Project Budgeting - Ultimate Guide to Budgeting

Updated: May 14

Welcome back to the "Ultimate Guide to Budgeting" series, where we deliberate over the concepts central to the strategic budgeting process. For this article, we will discuss the Project Budgeting system. The system is applicable when a company manufactures dissimilar and differentiated products, which is the case with Green Life Inc from our case study. A quick refresher on our case study before we move on. Zhao Feiyan and Yang Yuhuan have set up Green Inc., a holding company with 2 wholly-owned subsidiaries, Green Food Inc., which sells imitation-meat products and Green Life Inc., which carries out special projects to help upstream producers move into sustainable farming.

With that in mind, let's kickstart our journey into Project Budgeting! Do leave a like or comment.


  1. Project Budgeting & Job Order System

  2. Schedule of Rates, Activity-Based Costing & Gantt Charts

  3. Part I - Revenue, Material, Labour & Overheads Budgets

  4. Part II - Raw Material & Inventory Budgets

  5. Part III - COS, SG&A Budgets & Loan Amortization

  6. Part IV - Cash Budgets

  7. Part V - The 3 Proforma Statements

  8. Conclusion


There are 2 main budgeting systems, the budgeting system for homogeneous products and services which we discussed in the previous article, and another system for differentiated and dissimilar products and services, such as construction and software development projects, which is termed as "project budgeting". Each project is assumed to be dissimilarly unique, requiring different amount and type of material, vendors and labour.

The keys to creating an effective project budget are namely, a sales estimate, job-order system, estimates of labour and material needed for each project, Gantt chart for the scheduling of works and a Schedule of Rates, developed using the principles of Activity-Based Costing (ABC). As projects are typically more exposed to variables and risk, relative to homogenous products, the forecast period varies with the level of certainty. Generally, the higher degree of forecast certainty, the longer the forecast period can and should be.


Job-order system is used when the product or service produced is sufficiently distinct from other products produced by the firms. By adopting a job-order system, it allows a user to effectively track the revenues, expenses and profitability of a "job" or project. On the contrary, if a business sells homogeneous products and services, it uses the "process-costing" system which costs are transferred between business sub-units as the product moves down the assembly line as (work-in-progress inventory) before moving it to a warehouse as finished good inventory) and transferring to COGS when the product is eventually sold.

For example, one of the projects that Zhao Feiyan and Yang Yuhuan secured for the upcoming year is to convert Old McDonald's Farm into an organic farm, which is assigned a job order code of #001. Upon having knowledge of the scope of the project, the duo proceeds to use the information to estimate the amount of manpower, material and other overheads required to complete the project.


Using the information provided on the scope of the project, the duo estimates that the project can be delivered by the end of the fifth month and they proceed to schedule the works using a Gantt Chart. It serves to illustrate the scheduling and inter-dependency of works. In our case study, the team plans to complete each work before embarking on the next, citing that although each work can be started simultaneously, the lack of manpower, working capital, equipment, as well as inefficiencies arising from undertaking too much task could jeopardize progress if the option to start all works simultaneously is chosen.


The entrepreneurs then proceed to arrange the work sequence in the most logical order on the Gantt chart. The work will commence with the construction of the drying shed and end with the completion of the reservoir for rearing ducks.


The team then computes the cost estimates for the project by first finding the quantity of labour and material needed for each job. The cost estimate is then completed by multiplying the estimated quantity with a rate, extracted from the Schedule of Rates, which we will discuss in-depth in the next section.


The cost estimates will yield useful insights costs to help guide managers on pricing. The pricing decision is important as bidding too low exposes the business to the risk of the "winner's curse" while bidding too high might cause the firm to lose the tender. Usually, if the company is confident about its cost forecasts, it can afford to plan a thinner profit margin, making it more competitive but with lesser cushion. In our case study, Green Life Inc. plans a profit of $250 (18.51% above the cost) by pricing the project at $1,600.


Although outside the context of the job order system, it is beneficial to put a risk management plan in place to meet any contingency. The bigger the size and scope of the project, the more challenging it is to forecast the project's progress and outcome with certainty. Therefore, a larger-scale project necessitates a higher degree of risk management. Some long-term projects might even stretch across multiple accounting periods, and therefore, will materially affect the firm's finances for future periods. It is thus, imperative, to carry out risk management for such projects.

