OPERATING BUDGET: CHARACTERISTICS, HOW TO DO IT, ADVANTAGES - DUDAS - 2025

The operating budget consists of all the income and expenses that a business, government or organization uses to plan its operations over a period of time, usually a quarter or a year. It is prepared before starting an accounting period, as a goal that is expected to be achieved.

It is a plan of the expenses necessary to maintain the operation of a commercial company or public organization. For example, a typical operating budget includes the estimated labor and material costs required to run the business or manufacture products.

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It shows the company's projected revenue and associated expenses for the next period, usually next year. It is often presented in the form of the income statement.

Typically, management goes through the process of collecting budget data before the start of the year and then continually updates each month. It can consist of a high-level summary plan, supported by details that support each budget line.

Complete the budget

The difficult part of completing an operating budget is properly estimating the historical data and the likelihood factor of different market variables.

This budget should take into account historical sales performance, current trends in the industry or sector, seasonality, new products expected to launch, and competitive forces as well.

Often times, companies create more than one operating budget in order to anticipate a potential decline in revenue, or the launch of a new product that could boost profitability.

characteristics

The operating budget takes into account the expenses that a company knows it will have, the costs it expects in the future, as well as the revenue it expects to generate over the next year.

Therefore, an operating budget is basically an estimate of what a company thinks future costs and revenues will be. It is one of the two segments of the master budget. Describe the activities that serve to generate income for the company.

It is prepared before the financial budget is made. This is because a large part of the financing actions are not known until the operational budget is prepared.

The bottom line of the operating budget is the estimated operating profit margin. This margin is not equal to the net profit, calculated when preparing the financial budget.

Actual performance vs. budget

Each month a report is produced showing the actual performance of the company, along with the budgeted figures for the month, for comparison and analysis. This analysis includes questions such as the following:

- Are you meeting or exceeding your sales targets?

- Are there any expenses that were not included in the budget?

- Have the costs been well projected, or are there cost overruns that need immediate attention?

Answering these types of questions will help management to plan better, thus making the appropriate changes, which will lead the company to better performance.

Details by areas

Having the details helps improve the relevance of the operating budget, as well as adding value by using it to support business financial decisions.

Each department is responsible for formulating its own budget. The personnel involved in day-to-day operations are usually the ones who know the most about all the departmental budget items.

For example, the human resources area can assemble a budget that includes updated calculations for certain benefits, costs for each new employee, and other details that they regularly work with.

The purchasing department is familiar with the cost of materials and with issues that affect this cost, such as opportunities to reduce prices, seasonal purchasing costs, or external events that generate fluctuating prices.

How do you make an operating budget?

Historical performance will always serve as the basis for future-oriented budgeted amounts. It is prepared by considering many factors and assumptions, such as:

- Past trends in sales.

- Past trends in the price of raw materials.

- Changes in laws and government regulations regarding the industry.

- General economy.

Based on these factors, the income budget is initially developed. This is because all expenses will be based on this sales projection.

Then the expense budget is prepared. Expenses should be estimated based on sales and past trends.

Components

The operating budget starts with revenue and then shows each type of expense. This includes variable costs, which are expenses that vary with sales, such as the cost of raw materials and production labor.

It also includes fixed costs, such as the monthly rent for the building or the monthly rental payment for the copier. It also includes operating expenses and non-monetary depreciation expenses.

All these items will allow the company to project the estimated percentage of net profit.

Future income

This is the part where the company tries to predict how much money it will make over the next year.

For example, if a company makes phones and expects to launch a new model in the next year, it could anticipate an increase in profits by increasing future revenue.

However, if a company makes only one type of phone and anticipates that the competitor will launch a better device next year, it projects that sales will drop, because customers will want the newer phone.

Known expenses

These are expenses that a business knows it will have to pay. For example, electricity bills will need to be paid in order to keep equipment running. Insurance, wages or rent must also be paid.

Known expenses are those that occur each year. The company expects these expenses every time it plans a budget.

Future costs

They are those that can change from one year to another. They are not something the company expects to pay for every time it plans a budget.

