Overview of Colors of Money in Budgeting
Colors of Money Budgeting
What is colors of money budgeting? The short answer is that it is a less detailed version of activity based costing or ABC accounting.
Activity based costing (ABC) requires charge numbers and detailed tracking of all parts, labor and overhead expenses as they relate to specific activities or projects. "Colors of money" budgets use a similar structure to activity based costing but without nearly as much micromanaging or categorization of spending as ABC.
The “colors of money” method of budgeting is similar to the “buckets of money” or “envelope” budgeting used by families, but used on a much greater scale with the opportunity to flow down an overall budget to projects and business sites or work groups.
Colors of money in budgeting assign a color to each category in a business. Different colors may be assigned to utilities, engineering services, supplies and materials, employee pay, transportation and maintenance. Each color of money then flows down into detailed budgets for different programs, departments or activities like product lines. The color of the money determines its allowable use.
Money marked for utilities may be used for natural gas, water, electricity or compressed air. A facilities manager can choose to use utility funds to buy a new emergency generator or pay a lump sum for a contract, but they cannot exceed the amount of money allowed in the utility category. And the facilities manager cannot use money marked for utilities to pay his salary or buy materials for facility maintenance. Likewise, money marked for engineering services cannot be poached to pay for management expenses or buy raw materials. Money colored for “sinking funds” is set aside for sinking funds such as roof replacement or paying for new major equipment lines when existing ones are worn out. Sinking funds are then preserved and cannot be raided to pay operating expenses.
By assigning “colors” to the money, the limited, categorical use of the funds is retained even as it flows down to specific projects or managers. Money “colored” for education and training can be used for ethics courses, on site seminars or paying tuition reimbursement for select staff – but it cannot be taken away to pay employee bonuses or buy office furniture. Using colors of money in budgeting allows the end users to have flexibility in allocating the money while staying within the budgeted limits of each category set by the overall budget.
Each color of money has an intended purpose. Each color of money can also have its own rules on spending the funds. Each color of money can have rules on when higher level approval is required to make major expenditures or time limits on when the money must be spent. Each color of money can also have its own accounting rules, whether invoicing is required for all purchases or if cash drawers and receipts are sufficient.
Colors of money can also be used to track income sources and its uses. General income from product sales, royalties from intellectual property licensing agreements and interest on savings accounts can each be assigned their own color. Money from sales of a business division or stock sales can be marked one color and tracked and spent separately from general operating funds.
In corporate budgeting, each color of income can then be divided and earmarked for specific purposes. By tracking each income source by its own color, the impact of each income source is visible on the overall income statement. Expenses related to that income source can be paid for specifically out of that color of money. This prevents interest on company investments such as the pension plan being co-opted to pay basic operating expenses. It also allows businesses to earmark a portion of intellectual property income to pay for the ongoing legal actions necessary to supervise those licensing agreements instead of seeing the legal department managing that cash cow as an overhead category to be cut in the next round of layoffs.
As with all budgets, money may need to be transferred between budget categories to manage cost over-runs. However, each color of money can have its own rules on transferring money between categories. For example, money may be easily transferred between maintenance and operations while intellectual property funds and sinking funds require a Vice President’s signature to raid. This prevents one department from going over budget and taking money from other groups without accountability or full knowledge of upper management.
Requiring oversight and approval to change the color of money also provides immediate visibility as to the reasons and conditions the financial change-over required, instead of someone simply screaming at the end of the month that they have run out of money. This visibility improves the ability of a business to contain a problem that has triggered a cost over-run.
Considerations Before Adopting Colors of Money Budgeting
The ability to pull from a related spending category to handle unexpected expenses doesn't allow for consistent over-spending. Businesses must be aware of their spending and compensate for cost-overruns just as households do.
Colors of money budgeting is not an option if you are required to use activity based cost management with charge numbers tied to a particular contract; overhead charges for one project may not be transferable to another project or even between types of overhead spending on the same project.
The colors of money budget is simply a method of using the buckets of money approach to identify funds based on intent down through multiple layers of management or distribution. The colors of money budgeting method can make financial tracking and cost shifting simple enough to stay within the budget. Then the business has a better chance of meeting the ultimate financial goal – staying in the black.