Operating BudgetA plan that includes a business's projected revenue and expenses for an upcoming period
Running a business isn’t always smooth sailing.
You sometimes have to deal with unplanned expenses or unusual losses.
And just when you think that your business made enough sales to make a profit, its financial statements will tell you otherwise.
Now imagine doing all that without a plan, without a direction. You’re pretty much just going with the flow.
It’s stressful, right?
Thankfully, no business owner has to go through that.
There’s budgeting after all.
It can be a complicated process but if done correctly, its output/s can help greatly in managing a business.
One of the outputs of budgeting is the operating budget.
It is a budget plan that mainly focuses on the short-term (typically the following period).
It’s useful for planning a business’s operations for the following period/year as it typically includes details about the planned revenue, expected expenses, etc.
The operating budget is also useful for gauging the actual performance of the business.
Did sales exceed the budget?
Or did the business fall short?
Are expenses within expectations?
An operating budget can help in answering these questions.
With an operating budget, a business has a plan and direction on how to operate for the following period.
In this article, we will be exploring what an operating budget is.
How does one define it?
How does it work?
What are its components?
What benefits does it provide a business?
Would a business be able to perform better if it has an operating budget?
We’ll try to answer these questions as we go along with the article.
What is an Operating Budget?
An operating budget is basically a plan for the operations for an upcoming period (typically the next year).
It is a detailed projection of what a business expects its performance will be over a certain period of time.
A typical operating budget will show a business’s projected revenue and expected expenses.
A business will usually plan and formulate its operating budget before the start of each year, typically near the end of the previous year.
The business could apply adjustments to the operating budget as the months go by if necessary.
For example, there might be a significant difference in the estimation and actual cost of raw materials.
This necessitates an adjustment in the operating budget.
Businesses (even the government) use an operating budget to plan their operations for an upcoming period.
Since it includes details about the projected revenue and expected expenses, it is usually presented in a format that is similar to that of an income statement.
Periodically (usually monthly), the business will compare its actual performance to what’s on the operating budget.
This helps the business gauge whether it’s still operating within budget or not.
If there are any unexpected items such as an unexpected expense, the business may adjust the operating budget to accommodate them.
The Objectives of an Operating Budget
An operating budget is a great and effective management tool as it provides a clear profit objective.
Aside from that, it helps a business with the following:
Effectively Plan Ahead
Planning without figures in mind isn’t nearly as effective as planning with a budget.
Imagine putting “more sales” as a plan for the next year’s operations.
However, what exactly is “more sales”?
Does a $1 more count as “more sales”?
With an operating budget, this wouldn’t be an issue.
An operating budget includes details about the business’s projected revenue and expected expenses for the upcoming period.
Not only that, but an operating budget may also include guidance on how to achieve its figures.
Allocate Resources Properly
The resources of a business are limited.
As such, a business would want to allocate them properly.
An operating budget can help with that.
An effective budget will help a business manage the inflows and outflows of its resources.
Additionally, an operating budget will include details about the business’s expected expenses.
This helps the business plan the allocation of its resources.
Provide a Basis for Performance Evaluation
A budget isn’t just a plan.
It is also an evaluation tool.
An operating budget may be as detailed as including a portion for every function/department.
This helps the business in gauging the financial performance of its different departments.
Comparing actual performance to the budget is par for the course.
It helps gauge whether the business has met its objectives or not.
The Components of an Operating Budget
While the operating budget of one business may differ from another, each operating budget will have the following sections:
- Variable costs
- Fixed costs
- Non-cash expenses
- Non-operating expenses
This section will include the projected revenue of the business.
If a business has several ways of earning revenue, you’ll also find details about that.
For example, if a business sells goods and services, the projected revenue for each type of sale will be segregated.
It can be as detailed as providing details on the volume of sales and the average sales price.
For example, the revenue section may include the projected volume of sales for each product, the expected sales price of each product, the projected revenue for each product, and finally, the total projected revenue.
This can be presented in a monthly format (e.g. sales for January, February, March, etc.).
This section will include the expected variable costs of the business.
These are the costs that increase or decrease depending on the level of activity (usually the volume of sales).
For example, the amount of sales commission will depend on the amount of revenue.
This is why they are sometimes calculated as a percentage of revenue.
Some examples of variable costs include the following:
- Cost of goods sold
- Sales commission
- Direct selling costs
- Payment processing fees
- Cost of raw materials
- Direct labor
This section will include the projected fixed costs of the business.
These are the costs that don’t change accordingly to the changes in revenue.
They are mostly constant and will only change after the period.
For example, the cost of rent will remain the same until the end of its term.
These costs will be incurred whether the business makes a sale or not.
Some examples of fixed costs include the following:
- Salaries of office personnel
- Insurance costs
- Property taxes
- Licenses and fees
This section will include the projected non-cash expenses of the business.
These are expenses that don’t affect the business’s cash flow but still impact its net income, a measure of financial performance.
Rather than decrease the cash balance of the business, non-cash expenses decrease the balance of other assets such as accounts receivable, inventory, equipment, etc.
Some examples of non-cash expenses include the following:
This section will include the projected non-operating expenses of the business.
These are expenses that are not related to the main operations of the business.
However, they still affect its net income.
Some examples of non-operating expenses include the following:
- Interest expense
- Loss on the disposal of a fixed asset
- Income taxes