A budget is described as a financial plan that allocates available money to specific expenses. It can be used for personal use, business, household, and non-profit budgets.
With the help of a budget, you can see where your money is coming from and where it’s going, which helps make important choices.
There are many types of budgets. The two common types used by individuals are the personal budget and the family or household budget. A business may use an operating or capital budget to help manage its cash flows.
Non-profit organizations, whether they are governmental non-profits like the Red Cross or private non-profit like a church, will typically also have an accounting plan called a budget created for them each year to help manage their money flow.
The other main type of budget that can be used is an operating budget mainly used by businesses that involve operations that require the purchase of inventory, while capital budgets aid in financing long-term projects such as building new factories, buying equipment, etc.).
Characteristic of a Budget
A budget should always be created with careful planning and management. It will help you get a clear look at your money and how it is spent, allowing you to make smart choices on where your money should go.
Budgets are meant to be living documents and can be adjusted throughout the year as necessary. Open communication between family members or business partners is helpful when it comes time for adjusting spending habits and forecasts of future expenses.
Budgets should always be taken seriously to maintain an organized life full of sound financial decisions that contribute towards reaching long-term personal or professional goals, such as retiring early or opening up a new storefront.
You need to know how much income you have coming in each month and then match that with what you have going out per month to make it work. A budget is not meant to be limiting but rather empowering when used correctly.
Budgeting does not need to be difficult. Once you break it down into small steps over a while, you will become accustomed to the process and create the spending plan that works for you.
As long as you are on top of it by reviewing your expenditures regularly, then there should never be any doubts about how much money is being spent or on what things exactly are being spent.
You will find that the more carefully you track where your money goes each month, the better choices you can make with it so that more of it gets saved instead of just spent frivolously without keeping track at all.
Importance of Budgeting
- Expenditure control: Budgets assist an organization in setting out its planned revenue and its attendant expenditure hence assisting the organization monitor and control its expenses accordingly. It assists you in keeping expenses within the planned threshold while making adjustments for unplanned changes that could shift the amount to be expended. This, however, assists in control.
- Tracking Financial goal: Making a plan is very important; therefore, budget assist an organization in tracking its financial goals and monitoring appropriately if the company appears to be derailing the goals that you have set; a situation where certain decisions would thereby be made to ensure that the objects are kept on track.
- Performance evaluation: budget allows an organization to match employee performance to a set target, and this d could form a basis for promotion, performance bonus, or otherwise of employees who attain the set targets. Therefore it provides a tool for measuring performance.
- Cash allocation: There’s hardly ever enough cash to plan with; therefore, budgeting allows an organization to decide what cash levels be allocated to different aspects or f the business, either capital projects or recurrent expenditure, in a bid to keep the company afloat and meet its cash requirements.
- Funding planning: budgeting helps the treasurer within the company to plan effectively and decide the funding requirements of the company, thereby making plans concerning funding requirements for operating and investment.
- Profitability review: budget allows a business to review all strategic business units to understand which are profitable and the ones that are not. This is important as it helps the management decide whether to continue with a business line or shut down a loss-making unit in a bid to enhance profitability. Profitability review helps the company bid to lose sight of aspects of the business that could require them to shut down because other lines of business are compensating fit the business line.
Operating Budget: What It Is and How to Use It.
An operating budget comprises everything you expect to spend on your day-to-day operations throughout a predetermined period, typically one year.
It does not include any money spent on anything that has not already been bought or is expected to be bought soon, such as buying new equipment or building up inventory for future sales.
The three main reasons why companies (and individuals) need an operating budget are: to maintain profit levels before taxes; to control costs; and to see how much profit margins are changing month by month.
It can be used for personal, business, household, and non-profit budgets. With the help of a budget, you can see where your money is coming from and where it’s going, which helps make important choices.
A business will create an operating budget for their current year’s finances by estimating expenses, income, depreciation, and any other factors that might affect cash flow throughout a set period, usually a year or longer.
