Operating Budget

The operating budget refers to the estimation of all the revenues and expenses that a business would incur over a particular period and is usually done by the business analyst and with guidance from the company's management.

The method to estimate profits or calculate outflows and inflows vary as every business has its own cost and benefits. However, sometimes it is also prepared to pre-estimate the revenues we will earn after the period is over and plan further activities accordingly as each business activity is interconnected.

The annual operating budget is mainly connected with the estimations of all revenues and costs that the entity will incur over a set time to achieve the objective of the business. It contains all the details of income and expense that the business incurs daily and helps in assessing the company’s financial condition and its ability to meet manage the daily activities.

Every company has to prepare it at regular intervals as a guideline to make decisions regarding investments, capital expenditures, expansion and growth. Various information related to past and present financial data, the current market trends related to demand and supply, the actual sales figures and their deviation from the forecast and the objectives of the business are taken into consideration while preparing this budget.

The figures of the annual operating budget are compared with the actual income and spending. The deviation is evaluated to find whether the business is progressing in the right direction or whether some necessary action should be taken to control the process and steer it in the right direction.

There are mainly three types which are as follows:

1. Revenue Budgets: These are those budgets that forecast the expected revenues from the business over a set period.
2. Expenses Budgets: Budgets that forecast the expenses which are to be incurred over that set period are expenses budgets.
3. Profit Budget: It is a difference between the above two budgets, i.e., when we subtract the revenue budget from the expenses budget, we get a profit budget.

Suppose ABC Inc. wants to prepare its operating budget template based upon the actual data of the business in the past two years given below:

Now, from the above-given data, the operating budget sample for the year 2020 is as follows:

Thus, the above operating budget template gives us an idea about how they are prepared.

The steps in operating budget preparation are as follows:

1. Gather the actual data for at least the past two years.
2. Observe the trend of increase or decrease in revenue or expenses of the business.
3. Check trends of the industry in which the entity operates, i.e., industry norms and new government policies which have a significant impact on the activities of the business.
4. Observing the above parameters, analyzing the market, and observing the prospective customers and market cap would help us analyze the percentage increase in revenue and expenses accordingly.
5. Accordingly, prepare the operating budget by taking an expected increase or decrease in figures from the previous year's actual figures. After that, it calculates the expected profits.

Let us look at the various benefits that the business gets from preparation of an operating budget sample.

• The owner of the business or the analyst need not go in-depth as they can observe the position of the business by comparing actual budgets to get the results.
• It helps in tracking the income and expenses of the business that has already been incurred and has been forecasted for the future.
• A track and monitoring of the expenses incurred help avoid unnecessary wastage of resources and funds.
• Increases or improves the team's efficiency by giving them a deadline for expenditure and revenue as well as fixed budgets.
• Operating budget preparation also helps make informed decisions regarding any new and heavy investment opportunity, capital expenditure, innovation, or expansion.

Along with advantages the system also has some disadvantages that are given below:

• It is based on predictions and expectations that cannot be judged accurately as there are thousands of other factors in the environment in which an entity operates, such as regulatory policies, etc. For instance, let us say we are in the manufacturing business and manufacture plastic bags, and the government, by its notification, banned the use of plastic bags. Then, in this case, all our preparations and funds will get wasted.
• It requires time as continuous follow-up and improvements are required.
• There is time constraint related to the fact that budget is prepared based on a limited timeframe. In case of any sudden change in circumstance of the business environment, the budget may become irrelevant.
• The data collected may not always be relevant or not come from dependable sources. The projections or analysis may not always be accurate and not be aligned with the financial aim and objectives of the company.
• It may create some pressure on the management to limit use of resources for development, expansion or innovation purpose, hindering the growth of the organization.

Thus, paying attention to both the benefits and limitations while implementing the system is necessary.

Let us look at the differences between the above two types of budget.

• The former is typically for a short time, usually a year, whereas the latter is for a longer time, with involves many years.
• The former is meant for the daily expenses and income, whereas the latter is for heavy expenditures, like plant and machinery, land, growth and expansion.
• The main purpose of the fromer is to keep fund aside for carrying out the regular operations of the business whereas the latter is for long term return, planning, risk management, heavy investments, etc.
• Operating budget is prepared more frequently than the capital budget. Capital budget once prepared, may undergo some evaluation from time to time without freshly preparing the same thing again and again.

Let us understand the fundamental differences between the two financial budget procedures given above.

• The operating budget considers those figures, which are only for a particular segment, but, on the other hand, the financial budget considers all aspects of the business, which may result in financial terms.
• A financial budget is a broader term as it considers business as a whole compared to a particular segment we look after while preparing an operating budget.

This has been a guide to what is Operating Budget. We explain it with examples, differences with capital & financial budget, types & how to calculate. You may learn more about financing from the following articles –

• Static Budget
• Line Item Budget
• Performance Budget
• Advertising Budget
• Fixed Budget vs Flexible Budget