Good planning leads to efficient and effective use of scarce resources such as time and money. A budget is a managerial tool used to plan and control the use of the available resources. Therefore, this is helpful to any individual or any firm. It clearly indicates the business owners’ goals and objectives and forecasts where they would be in a specific period.
What is an Operating Budget?
An operating budget summarizes the projected firm’s revenue and expenses over a specific period, for example, a year. It is compiled and presented in an income statement format and is often used by corporations, organizations, or governments to plan its operation. In most firms, the management team usually comes up with a budget at the beginning of a financial year; then changes can be updated any time of the stipulated period, let’s say monthly.
An operating budget plan will help in:
- Helps to keep track of income and current expenses. Operating budgets show both amounts of money already spent and the expected returns. It controls how these funds are spent and ensures that the firm works hard enough to meet its set targets.
- Establish financial accountability. Keeping track of the business’s expenses allows a manager to put aside funds to gather for other things such as payment of employees, payment of the debt, and investing.
- Improves the efficiency of the business. It guides the lower managerial team to better and efficient planning of all the business operations; hence, this improves the organization’s general efficiency.
- Forecast for future expenditure
- Reduce debt
Component of an Operating Budget
The main elements of an operating budget are listed below. These are the general components and can apply to most of the firms.
Revenue refers to the income received from the normal operations of the business. The majority of revenues for most firms is generated from sales. Revenue generally includes sales, service revenues, fees earned, and interest income.
These costs are dependent on revenue; therefore, they are determined just after revenue is calculated as a percentage of the sales. They are comprised of the following: cost of direct selling, goods sold, commissions on sales, payment processing fees, cost of direct labor, freight expenses, and marketing costs.
These expenses are constant within the time frame of an operating budget and cannot be affected by revenue changes. These costs include: office rent, insurance, utilities, telecommunication and management salaries
They are expenses which do not involve cash transaction, but they are included in the income statement. They include depreciation, unrealized gains or losses, stock-based compensation, impairment expenses, deferred income taxes, and amortization.
These are expenses incurred by a firm from activity that is not among its core operations. They include restructuring costs, losses as a result of fire or natural calamities, losses from investments, discontinued operations, taxes, and changes in accounting principles.
Capital costs in an operating budget:
Capital costs are not recorded in the operating budget. Capital costs or expenditures refer to the money set aside for acquisition, maintenance, or improvement of fixed assets such as property, buildings, equipment, and technology.
How to Create an Operating Budget
When coming up with an operating budget, you must consider some factors such as past sales trends, changes in the government regulations and laws of taxes, and the overall economy.
Come up with a sales budget
This is a forecast of the possible revenues and income from products sold and services you will offer over a specific period, for example, a month. Projecting your sales monthly is important since it allows you to adjust your spending and create a plan for seasonal changes in your income. You should consider the following factors when projecting your sales:
- Returns from your current sales.
- Trends of your products and services
- Product or service launches
- Marketing campaigns
Budget your costs
After you have come up with a sales budget, you should then proceed to budget your costs. Your costs here are the expenses that are directly connected to the selling of your products or services. These costs can also be referred to as costs of sold goods, and they include:
- Cost of the merchandise to be sold
- Cost of services to be provided or labor
- Cost of production
Budget your operating costs
This is one of the crucial steps, first have your past budget, profit, and loss reports. Before you start your budget, generate a list of all your categorized expenses. Using the past year’s report as a guide, identify your variable and fixed expenses.
Fixed expenses are those expenses that are constant, which means the amount you pay after a specific period, say monthly or yearly, is the same. Fixed expenses include:
- Insurance costs
- License and permit fees
Monthly software subscriptions
Variable expenses refer to the expense that varies from time to time based on seasonal changes and business activities. Examples of such expenses include:
- Shipping costs
- Marketing costs
- Short-term contractors
Account for unexpected expenses
Before you finish generating your forecast budget, it is necessary to come up with a line for unexpected expenses. This can be done in two distinct ways you either set aside some funds or adjust your budget by making an increase of funds to gather for unexpected expenses.
Adjust your budget
You need to review, then assess your budget and find out if it is really valid for your firm. If it doesn’t work for your business, then you make adjustments. When making adjustments start with expenses, first variable expenses, then fixed expenses. Is there anything for you to reduce? Can you adjust your plan to cost less?
Track your budget vs. actuals
Budgets can never be constant; that is why you need to check them regularly and see if it is in line with what you planned for. You need to review your actual numbers every month and see how much you have done and spent as compared to your projected budget. This gives you a better understanding of how you spent, and it will enable you to come up with an efficient and better budget. Find out areas that you feel you are overspending or spending less. Have you met your goals on revenue? If not, how far are you? Are you in line with your predictions on unexpected expenses? These are just a few things that you need to take into consideration before you make changes to your budget.
Components of an Operating Budget for Small Business
This is a forecast of the possible revenues and possible returns from products you purpose to sell or services you will offer over a specific period, for example, a month.
After you generate the sales budget, you need to come up with a production budget. A production budget comprises three parts: direct materials budget, direct labor budget, and overhead budget. They are all critical for the production of the budget. It enables the business owner to know the number of products to produce and meet the sales need.
Direct materials purchase budget
This is the budget of all the raw materials needed for production. The budget states the cost and amount of the raw materials required.
Direct labor budget
The relationship between labor and output determines the hours for direct labor. Generate the total number of units of direct labor, then determine the direct labor hours per unit cost
This is a plan prepared to project the expected costs of the firm, excludes indirect material purchases and direct labor budgets.
Ending finished goods inventory budget
It supplies data for the balance sheet and gathers information on direct materials budget, direct labor, and overhead budget. This information is needed to calculate per unit cost.
Cost of goods sold budget
Using the previous inventory from the finished goods, prepare a budget for the cost of goods. Use the information from the direct materials budget, direct labor, and overhead budget.
Selling and administrative expenses budget
This is the non-manufacturing aspect of the projected budget and comprises two components: fixed and variable cost. For example, sales volumes determine how much commission a business owner can get.
Budgeted income statement
After completing all the steps, you realize that you have what it takes to develop the projected income statement. Operating income is the result of the budget income statement
Free Operating Budget Plan Templates
When it comes to operating budget templates, there are a variety to choose from -Go through the templates provided and choose one that suits you best. Choose and download from our professionally designed templates to get started. You simply need to select the template that you want to download, click on the download button, customize the downloaded template, and you are good to go!
Generally, the operating budget projects how much the business achieves what they want, thereby setting a target for employees and motivates them to work harder towards their goals and objectives. It keeps the employees on track and enables them to take control of the business in all circumstances. Good planning and appropriate allocation/ management of all resources yield better results.