Operating budget

What is an operating budget?

An operating budget is a financial plan for the expected expenses and revenue of a company over a given period. Generally, operating budgets are projected for a single year. They're drawn up at the end of one year to plan the finances for the company during the following year.

Operating budgets are essential components of a company's overall business plan. As projections of what a company expects its revenue to be compared to its expenses, they're necessary for setting realistic business goals and making plans to achieve those goals. 

Company managers use operating budgets to gauge the success of business processes. They can compare the projections in an operating budget to real-time business results to identify inefficiencies and make necessary improvements. 

For example, if managers discover that their hiring costs are not in line with their projected expenses according to the operating budget, they may make revisions to their hiring processes, such as working with a third-party company that specializes in hiring practices.

What is included in an operating budget?

An operating budget is generally made up of several different components, such as:

• Projected revenue. This refers to the amount of money a company estimates it will earn over a given period. Revenue is projected by analyzing the figures from past years or by analyzing the amount of inventory relative to the price points at which the inventory is sold.

• Fixed costs. These are regular business expenses that tend not to fluctuate too greatly from year to year. Fixed costs include rent, utilities, and business insurance, as well as the cost of purchasing, renting, or maintaining equipment.

• Variable costs. Variable costs, on the other hand, tend to move relative to the business volume. The cost of labor, whether that's domestic or raw materials, and transportation expenses are a few examples.

• Non-operating expenses. Expenses that are not directly related to daily business activities are considered non-operating expenses. They include things like inventory write-downs, interest payments, and costs from asset disposal. 

• Non-cash expenses. These are expenses that don't involve a payment. They affect a company's revenue but not its cash flow. Companies may incur a variety of non-cash expenses, including amortization, compensation from stocks, depletion, and depreciation. 

Who formulates an operating budget?

Management teams and other company executives generally formulate the operating budget. Projecting what it should include is largely about estimating how the business will perform over the coming period, whether annually or quarterly. To make this estimate, executives analyze the company's performance in previous years and then account for other factors likely to affect future performance. These factors are known as market variables and include things like: 

• New company products and initiatives

• Economic conditions

• Industry trends

• Sales fluctuations

• Market competition 

That said, it's clear that operating budgets aren't only about revenue. They're about the expenses a company is likely to incur. As a result, executives must estimate the probable total expenditure within each company department. It's often up to department managers to make projections on the expenses relative to their department. Higher-level executives generally make projections for revenue outlays applicable to overall company operations.