in your short-term budget. Would you consider the cost to be fixed, variable, or some of each? Exactly how would you predict the cost?
Forecasting Income
Forecasting income is harder than forecasting expenses.
Expenses come from decisions we make, work our team does, and things our team buys. We are in control of them (or we should be). But income is a result of choices made by our cus- tomers. If they buy from us, our income goes up. If they don’t, it goes down. We can influence income through marketing and sales efforts and by producing a high-quality product that cus- tomers want, but we don’t determine it. As a result, it’s harder to estimate.
There are two basic approaches we can use to estimate income. We can base our forecasts on past income or on our marketing and sales plan. Let’s look at each in turn.