On the upper-right corner is the ARTA risk-management framework, which suggests countermeasures depending on the likelihood and severity of hazards. The business should then develop more-detailed contingencies based on the proposed countermeasures.



For consistency and efficiency during costing, it is advantageous for a firm to maintain a schedule of rate. The rates for various material could be their estimated costs or the pre-agreed "locked-in" price with the vendor. The estimated labour rate varies on the skills, specialization, etc, and therefore, it is a good practice to segregate the production labour into teams of different experience, specialization and skills. The challenge of estimating the overhead rate could be met using the principles of Activity-Based Costing (ABC), which we will discuss in the next paragraph.


Activity-Based Costing (ABC) is a method to allocate overhead costs. Overhead costs are costs that are NOT directly tied to the material and labour used in the production process. Some examples of overhead costs are supervisory, production support, utilities incurred from the production process, supplies used for machinery, etc.

Considering overhead costs allow the business to have a more comprehensive overview of costs, which is critical in the pricing decision. For example, Green Life Inc. is about to undertake 2 projects. One is to upgrade a farm into a high-tech farm, while the other is to refurbish an existing farm. Understandably, the high-tech farm project is likely to incur higher overheads, such as design, engineering, purchasing, etc. So the question lies with how users can reasonably assign costs to each project.

For our case study, Green Life Inc. incurs 3 direct overhead costs, namely supervisory, depreciation and supplies. As such costs are closely related to labour hours (the higher the activity driver, the higher the overhead costs), labour hour is chosen as the activity driver. As the business is expected to use a total of 1,650 direct labour hours for the period, the direct overheads are totalled and divided by the total labour hours to derive a per-labour hour overhead rate. Likewise, if the company incurs equipment maintenance and supplies costs, machine hour could be a better activity driver.

For the #001 project to upgrade Old McDonals farm into an organic farm, as the project is expected to incur 250 hours of labour, $250 worth of overhead costs is added to the project.


In addition to the project Job Order #001, Zhao Feiyan and Yang Yuhuan have secured another 3 projects, which are scheduled to start at a later date. They are also in the running for several projects and are expected to secure a further 4 projects. The projects' commencement and completion dates are then mapped into the Project Scheduling Gantt Chart.

The project revenues are earned when performance obligations are completed. For Job Order #001, the team expects to complete the drying shed by January, thus earning the $400 attached to the performance obligation in the contract. Typically, revenues are recognized on the financial statement using the input and output method, which are discussed further in-depth in our article on revenue. This Gantt chart serves as the revenue forecast.

Next, the material usage and labour needed can be computed based on the size and scope of the works. They are subsequently mapped into the Gantt Chart to track the usage across the periods. The expected material and labour usage for each period are critical inputs for the budgeting process.


With the respective schedules in mind, Zhao Feiyan and Yang Yuhuan proceed to create the revenue, material, labour and overhead budgets based on the information presented in the Gantt charts.


The revenue budget is created with inputs from the Revenue Planning Schedule Gantt Chart. As it has everything to do with projects that span across multiple periods, it is materially affected by the timing and choice of revenue-recognition method.


Generally, there should be separate purchasing budgets for each distinctive type of material. However, for simplicity sake, both material, wood and brick, are grouped into the same table for this case study. The unit rate is extracted from the Schedule of Rates.


Typically, there should also be separate labour budgets for different teams of labour. It will help the managers to partake in better labour planning. However, for the benefits of illustrating how project budgeting works in a simple and succinct method, we have categorized the labour pool into a broad category with an average wage of $2.00 per hour.


The overhead expense is assigned using labour hours as the activity driver. Therefore, with more labour hours required for the job, the more overhead expense is allocated to the job. But doing that, one has to create a depreciation schedule to compute the periodic depreciation expense for the production equipment, to correctly compute the overhead budget.

The direct overhead budget is then created with inputs from the above-mentioned depreciation schedule, as well as other indirect production expenses.



Raw material is accounted separately from inventory. The ending raw material for each period is the totalled value of material at the end of each period.


