What Is Cost Budgeting? (With How-to Steps and Tips)

By Indeed Editorial Team

Published September 5, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

A cost budget is a financial tool companies use to assess and plan business expenditures. It assists project managers and corporate executives in tracking and analyzing spending patterns. If you're responsible for a company's or project's budget, it's useful to learn about this strategy to help save money, enhance profits, and plan future budgets more effectively. In this article, we discuss what cost budgeting is, explore its components, explain why it's important, outline how you can create a cost budget, and provide some tips.

What is cost budgeting?

Cost budgeting is a method for developing a financial plan and budget based on cost estimates. A budget is a financial mechanism you can use to manage costs, while cost budgeting is a type of budget where you total all predicted costs for a certain timeframe. You use it when planning new projects and when developing quarterly or annual budgets. You can also use it to analyze project performance in relation to spending.

Related: Guide to Understanding Cost-Based Pricing (With Formulas)

Different elements

It's important to create a cost budget that's specific to the organization or project. A cost budget comprises the following items:

Cost estimates

To create a cost budget, use the numbers from the cost estimates. Cost estimates predict the total cost of each stage of a project. A cost budget includes estimates for the following types of costs:

  • Direct costs: Direct costs are expenses incurred in the production of tangible products and services. In a manufacturing corporation, for example, this includes supplies, production labour, and transportation fuel.

  • Indirect costs: Indirect costs are expenses incurred during regular business activities. This includes rent, staff wages, and communication services like internet and phone charges.

Related: What Is Management Reserve for Project Budgets? (And How-to)

Project schedule

A cost budget sometimes includes specific information on the project's timeframe. This can help in planning for each task in the project and ensuring adequate funding for each step. For example, when developing a cost budget for a new building, you can divide the project into sections such as initial construction, electrical, and plumbing.

You can then develop a schedule for each of these tasks. The initial construction might take one month, while plumbing and electrical work each take a week, and the schedule can help you plan for the associated expenditure. You might use this information to determine that the first construction phase requires $100,000, and prepare for it in your budget to ensure the project has enough available financial resources to meet these needs. You can then assess the project budget at the end of the month and make modifications if necessary.

Related: What Is a Cost Management Plan? (With Elements and How-to)

Contingency reserve

Depending on the project and sector, some experts incorporate a contingency into their cost budget. A contingency reserve is a portion of the budget put aside for unforeseen developments. Even with careful planning and cost prediction, unexpected expenditures often arise, and a contingency reserve helps mitigate this risk.

Related: What Is Project Cost Management, and How Can You Use It?

Benefits of cost budgeting

It's important to develop a cost budget when planning a new project or business strategy. Here are some of its benefits:

Increases efficiency

Financial experts use cost budgets to examine project expenditures. This helps them to reduce waste and increase efficiency. For example, when creating a cost budget, a project manager may notice the organization is paying an external marketing price despite recently establishing an internal marketing team. They use this data to refine their processes and increase overall business efficiency.

Improves profitability

Using a cost budget can help reduce total project expenses and increase profitability. For example, while creating a cost budget, a production team may discover their material expenses are higher than predicted. This knowledge might encourage them to find a new vendor or another source of raw materials. This can assist companies in lowering their costs and increasing their revenue so they can generate a higher net profit on each item they sell.

Related: How to Write a Project Budget (Importance and Steps)

Helps professionals meet business goals

A cost budget can assist financial experts in meeting corporate objectives by developing a plan for each project. An expert can guarantee the project runs well by planning each expenditure and timeframe. For example, a software corporation might develop a cost budget for each fiscal period. They can alter their company plans by comparing actual expenditures to projected costs for each quarter. For example, if they budgeted $1,000 for quarterly manufacturing costs but spent $1,500, they might decide to change their production method to save money.

Related: Forecast vs. Budget (Plus How to Forecast a Budget)

How to develop a cost budget

If you're creating a cost budget, you can consider following these steps:

1. Set budget guidelines

You can use a cost budget for a financial quarter or a single project, and setting realistic guidelines or rules can make the actual expenditures more accurate. When determining your budget parameters, remember the budget's function and objectives. For example, if you're developing a new production project, construct a project budget that shows the expenditures for each step of production.

2. List all costs

Following the establishment of your budget guidelines, list all the forecasted expenditures. You can then list the expense categories without allocating specific amounts. Including both indirect and direct costs associated with physical production and general company activities can help provide a more realistic budget. This involves considering rent, equipment, salary, supplies, and utilities. If you're part of a project team, you can go through this information with your colleagues to verify that you've included all project expenditures.

Related: What Is a Production Budget? (With Components and Example)

3. Identify known costs

After you've compiled a broad list of costs, you can begin entering the figures into your budget. Examine the cost list and enter the costs you already know. Rent and salaries are examples of fixed expenditures. You may be able to determine more accurate fixed costs using bills and statements from the preceding quarter or year.

4. Estimate expected costs

Begin by including variable expenses, such as payroll and supplies. Calculate expected costs using previous projects and financial records. For example, when launching a new manufacturing product, you can use the balance sheet for a similar product to estimate predicted sales and determine the variable costs for producing each item. This figure can forecast future spending. If a team spends $5 on each item and intends to sell 100 items in the following quarter, the estimated expenditure is $500.

Related: Guide for Creating an Effective Budget in Marketing

5. Set the timeline

You can set a realistic timeline by considering when each phase of the project is likely to conclude. Breaking each phase of a project into smaller sections and establishing weekly or monthly targets can make this more attainable. This helps with tracking expenses during a specific timeframe and ensures there's enough cash available.

6. Analyze and refine

You can reference the cost budget regularly to examine total expenses and progress during a project. To enhance cost efficiency, consider assessing the cost budget at the start of a project, then again mid-way through. For example, if a cost budget reveals your team requires $10,000 for a project and this is more than you forecasted, you can use the cost budget to identify other areas where you can reduce costs.

7. Compare actual costs

Track real expenditure and compare it with estimated expenditure throughout the project. This assists you in determining where you can save money. For example, if you expected to spend $2,000 on supplies but spent $3,000, use the cost budget to refine your approach. To cover this higher expense, you can use the contingency reserve, cut costs in another area, or find extra funds.

Related: Tips for Planning a Budget (And How to Create One)

Tips for creating a cost budget

When creating a cost budget, consider these suggestions:

Make your estimations carefully

When setting up a cost budget, try to make accurate projections. When possible, make high estimations. This helps ensure you have sufficient money to finish the project. For example, if you're budgeting for your building's power expenditure, use previous electricity bills to establish the predicted cost. If this monthly expense is normally between $100 and $200, make your estimate closer to $200 to ensure you have enough money.

Select a format that works with your accounting software or system

When creating a cost budget, you can stay organized by entering costs and dates into a spreadsheet or budgeting software program. Consider the format carefully, and use one that's compatible with the company's accounting program or cost-tracking software. This makes comparing real prices to your estimates easier.

Related: Comparing Cost Saving vs. Cost Avoidance (Key Differences)

Schedule time to review and revise your budget regularly

Cost budgets are a useful tool for tracking spending and performance, and they can help you make essential changes during a project. Go through your budget regularly and compare the anticipated expenses to the actual project costs. This information may alter your budget for future phases of the project. For example, if you evaluate your budget on a weekly basis, you might discover your material costs are higher than intended. Adjust your budget to reflect this change. Doing this helps ensure you have sufficient funds to finish the project.

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