For example, if a company has an old machine that looks like it will need to be replaced within the next year, it will be considered a future cost.

Since it is not known exactly when it will stop working, it is budgeted as a future cost so that there is enough money in the budget to cover the cost of a new machine.

Advantage

Communicate goals

It provides a way to set and also communicate financial goals for the coming year, which can be used to hold employees and management accountable for achieving those goals.

Prepare for the unexpected

It provides an opportunity for companies to prepare in case of unforeseen circumstances.

For example, a company can set its revenue and expense targets by planning to have enough profitability to put money in a crisis fund.

This fund could be used in the event of an economic downturn, the loss of a large supplier or frequent customer, or any other type of business problem that could also negatively affect the company's cash flow.

Tracking income and expenses

Helps keep track of income and expenses. Control expenses while encouraging hard work and achieving your sales goal.

Companies prepare a schedule to compare the budget with the actual financial results for each month, or each quarter, to see how the actual performance of the company is pursuing the budgeted objectives.

Disadvantages

Businesses need to be able to stay in touch with the current financial status of the business to be successful, as well as project what to expect in the coming months in order to plan for next year's income and expenses.

Art and science

Creating an effective budget is part art and part science. As a business owner, you will need to figure out where to put the bar in terms of creating a budget that reflects the type of performance the team is capable of delivering.

At the same time, one must consider what the company must do to stay in line or beat its competitors and thus be able to stand out in the market.

Determine objectives

It's important to set budget targets high enough that the market and investors perceive your company as a leader and a winner.

However, the objectives should be kept at a realistic enough level so as not to create a negative perception if the objectives are not achieved.

Examples

-Budget lines

The operating budget should reflect the activities in the company, as well as the chart of accounts. An example of its structure is the following:

Sales

- Sale of product / service no. one

- Sale of product / service no. two

- Sale of product / service no. … Estimated sale for each product / service.

Variable costs

- Cost of merchandise sold.

- Direct sales costs.

- Sales commissions.

- Direct labor.

- Transportation costs.

Fixed costs

- Salaries for staff in stores and offices.

- Rental.

- Electricity, water.

- Building maintenance.

- Cleaning.

- Travel expenses.

- Stationary phone.

- Mobile phone.

- Internet connection.

- Hosting and updating of the website.

- Marketing and publicity.

- Insurance.

- Leasing expenses.

- Minor purchases.

- Equipment maintenance.

- Accountant.

- Lawyer.

- Other consultancies.

- Unexpected expenses (5% of expenses).

Non-cash expenses

Although these expenses do not affect cash flow, they will affect performance in the financial reporting of results.

- Depreciation.

- Computing team.

- Plant / buildings.

- Machinery.

-Budget grouping

Companies choose to group the budget in different ways. For example, based on size, structure, type of business, and other considerations.

For example, you may decide to group a budget by divisions, with categories such as management, finance, plant, or IT. Each of these sections will have the same components, such as payroll, fees, computer and office expenses.

Some companies prepare their budget by cost center or department, rather than divisions.

In a manufacturing company this could be the manufacturing department or the maintenance department. These departments are responsible for direct operating expenses and have no share of the revenue generating portion of the business.

For this type of budget, it is difficult to calculate the profit for each cost center, because it requires that it be allocated income and overhead.

References

1. CFI (2019). What is an operating budget? Taken from: corporatefinanceinstitute.com.
2. Cynthia Gaffney (2019). What is an Operating Budget? Small Business - Chron. Taken from: smallbusiness.chron.com.
3. My Accounting Course (2019). What is an Operating Budget? Taken from: myaccountingcourse.com.
4. Study (2019). What is an Operating Budget? - Definition & Examples. Taken from: study.com.
5. Rosemary Peavler (2019). Parts of an Operating Budget for a Small Business. The Balance Small Business. Taken from: thebalancesmb.com.
6. Cynthia Gaffney (2018). What is an Operating Budget? Bizfluent. Taken from: bizfluent.com.
7. Sanjay Bulaki Borad (2018). Operating Budget. Efinance Management. Taken from: efinancemanagement.com.