The operating budget refers to the detailed projection of all the revenues and expenses that a company would incur over a period of time, typically quarterly or yearly, to use to plan its operations. In fewer words, it is a calculation of varying outflows and inflows in a company to show the expected activity for the following year.
What are the Uses of an Operating Budget?
An operating budget helps a company plan in advance and achieve the expected goals. Each quarter, company managers can compare the achieved results and the desired results of an operating budget to analyze the following questions:
Were there any unexpected expenses?
What were the unexpected costs?
Did sales rise or sink more than predicted?
Does the year plan need to be adjusted?
After analyzing the results, companies have the opportunity to change or update their actions and strategies to achieve a better execution for the year.
What are the Components of an Operating Budget?
Each business has unique and distinct characteristics. It may need to add a high-level summary and more detailed sub-budgets into the operating budget to make it more relevant and valuable.
But, here are some standard components that apply to most industries.
Revenue includes all the inflows a company makes by selling a good or service. It is usually broken down into drivers and components for more significant insights.
Revenue drivers contain a volume of units, products, contracts, customers, etc., along with average price, segment price, per unit price, etc.
2. Variable Costs
Variable costs depend on revenue and often fluctuate with the sales volume. These costs include freight, payment processing fees, cost of goods sold, direct selling costs, etc.
3. Fixed Costs
Fixed costs usually don’t change with revenue and often remain constant for a certain time frame of the operating budget. Rent, utilities, loans, leases, insurance, etc., usually fall under fixed costs.
4. Non-Cash Expenses
Non-cash expenses don’t impact cash flow except for taxes and the company’s overall financial performance report. It usually includes amortization, depreciation, unexpected gains or losses, deferred income taxes, etc.
5. Non-Operating Expenses
Some costs are not directly under a company’s business activity, but companies still include them in the budget plan. Some examples of non-operating costs are losses from assets, costs from currency exchange, and interests.
6. Capital Costs
Companies usually don’t include capital costs in their budget plan. This is because capital costs are long-term costs, whereas an operating budget is a short-term plan.
What is the Importance of an Operating Budget?
The operating budget works as a route map for the company to manage and keep track of its expenses in the following sectors:
Previously incurred revenues, expenses, and losses.
To set a limit for the expenditures and a goal for the revenue. It creates a setline following which the company can plan to work so that resources are efficiently used and the benefits are maximized.
How to Prepare an Operating Budget?
Preparing an operating budget is not a single-person job. It must include executives and managers for a practical report for the year.
A collaborative effort can create a highly detailed operating budget by following the steps below:
Actual and accurate data collection for the past two years.
To observe the increase and decrease trend in revenues and expenses.
To estimate the following year’s revenue.
To check the market variables similar to the company that can significantly impact the following year's sales for better or worse.
To check trends for new industry norms and government policies that can affect the business’s activities.
Executives and managers must account for their department’s expenses in an estimated expense report.
To get an analysis report on the revenue and expense increase percentage by observing the market, prospective customers, and market cap.
Lastly, preparation of an operating budget based on the previous year’s data to get an expected report of an increase or decrease in figures and an estimated profit for the next year.
Gathering all the information is hard for the employees, but it is necessary to build a sustainable strategy for the company's benefit.