Determining expenditure levels for each category of selling expense is very difficult. Two methods for determining budget levels are discussed below
Budgeting by Percentage of Sales Method
Many business people plan and control their enterprises by percentages. Using this method, the manager multiplies the sales, forecast by various percentages for each category of expense. The resultant product then becomes the dollar amount budgeted for each of the respective categories. The percentages used for each category may be based on the manager’s experience and/or feelings about what portion of the sales dollar can or must be spent ‘on each business function to achieve ‘the desired profit. The percentages might also be based on published industry averages for expense categories. These published averages should be used only as guidelines which must be adjusted to reflect the unique aspects of the particular organization. These percentages are then used in controlling sales and their costs.
Of course there are no guarantees that setting the budgets using these percentages will lead to optimal performance. In fact the expense allocations, using this method, will follow the direction of change in sales. For example, if sales are forecasted to decline, then the budget allocations for all expense categories will decrease as well. This may or may not be the optimal allocation to counter the sales decline. Additionally, the effectiveness of this method is dependent on the firm having accurate sales forecasts.
Despite the limitations, the manager knows that if expenses are kept within their percentage budgets, final operations will come out as planned.
