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The Concept of Operating Budget Explained with an Example

The Concept of Operating Budget Explained with an Example

An operating budget helps the management to envision the expenses and the income necessary to run the current operations of a business entity. This BusinessZeal article describes the concept of operating budget along with an example that will help you to understand it better.
Neha B Deshpande
An operating budget helps the management or the entrepreneur in forecasting the operating profits of the organization for a given time frame. A comparison with the actual profits helps them analyze the reasons of variance and take corrective actions, in case of an unfavorable variance.

An operating budget can be described as a budget that forecasts the expenses and income of an entity to run its current operations for a specific period. It implies that it excludes the capital expenditure and incomes that are long-term in nature. It is not possible for any organization to survive without incurring revenue expenses and without earning revenue. An operating budget monitors only the revenue transactions of a business entity.

An operating budget may be further divided into other sub-budgets, such as the sales budget, expenses and revenue budget, etc. It can be prepared on a monthly, quarterly, six-monthly, or yearly basis, depending on the budgetary cycle of your organization and the peculiarities of your business. Thus, with the help of an operating budget, you can estimate the profits of your organization.

Example of an Operating Budget

Given below is an example of an operating budget calculation. (The name of the enterprise and the data are hypothetical.)

ABC Financial Consultants
Operating Budget for November 2014

Particulars Budget (Amount In $) Actual (Amount In $) Variance (Amount In $)
Consultancy Fees 40,000
Other miscellaneous income 2,500
Total operating income (A) 42,500
Books and Periodicals 5,000
Insurance 2,000
Telephone 3,000
Rent 4,000
Legal Expenses 2,500
Payroll Expenses 7,000
Internet Expenses 1,000
Travel Expenses 1,200
Office Supplies 700
Repairs and Maintenance 800
Seminar and training 2,000
Other miscellaneous expenses 1,500
Total Operating Expenses (B) 30,700
Estimated Profit (A - B) 11,800

Note: Payroll expenses are inclusive of salary, medicare, and other social security benefits payable to the employee.

An operating budget can be made more complex and comprehensive by structuring it in a different or more detailed way. For example, sales can be made more detailed by classifying them on the basis of geographical segments. The nature and complexity of the budget depends on the structure of your organization and the budget items differ as per the business type.

Preparing an Operating Budget

Preparing a budget requires expert-level knowledge of the business and the industry. Collect information of the operating and allied activities of the business.
Refer to budgets of the earlier years. If you weren't involved in preparing them, consult the personnel who were.
On the basis of the historical data available, break down the expenses into variable, semi-variable, and fixed costs. Consult the authorized personnel responsible for the respective departments.
For fixed costs, take note of changes; for example, your lease agreements, annual maintenance contracts, etc. may be renewed. Take supporting evidences and update the budget accordingly.
For variable and semi-variable expenses, consider if your business has any new expenses coming up. For example, if you're venturing into a new line of production, you need to project the revenue expenses and income for the new business line.
Consider the increase in production levels, number of staff, new recruitment and the training costs associated with them, inflationary conditions of the industry in which your business operates, etc. Thus, every line item of the budget has to be analyzed to make an estimate considering the current situation.
Similarly, for revenue income, you need to consider the change in investment plans, the boom in the industry, growth in the number of sales outlets, etc.

Of course, the above-mentioned guidelines are for a simple business plan and it is relatively easier for an entrepreneur of a small business to design an operational budget. However, large organizations have complicated structures and the operating budget needs to be carefully analyzed and be detailed. A lot depends on the skill of the person making the budget. Usually, it is designed by the top-management with the help of the chief accountant or the manager of the budget department.

Operating Budget Vs. Capital Budget

An operating budget projects only the estimates of expenses and income for the current operations. 'Operations' of any entity refers to the revenue-generating activities of the organization. Thus, it considers only the revenue items and not the items which are capital in nature. To know the difference between revenue and capital expenditure, you can refer to our article on the difference between capital and revenue expenditure. As the name suggests, a capital budget forecasts the capital expenses and revenues of any organization, i.e., items of a long-term nature. For example, your organization may be planning to initiate a new project, for which you need to invest in buying new machinery. In such scenarios, the capital budget comes into picture. However, as compared to an operating budget, a capital budget may have fewer line items. Both are needed by the management to predict the financial health of the organization.

An operating budget helps you keep a tab on the revenue expenses and income of your organization. The reasons for variances must be analyzed. However, it must be taken into consideration, that an unfavorable variance does not necessarily imply mismanagement of resources. There can be certain unforeseen circumstances that may result into dumbfounding results, or it might be the result of an error in prediction by the budget-maker. In normal circumstances, the management can detect possible cases of wastage of resources, misapplication of funds, fraud, etc. through the variances. Whatever the case may be, an operating budget is an effective tool for financial planning.