Line Item Budget Definition Example How It Works

Line Item Budget Definition

Purpose

Line item budget is mainly used by small businesses that don’t know about sophisticated accounting systemsAccounting SystemsAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more and don’t have the infrastructure and budget to set up one. It doesn’t reflect revenue; they only show the expense. So they depend on this simple budget where several categories of Expenses are presented in a line.The primary purpose of Line Item is to help managers control their expenses. If in any month, the expense crosses as compared to the previous month, then the manager becomes alert and controls the expense to match the overall yearly budget compared to the previous one. The comparison between the past and present expense figures always signs a warning for the managers.

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Example of Line Item Budget

Mr. X is the budget specialist for a small business that operates in New York. He has prepared the Line budget for January 2020 and is planning necessary steps that should be taken to not deviate from the yearly planned budget.

Solution

So after studying this budget, the manager sees that the Budgeted expense for January was $68,500, and the Actual Expense was $74,000. So the organization has spent more than what was estimated.

Now the manager will check individual expense categories minutely to see where precisely the budget has crossed the estimate and will take necessary measures to prevent that from happening in the next month.

Office supplies need to be checked; as office supplies have crossed the budget, it means more supplies were ordered this month, and it should also be enough for the next month, so the ordering of office supplies for the next month should be below. The salary is in line. So no adjustment is required. Advertising cost has gone up, so it needs to be checked next month.

Canteen Expenses have increased by a small amount, and it is difficult to check as you can’t ask employees to eat less, but you can request them to stop wasting food. So awareness needs to be taught.

Characteristics

Line Item Budget is a columnar representation of expenses. Several categories of expenses are represented column-wise, and each category can be compared with the previous year in a single row.Suppose it is seen that for a particular category, the expenses are rising year on year. In that case, it may be due to inflation in that specific category, and it should be balanced by reducing expenses in other categories. Several past year columns can also be created to see whether the trend of expenses is upward sloping or downward sloping.For the current year column, decide what should be the budget considering inflation and several other economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others.read more. Decide the budget and fill the column with an approximate budget. After the month has passed, fill in the real expense and see how much you deviated from the projected budget.Usually, it is prepared month-wise. It helps managers curtail expenses in case monthly budgets are way out of line compared to projections.

Advantages

Creation and understanding of Line Item Budget are straightforward. You don’t require accounting knowledge to understand which item will be debit or credit. You need to fill the actual and projected expenses in tabular format. The difference can be seen in the naked eye and can be compared easily with the previous year’s data. If the expense has crossed a stipulated budget in any particular month, it acts as an alarm, and managers become attentive to control the budget for the following months.

Disadvantages

The line budget is fixed at the beginning of the year. It requires permission from higher authorities to make changes in the Line Item Budget. So if the manager feels that the prepared budget is not a correct reflection of the estimated expenses due to precise changes, then the manager can’t change the budget.As it only concentrates on the expenses, it gets difficult for managers to show the exact reason the budget has crossed the estimation. It could be that the Salary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability.read more salary payable has increased due to the appointment of new employees, which has increased revenue. Still, as there is no place to show the change in revenue, salary expense increase is treated as over budget.

Conclusion

Line Item Budget is straightforward to prepare and maintain. Small businesses that don’t have sophisticated account knowledge can take the help of this budget to check their monthly expenses. Being over the budget doesn’t necessarily mean that cost has shot up; it could be that revenue has increased due to the extra cost. So this thing should be kept in mind whenever you make a decision based on Line Item Budget.