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Operating Budget

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Operating Budget

Successful businesses base their plans on calculated financial projections to minimize the chances of failure. One such projection is an operating budget.

What’s an Operating Budget

An operating budget details an organization’s projected revenue and expenditure over a stipulated period. This time frame could be monthly, quarterly, or a business year.

Components of an Operating Budget

An operating budget typically consists of revenue, fixed and variable costs, plus other expenses.

Revenue

Revenue details all the ways a company generates income through its operations. Most companies don’t prepare a year-over-year forecast but instead break it into its underlying parts. This way, they gain significant insights into their income sources.

Typical Components of Revenue

Price

Average Price
Per Unit Price
Segment Price

Volume

Units
Customers
Contacts
Products

Variable Costs

Variable costs are expenses dependent on sales volume. They aren’t constant and include payments for raw materials, freight, sales commissions, labor, and more.

Fixed Cost

This component refers to set expenses that companies pay independent of sales volume. Fixed costs are typically constant and include rent, utilities, insurance, management salaries and benefits, and more.

Other Expenses

Company expenses outside fixed and variable costs also appear in an operating budget.

Non-Cash Expenses

Non-cash expenses don’t impact cash flow, except on taxes. It includes depreciation, stock-based compensation, unrealized gains, amortization, and more.

Non-Operating Expenses

These expenses aren’t directly linked to a business’s operating activities. Interest payments, taxes, costs from currency exchanges, and more belong to this category.

Side Note

Companies typically don’t include capital costs in their operating budget. The latter targets a business’s income statement and doesn’t include capital expenditures.

Why a Business Needs an Operating Budget

An operating budget helps companies map out and achieve their business objectives. Managers routinely compare actual results to this projection and answer the following questions:

Is the company meeting or surpassing its estimated sales target?
Were there expenses unaccounted for in the budget?
Does the operating budget provide a fair cost estimate, or are there cost overruns?

Analyzing the operating budget helps businesses achieve the following:

Adapt to changing market conditions
Update strategies
Improve performance
Manage expenses
Reduce business debt
Develop financial accountability

How to Prepare an Operating Budget

Preparing an operating budget requires all managerial hands on deck.

Step 1— Projecting Revenue

Executives and managers draw up a revenue estimate for the coming financial year. They achieve this feat by analyzing the organization’s performance history while considering market variables that could influence sales volume. Examples of these elements include the following:

Changing market trends
New products coming to the company’s line-up
Competing brands’ actions
Seasonal changes
Economic changes
Policy changes

Step 2 — Projecting Expenses

The next step in creating an operating budget is drawing up potential expenses. Managers will need to create one for their respective departments.

For example:

The production department would have more accurate knowledge of the cost of raw materials, seasonal inventory costs, and more.
The HR sector would be more knowledgeable with budget projections involving employee benefits, recruitment costs, and more.

When calculating expenses affecting the entire business, such as taxes and rent, executive members are often best fit for drawing up such projections. Also, considering previous records and market variables can help businesses create reasonable expense estimates.