An operating budget is great if you want to know exactly how much cash spending you have going out each month, so there should be fewer surprises when you have to pay bills.
Operating budgets allow companies to easily control costs by using available funds sparingly and sending out money as needed (versus having large sums of money accumulate as unspent income).
An operating budget is good for companies that want to set goals and see how they achieve them month by month.
A household or individual can also use an operating budget to keep track of their everyday spending habits. By knowing the amount of money coming in each month, you will know how much you can spend on food, housing, entertainment, etc.
If the money left is not enough after bills are paid (housing cost, utilities, insurance, etc.), then it may be time to lower costs by either getting a second job or cutting back on some luxury items to save more money in your emergency fund which should always equal six months’ worth of take-home pay (after taxes). An operating budget is good for anyone who wants to learn financial literacy.
Implementation of Operating Budget
An operating budget is a marketing plan that outlines the total revenue and costs arising from an organization’s regular operations.
Operating budgets are prepared by each department in an organization but must be approved by upper management before implementation. The completed budget provides information to management to determine if expectations for returns have been met or adjustments need to be made.
Operating budgets are usually based on historical data collected by the finance division of the company. However, they may also include estimates for revenue and expenses based on expected growth rates over time.
Operating budgets are updated and reevaluated at least once per year as changes occur within the organization (e.g., new products launched, expansions) and economic conditions change (e.g., inflation, recessions).
The use of operating budgets varies depending on the size and type of organization. For example, a small organization may have one or two copies of an operating budget spread throughout the company, while a larger corporation may have thousands.
Operating budgets are most beneficial when shared with everyone in an organization, so each department is aware of potential changes to its financial situation before they arise. This allows employees to prepare resources for various events that could affect their work (e.g., layoffs).
An operating budget typically contains common sections across all organizations, including revenue, fixed costs, variable costs, cash flow projections, capital expenditures, salary expenses, production rates, etc.
Such sections will be discussed in further detail below. There are also sections unique to each organization that may not be addressed here.
Revenue is the total income an organization will receive for the sales of products and services. In addition to revenue, expected sales volumes must also be considered to ensure enough product supply is available if demand increases.
Suppose there are no changes in projected revenue or expenses. In that case, management can calculate whether the company’s net income has increased or decreased by comparing net income from the current period with past periods, usually one year ago.
Examples of Historical Data Used as A Basis for Preparing an Operating Budget Include:
- Previous months’ bank statements detailing all transactions within a specific time frame
- Credit card statements detailing every purchase made over the same time frame
- Employees’ written reports on monthly expenses
- Previous years’ income statements (P&L).
Variable costs are the total unavoidable costs that arise directly from the production of goods or services. Variable costs typically change depending on activity levels within an organization.
An increase in sales volume will result in an equivalent increase in variable costs, whereas a decrease in sales volume will also cause variable costs to decrease.
Fixed costs are those expenses that remain relatively constant regardless of the level of activity within the organization. These may include rent, utilities, administrative salaries, etc.
If there were no changes to revenue or expense items, management would calculate whether net income has increased or decreased by comparing net income from the current period with past periods (usually one year ago) by subtracting variable costs from revenue.
Examples of Financial Data Used when Preparing an Operating Budget Include:
- Purchasing and sales history
- Time-related cost reports
- Rate schedules for services such as utilities, transportation, etc.
- Standard industry rates (SIRs)
- Historical prices paid for goods or services
- Estimated costs based on future conditions and expectations
- The depreciation schedule for capital expenditures
- Amortization schedule for intangible assets such as patents and trademarks.
After all, costs have been calculated and subtracted from revenue. The resulting net income is used to determine whether management needs to improve performance to remain competitive.
This could mean increasing revenue, decreasing expenses, or both. An increase in volume can result in revenue and variable costs, whereas a decrease in volume typically increases total variable costs but leaves revenue unaffected.
