What is an Operating Budget?First of all, a budget is a plan to spend money. Therefore, it follows that budgeting is the process of creating that plan on how the money will be spent. Within the budget, business entities will account for all costs and necessary expenditures. These daily expenses are projected from daily operations, including raw materials, machinery, labor and utility expenses among others. The company will generally use income projections when planning for an operating budget. Operating budgets are usually created before the start of a new financial year. They are often presented in an income statement format with a schedule that allows the management to provide updates of monthly expenses incurred. This allows the management to make updates based upon monthly expenses incurred. In addition, they are always prepared before the financial budget since many of the financing activities aren't known until the operating budget is made. Show
Back to:BUSINESS & PERSONAL FINANCE How Does an Operating Budget Work?The operating budget is one of the two parts of the master budget and is mainly divided into two broad categories of either revenue or expenses:
Objectives of an Operating BudgetAn operating budget is a vital tool for business managers as it provides them with a clear profit objective that the business aims to attain. Below are examples of reasons behind the formulation of an operating budget:
Operating Budget ComponentsAs a business grows the process of assembling an operating budget may become complicated and therefore require more time in the process. Typically, an operating budget consists of revenue and expenses. The expenses may be variable such as of raw materials, fixed costs, such as the monthly rent, or operating expenses, such as interest on business loans. These items are essential in enabling an enterprise to calculate their projected net income and net profit percentage. Creating an operating budget can be broken down into two stages: Preparing to Make an Operating Budget
Formulating an Operating Budget
Sales forecast collected earlier from the sales team and in consideration of factors such as the general state of the economy, pricing policies, advertising, and competition is put together to form an aggregate sales forecast. The sales budget may be slightly different from the sales forecast after it is adjusted according to the business goals.
After developing a sales budget, the next task is the production budget which budget tells the business owner how many units of the product to produce to meet sales needs and ending inventory requirements. There are three parts to the production budget: direct materials purchases budget, direct labor budget, and overhead budget.
This outlines the amount and the cost of each type of the raw materials that the business needs for the production process. The firm's inventory system helps in determining the number of raw materials needed at a particular time which can be factored in the budget.
The amount of funds allocated for work provided in the business is usually determined by the relationship between labor and production outputs. That is how the total number of hours in direct labor and the cost per unit is determined.
This includes anything that has not been budgeted for in the direct materials purchases and direct labor budgets that is involved in the production. Generally, direct labor drives the overhead budget. The costs that vary with direct labor are called variable overhead; everything else is fixed overhead.
This budget is significant as it provides the information needed to calculate per unit costs of a product. Per unit cost is computed from the direct materials purchases budget, direct labor budget, and overhead budgets. Also, it provides data for the balance sheet that is crucial in calculating the cost of goods sold on the income statement.
If you have the ending finished goods inventory from the previous period, then a business can comfortably prepare the cost of goods sold budget using the information from the direct material purchases budget, direct labor budget, and overhead budget.
The non-manufacturing part of the operating budget is selling and administrative expense which can either be a fixed or. For example, Utilities may be fixed, but sales commissions are based on sales volume and are therefore considered variable costs.
When all the above budgets are prepared, the necessary information to create budgeted or forecasted income statement will be available. The income statement prepared is the operating budget for the business. This information is what will be used to develop a financial budget for the company to complete the master budget. Variance AnalysisVariance analysis is a tool that applies to both operating as well as financial budgets. Analysis of variances helps to identify the cause of variation in actual costs incurred versus the initial budgeted expenses. Sales volumes can change due to timing and unanticipated expenses as well as product demand can emerge for specific products. Effective monthly variance analysis can help an enterprise to identify such trends and opportunities as well as threats to short-term or long-term business goals. For example, a decision to hire additional seasonal labor to meet a peak in product demand will change the operating budget. Identifying a variance allows enterprises to adjust the operating budget accordingly to cater for the variations by looking at:
Variance analysis is essential in managing budgets by monitoring and controlling planned versus actual expenses. It helps to identify costs variances that might lead to adjusting business goals, objectives or strategic plans.
A variance analysis will be able to identify the level of statistical sales variance deemed a successful sales threshold in a financial year according to the companys goals.
Variance analysis helps to establish relationships. For instance, it may prove that when sales volume for product A rises, there is a correlated rise in the sales for product B.' Improved features for one product might result in sales increases by the business. Also, Variance data allows an analyst to identify factors such as seasonal changes as the root cause of positive or negative variances. Benefits of an Operating BudgetSome of the benefits of planning for the day-to-day operations of business include:
In conclusion, it is clear that the importance of a budget cannot be overstated, therefore to ensure budgeting is done accurately; it may be worthwhile to hire a professional accountant, or a business manager to help in the budgeting process. An expert can help establish an accounting system for the business, track expenditures and provide timely reports that help enterprises to get informed decisions about business operations. How is revenue budget prepared?The budget has four stages viz., (1) estimates of expenditures and revenues, (2) first estimate of deficit, (3) narrowing of deficit and (4) presentation and approval of budget. The process begins with various ministries providing initial estimates of plan and non-plan expenditures.
Which is normally prepared first when making operational budget?The sales budget is normally the first operational budget produced and is prepared using the estimations in the sales forecast.
What is the order in which budgets are prepared?Preparing a financial budget first requires preparing the capital asset budget, the cash budgets, and the budgeted balance sheet. The capital asset budget represents a significant investment in cash, and the amount is carried to the cash budget. Therefore, it needs to be prepared before the cash budget.
Are financial budgets prepared before operating budgets?Financial budgets must be completed before the operating budgets can be prepared. The number of direct labor hours needed for production is obtained from the production budget. A production budget should be prepared before the sales budget. The direct materials budget contains both quantity and cost data.
|