For project budgeting, all production-related expenses, such as direct labour, material and overheads incurred are recorded as inventory. The cost is transferred to the cost of sales (COS) after the project is billed to the customers. Due to timing difference, the team expects to bill 80% of outstanding works within the quarter and the remaining by the next.



After progressive performance obligations are billed to customers, the inventory cost is transferred to the cost of sales (COS). Therefore, the COS is very dependent on the company's billing policy.


Before compiling the SG&A Budget, one has to calculate the periodic depreciation expense for the selling, administrative, and general assets of the firm. However, depreciation expense is a non-cash expense incurred under the matching principle, which states that the cost must be allocated over the periods which the asset is used to generate revenue, as the asset is already paid-for at the time-of-purchase.

The SG&A expense budget is then compiled with inputs from the depreciation schedule for SG&A assets, as well as administrative, selling, marketing, R&D and other general expenses.


Last but not least, before proceeding to the respective cash schedules, a loan amortization schedule has to be created to compute the periodic interest expenses and principal repayments for each period. For more information on loan amortisation, you may refer to our article on interest.


After the relevant budgets are drawn up, the team proceeds to create the respective cash schedules and budgets, to estimate the timing and amount of cash inflow and outflow


To estimate the receipt of cash from everyday activities, the team has to come up with the assumption on credit collection based on the business's credit policy. As the progress billing has to be certified prior to the issuance of invoices, which comes with a 30-day credit-term, the team expects only 50% of revenue to be collected within the quarter.



The following cash schedules require further assumptions to estimate the timing and amount of cash outflow. These assumptions are generally the functions of the credit granted to the business by suppliers and vendors, business's internal payment and payroll cycles, etc.


This schedule accounts for cash receipt from non-operating, non-everyday activities, such as from investment (selling of investments) and financing (fundraising) activities. Zhao Feiyan and Yang Yuhuan intend to raise fund by raising $5,000 in equity and $5,000 in debt at the beginning of Q1 and the information is recorded in this section.


This schedule accounts for cash disbursements to pay for non-operating, non-everyday activities, namely investing (purchasing investments) and financing (dividend and principal repayments) activities.


The cash budget complies information from the relevant cash schedules, neatly arranged into cash receipts and payments to accentuate its sources for the benefits of decision-makers.


Some businesses might also opt to maintain a mandated level of cash in the bank to meet unexpected liquidity needs and cash shortage. As of now, the business does not see the need to maintain a minimum level of cash (or idle capital) but aim to do so starting from the next year.

To make up for cash deficits below the minimum cash balance, the business should firstly, liquidate any marketable securities they have in hand and secondly, tap on the line-of-credit facilities. On the contrary, cash surplus in excess of minimum cash balance is firstly used to pay off any existing outstanding line-of-credit and secondly, invested in short-term, higher-yielding marketable securities.



The proforma income statement aggregates information from previous budgets and schedules. However, before it can be done, the net interest expense has to be computed by deducting interest income from the cash-in-bank and marketable securities from the interest expense on outstanding debt.


The retained earnings are the portion of undistributed net profit and can be calculated by subtracting dividend payment from net income. The PLUG balances the Asset and Liabilities+Equity account, A persistent positive number suggests that the business has excess capital and can afford to invest more in assets or distribute more dividend while a negative number suggests that the business is experiencing a deficit in the capital and thus, requires more capital investment in the form of equity and debt or selling non-core assets.


Last but not least, the team rounds up the budgeting exercise by completing the proforma cash flow statement. The cash movement in and out of the business is separated into the 3 sources, operating, investing and financing. The net cash flow is then recorded as the net change in cash and reconciled with the beginning and ending cash balances. It is normal for a startup to experience negative operating cash flows (CFO) and positive investing and financing cash flows for a few years after its foundings but it is typically a must for a healthy and mature organization to have persistently positive operating cash flow.


The project budgeting exercise is concluded with the 3 proforma statements. However, some users may add value by supplementing the budgets and proforma statements with financial ratios for each period. Doing so will allow businesses to set clear and measurable financial targets with the appropriate financial ratios, then elaborate on the plans to achieve the targets by tweaking the revenues models and cost structures using the budgets.


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