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A budget is a projection of any expense or revenue over a given period of time. The timing may be one month or one year. A budget is an instrument that is useful to individuals or any organization as it indicates the goal of business owners to take their company where they want to in the coming period. The operating budget is an all-inclusive document that outlines both the operating expenses to be incurred and the profits to be generated for a given period of time. This article strives to elucidate the concept of the operating budget, its purpose, components, and manner of preparation.
The operating budget consists of both revenue and expenses over a period of time (usually a quarter or a year) and is used by a corporation, government or agency to estimate, plan, and finance its activities. An operating performance budget is planned as a target or schedule which the organization plans to meet in advance of a reporting period.
An operating budget is a projection of the anticipated revenues and expenses for one or more future periods. The management team usually formulates an operating performance budget just before the start of the year, which displays planned levels of operation for the whole year. Indeed, if the operating budget is for a period of one year, the same may be subdivided into additional parts like a quarter or a month.
To quote precisely, the operating budget is a comprehensive document that outlines both the operating expenses to be incurred and the incomes to be generated for a given period of time.
Operating expenses such as raw material acquisitions, manufacturing costs, interest on a short-term loan, employee’s compensation, office repairs, administrative expenditures, etc. are considered for operating budget purposes. Similarly, the operating incomes such as sales revenue, income by the sale of by-products, etc. are considered for operating budget purposes.
A variety of subsidiary schedules might support this budget, containing details at a more detailed level. For instance, separate supporting budgets might be available that cover payroll, the cost of the products produced, factory overheads, and inventory.
To assess the magnitude of any variances from predetermined plans, actual results are then compared with the operating budget. Over the year, the company’s management can adjust its activities to match actual results with the operating performance budget.
An operating performance budget is useful to a business for the following purposes:
The operating performance budget is an estimation of operating profit derived from routine business activities of a company. This is done by comparing the operating revenues and operating expenditures of a budget period. The company’s cost of the goods sold (COGS) is subtracted from its revenue to obtain its gross income. Upon the calculation of gross revenue, all operating expenses are subtracted to achieve the operating profit of the company. Operating profit refers to the profit generated from core business activities of the company and hence, excludes the accounting for non-operating expenses such as interest costs, dividend, etc.
An operating performance budget begins with revenue, then shows every type of expense. Each sector is special, and each market has its variations, but some elements are fairly universal to refer to most of the industries. Some of these main components of an operating performance budget which are generic to all industries are as follows:
The following items are usually dispensed with while preparing an operating budget:
Operating performance budget is designed by taking into account several considerations and assumptions. Below are some of the considerations that are used to plan the organization’s operating budget:
Based on the above-mentioned factors, sales or income budget is developed at first. The reason is that all the expenses shall be based on the sales projections made by the business organization. When the sales or income budget is created, the expenditure budget is prepared. The expenses have to be calculated on the basis of the sales, past tax regulatory patterns, and, interest rates on borrowing, etc.
An example of an operating performance budget is given as follows: