Operating Budget Definition
Operating Budget refers to the estimation of all the revenues and expenses which a business would incur over a particular time period and is usually done by the business analyst along with guidance from the company’s management. The method to estimate profits or calculation of outflows and inflows vary from business to business as every business has its own cost and benefits.
Types of Operating Budget
There are mainly three types which are as follows:
- Revenue Budgets: These are those budgets that forecast the expected revenues from the business over a set period.
- Expenses Budgets: Budgets which forecast the expenses which are to be incurred over that set period are expenses budget.
- Profit Budget: It is a difference of above two budgets i.e. when we subtract the revenue budget by expenses budget we got a profit budget.
Example of Operating Budget
Suppose ABC Inc. wants to prepare its operating budget based upon the actual data of the business in the past two years given below:
Now, from the above-given data, the budget for the year 2020 is as follows:
How to Prepare Operating Budget?
The steps to prepare this budget are as follows:
- Gather the actual data for at least the past two years.
- Observe the trend of increase or decrease in revenue or expenses of the business.
- Check trend of the industry in which entity operates i.e. industry norms new government policies which have a significant impact on the activities of the business.
- By observing the above parameters analyze the market and observe the prospective customers and market cap which would help us in analyzing the percentage increase in the revenue and expenses accordingly as well.
- Accordingly, prepare the operating budget by taking an expected increase or decrease in figures of previous year actual figures thereafter calculates the expected profits.
It gives a route map to the business how much we have to spend on which portion of expenses by keeping continuous track on the following areas:
- The revenue and expenditures incurred by the business and are yet to be incurred during the set time.
- By fixing a set amount of expenditure or revenue as well it somehow fixes a setline in which we have to work so that the resources could be utilized to the maximum benefit of the enterprise.
Operating Budget v/s Financial Budget
- The operating budget takes into account those figures which are only for a particular segment but on the other hand 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 as compared to a particular segment which we look after while preparing an operating budget.
- The owner of the business or the analyst need not go in-depth as he could observe the position of the business by comparing actual budgets to get the results.
- A track and monitor on the expenses incurred helps in avoiding unnecessary wastage of resources and funds as well.
- Increases or improves the efficiency of the team by giving them a deadline for expenditure and revenue as well as fixed in budgets.
- It is based on predictions and expectations which could be judged accurately as there are thousands of other factors as well in the environment in which an entity operates such as regulatory policies, etc. For an 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.
The 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. Sometimes it is also prepared to pre-estimate the revenues which we will earn after the period is over and to plan further activities accordingly as each activity of the business is inter-connected.
This has been a guide to the operating budget and its definition. Here we discuss components, types, examples, and how to prepare an operating budget along with benefits and drawbacks. You may learn more about financing from the following articles –