What are the advantages and disadvantages of using the percentage of sales method for operating budgets?

1 Simplicity and consistency

One of the main advantages of the percentage of sales method is that it is simple and consistent. You only need to estimate the sales revenue and apply a fixed percentage to each expense category, based on historical data or industry benchmarks. This reduces the time and effort required to prepare the budget, and makes it easier to compare and adjust the budget across different periods and scenarios.

2 Responsiveness and flexibility

Another advantage of the percentage of sales method is that it is responsive and flexible. It allows you to adjust your expenses according to the changes in sales revenue, which can help you maintain a healthy profit margin and cash flow. It also enables you to incorporate different assumptions and projections for sales growth, and see how they affect your expenses and profitability. This can help you plan for different contingencies and opportunities.

3 Inaccuracy and oversimplification

One of the main disadvantages of the percentage of sales method is that it can be inaccurate and oversimplified. It assumes that all expenses are proportional to sales, which may not be true in reality. Some expenses may be fixed, such as rent, depreciation, or salaries, or may change at a different rate than sales, such as advertising, research, or taxes. This can lead to underestimating or overestimating your expenses, and affecting your budget accuracy and reliability.

4 Rigidity and complacency

Another disadvantage of the percentage of sales method is that it can be rigid and complacent. It relies on past data and trends, which may not reflect the current or future market conditions, customer preferences, or competitive strategies. It may also discourage you from exploring new ways to reduce costs, increase efficiency, or improve quality, as you may stick to the same percentage for each expense category. This can limit your innovation and adaptation, and affect your long-term growth and sustainability.

5 Alternatives and improvements

The percentage of sales method is not the only option for preparing an operating budget. You can also use other methods, such as the zero-based budgeting, which requires you to justify each expense from scratch, or the activity-based budgeting, which links each expense to a specific activity or output. You can also improve the percentage of sales method by using different percentages for different expense categories, based on their behavior and relevance, or by adjusting the percentages periodically, based on the actual results and feedback.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?