An operating budget may be prepared on an individual department level, for example, retail operations versus the company as a whole, depending on the information available to management at the time of preparation.
Sales projections are essential to developing an appropriate business model and understanding likely results from decisions made within that model. Sales projections should reflect expected demand and anticipated product mix (i.e., how many units of each product will be sold).
Management needs accurate sales forecasts to determine whether there is sufficient supply to meet expected demand, and if not, determine whether additional resources are needed.
Sales volume affects total variable costs because each product carries a different variable cost rate per unit sold.
When is an Operating Budget Complete?
A complete operating budget should include detail on fixed costs, variable costs, and expected revenues. The fixed cost would stay the same regardless of how many widgets are produced.
These fixed costs will change based on changes to volume if any other costs are affected by volume also – for example, if labor rates increase with increased demand.
Variable cost per unit is calculated by multiplying total variable cost per month (from the list) times the number of units sold in one month. Revenue is gotten by multiplying the price per unit time’s number of units sold in one month.
If there are no additional costs that depend on current volume, then net income will be revenue minus all expenses, which equals profits for the period; however, it is advisable to break out each item to ensure that management can understand what is driving changes in income.
The budget should include monthly summaries for the coming year and detailed quarterly data to support critical decisions at each frequency.
A complete operating budget should be prepared for multiple periods, typically three months, six months, and one year beyond the current month. Additionally, there may be requirements to break out several different types of forecasts (e.g., daily or weekly).
In a multi-period spreadsheet model, it will be necessary to prepare formulas that recalculate values as needed to look forward from period to period. This is because it would not make sense to have a formula with references to cells from a period further along in the model rather than the current period.
Ideally, managers would like the information in an operating budget to adjust volumes and pricing proactively before necessary changes. Still, it is often impossible to do this quickly enough (e.g., if the market for a product is changing or competitors are raising prices).
In that case, it may be better to make reactive decisions based on properly prepared information rather than reacting with incomplete data sets. This way, management can make informed decisions even though they cannot necessarily control all variables related to sales (i.e., demand).
Some Key Elements of An Operating Budget Include:
- Forecasted revenues from expected unit sales at different price points
- List of variable costs associated with each unit sold, including labor, raw materials, transportation, and other expenses that are impacted by volume
- Variable cost per unit times number of units sold in one month to derive total variable costs for the period
- Fixed costs that don’t change based on volume can include administrative salaries, rent, legal fees, etc.
- Net income (revenue-variable costs-fixed costs)=profit.
Preparing Operating Budget Using Microsoft Excel
Ever wonder how to prepare your operating budget quickly and efficiently? Microsoft Excel is a great tool that can help you do just that! It may be helpful to watch some tutorials on YouTube, but here are some steps for you.
- Open Microsoft Excel (or download the spreadsheet I have attached)
- Click on the “File” icon in the top left corner of the screen to open your computer’s file menu. From there, click “Open…”
- A window will pop up, allowing you to navigate to where your budget is stored. Usually, it should be located in a folder titled something like “Finances.” Here, double click that folder and then double click on “Operating Budget.”
- The spreadsheet should then open in Excel. If you want to view the column names at the top, you can click on the little arrow next to “A,” and it will expand!
From there, type in your numbers under each category. Do not worry about formatting or formulas just yet. If everything looks good, just copy/paste all of your sheets into an email addressed to yourself! I hope this helps save you time!
Conclusion
With a total operating budget, management can understand whether there is sufficient supply to meet expected demand and, if not, determine whether additional resources are needed.
To properly prepare an operating budget, managers should forecast future cash flows and revenues and prepare pro forma financial statements.
Managers should also work with suppliers to expedite any anticipated components needed by specific deadlines to avoid production bottlenecks.
Maintaining communication channels open across various units within an organization might help ensure that all units receive necessary information proactively or rapidly enough to keep up with changes in volume and demand for particular products.
