Overview Of Operating Budgets
Every organisation needs to have clarity on its future roadmap in terms of expenses so as to continue its day to day operations smoothly. This process is called budgeting. Budgets are typically classified as operating budgets, capital budgets and financial budgets.
A master budget is usually in place to which estimates cash inflows and outflows and other assets based on the future sales and expense expectations. A financial budget deals with forecasting capital expenditures. This is done so that work can progress smoothly without being impacted by insufficiency of cash like upgrading its plant and machinery etc.
An operating budget is more concerned with revenue expenditures or those which are possible in the near term, typically within the next one year. It is an estimation of how much a company will make within a year and what expenses will have to be made within that year. Forecasts are typically made in areas related to sales, manufacturing costs, overhead expenses, administrative expenses etc. This helps companies to maintain sufficient cash with itself so that day to day operations are not impacted.
Since it is estimation, historical trends are analysed, future economic and business environment is taken into consideration and keeping in mind the company's plans for the year, estimates are made.
Components of an Operating Budget
Sales: Sales constitutes the most important component of the operating budget. Sales or Revenues are generally determined by the units a company plans to sell and the price points at which these sales will materialism. An estimate of both these sub components will be done in other words, how much the company will be able to sell or services the company will deliver and at what price. Depending on the nature of the business monthly or quarterly volumes are taken for estimation.
Expenses: Next is the budget relates to expenses, broadly expenses can be classified into three major categories - fixed costs, variable costs and other expenses. Variable cost include those expenses which have a direct correlation with unit sales. For example raw material costs, labor costs, costs related to transport of raw materials and finished goods. It is a direct function of production as it will vary as much as the production output varies.
Fixed costs are those which a fixed for the given time period and do not vary with variations in the production output. Within a reasonable range of output they remain fixed. For example, the rent for factory building will not change whether the company is producing goods or not. Other items under this head include administrative costs, salaries, utility bills, internet charges, interest costs, depreciation costs etc.
Other expenses include expenses such which are made at discretion such as if any additional services required in between or unforeseeable expenses.
Profits: When revenues and expenses are taken into consideration together, a reasonable idea about the profits that can be made is derived.
Significance Of An Operating Budget
This exercise helps in checking if a company's expenses are justified. It gives a financial road map as to where the company is headed in terms of growth and if any corrective measures or changes need to be made. It helps break down expenses and analyse how efficiently a company can be run. Having an estimate is also important so that the company can build reserves by way of savings and investments for the future and ride over temporary setbacks. When actual sales and revenues kick in and the actual expense numbers are available they can be compared with operating budgets to understand how much variance has taken place and what the plausible reasons are.
Corrective measures can be taken in terms of cost reduction and enhancing production efficiency. It helps a company run its business in a very cost effective and organised manner as it can work towards achieving its goals with the estimates.
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