Definition: An operating budget portrays a company’s expenses, expected costs, and estimated income, considering the quarterly or the annual performance. Accountants complete the operating budget before the accounting period starts in order to include income and cost projections.
What Does Operating Budget Mean?
The challenging part of completing an operating budget is to properly estimate the historical data and factor in the probability of different market variables. An operating budget must take into account historical sales performance, current trends in the industry or the sector, seasonality, new products expected to be launched and competitive forces. Often, firms create more than one operating budget aiming to anticipate a potential decline in revenues or a new product launch that could boost profitability.
Let’s look at an example.
Example
An effective operating budget provides details on the price and the expected product volume to estimate total sales. Therefore, a key component of this budget is sales, followed by variable costs, fixed costs, interest, and depreciation.
Costs include raw materials and finished goods ready for sale, salaries, wages, utilities, rent or mortgage, car maintenance and service, postage, cleaning, transportation costs, travel expenses, office supplies, marketing/advertising expenses, insurance, professional services and so on. Interest includes Interest on bank loans and/or overdraft fees.
Once the budget is complete, accountants prepare a summary to demonstrate their projections. Often, there is a column for actual costs in order to compare projections to actual revenues and expenses. Normally, managers are called in to answer questions such as:
- Are sales goals met or exceeded?
- Are cost projections met or exceeded?
- Are there incurred expenses unaccounted for?
Such information helps finance managers to perform a better planning of future sales and costs and proceed with effective business decision-making. For instance, if the cost projections are exceeded, it makes sense to review both variable and fixed costs to find out why this is happening.
