A budget ceiling, sometimes incorrectly referred to as a debt ceiling, is a cap on business spending based on one or more formulas or limits set by a business. Understanding the different methods businesses use to set budget ceilings will help you maintain flexibility in your spending without going into unmanageable debt or robbing Peter to pay Paul.

Budget vs. Debt Ceiling

In its simplest form, a budget ceiling is a cap on spending. For example, a small-business owner might set a limit of $10,000 on all company spending for a month, or set caps on all types of spending for the year. This ensures that the company does not spend more than it makes, based on expected revenues, often estimated based on recent sales. During the course of the year, the company might review its performance and raise or lower its budget ceiling based on income. It does this by performing a budget variance analysis. The term “debt ceiling” most commonly refers to the limit on the amount of money a government can borrow to fund its operations, make future commitments and pay its debts. The country’s budget is then created in response to its debt ceiling.

Overall Budget Ceiling

One way to set a budget ceiling is to set a limit on total company spending. This works best at small company where the owner or small group of managers are able to keep track of all spending and adjust what different areas or functions spend. For example, if a business owner sets an overall budget ceiling of $10,000 per month for her company, she might reduce her budgeted marketing dollars if labor costs increase that month, if that’s necessary to meet her $10,000 spending limit.

Departmental Budget Ceiling

Another way to use a budget ceiling is to set limits on spending by department. This requires each department manager to create his own budget, or the owner to create budgets for the different functions of her company, such as marketing, IT, sales and human resources. Some departments might not have a budget limit, such as production or sales, since their performance is tied to sales volumes. Others, such as marketing and IT, might have pre-set budgets if their performance isn’t affected by rising and decreasing sales volumes. Some companies create capital budgets, which set spending for long-term assets such as machinery, buildings or computer systems. Budget ceilings for these expenditures get set based on a company’s capital reserves or available credit, rather than on expected revenues.

Revenue-Based Budget Ceiling

Another way business owners create budget ceilings is to tie spending to revenue. For example, a sales department might be given a travel or promotional budget based on a percentage of revenues. If a sales rep has rising sales, his promotional or travel budget would increase as his sales increase. This gives businesses flexibility to take advantage of windfalls and prevents them from overspending because they based spending on overly optimistic revenue projections.