What is an Operating Budget?

An operating budget is a detailed forecast of what an organization expects for revenue and expenses over a specific period. In many cases, operating budgets are developed late in the year, with the projections covering the following four business quarters.

Companies develop operating budgets to help allocate resources, prioritize expenditures and track performance. During the time the budget covers, companies can decide if they should stay the course or change their strategies and tactics by looking at any significant differences between the projected and the actual numbers. An operating budget is a way to plan for the future, track current progress toward established goals, and provide guidance on adjustments needed throughout the process.

For example, a restaurant chain might notice by March that revenue is lower than expected due to a drop in the overall number of patrons. If the decrease tracks with a general, industry-wide trend, they might decide to simply ride it out after revising the operating budget to better reflect the state of the industry. However, if the chain is the only one currently losing customers, they might decide to run a few extra coupon campaigns in the second quarter to win people back, switch advertising agencies, or move more money into developing new dishes. In either case, the operating budget provides the guidance on what levers might need to be pulled. 

What Are the Different Parts of an Operating Budget?

The two big categories in an operating budget are revenues and expenses. Revenues can include sales and investment income, and companies can make simple or more complex projections, from basic year-over-year numbers to more detailed breakdowns by average sales, for example. There are many different types of expenses you can include in an operating budget, such as variable and fixed costs as well as non-cash and non-operating expenses.

Variable and Fixed Costs

Variable costs are those more or less directly connected to sales. So, for every car an automaker sells, it costs them the same amounts in materials and labor, shipping and warehousing. There are different types of variable costs, including direct:

• Labor
• Materials
• Overheads

For labor, for example, the company needs to pay salaries to employees:

• In the factories
• Behind the delivery fleets
• On the sales floors

The more cars they sell, the higher these costs climb.

Fixed costs, though, tend to remain the same regardless of sales. Rent on the office space for the marketing team remains the same regardless of how many cars get sold. Across industries, properly projecting and carefully controlling fixed costs tend to have large impacts on an organization, which is one of the reasons operating budgets are considered so important to enforce expense management.

Non-Cash and Non-Operating Expenses

Both non-cash and non-operating expenses are also in the operating budget. Non-cash expenses include depreciation, amortization, unrealized gains and losses, compensation tied to stock, and deferred income taxes. Non-operating expenses are costs that are not directly related to the organization's main focus. Examples can include paying off debt or settling lawsuits.

What Are the Differences Between an Operating Budget and a Capital Budget?

Operating and capital budgets are different both in terms of content and use. With a capital budget, the focus is on long-term investments with significant implications for the company. For example, constructing buildings, acquiring expensive assets and equipment, and purchasing and developing land would be considered a part of the capital budget. So, unlike operating budgets, which tend to cover only a year, capital budgets have longer, often multi-year, timeframes. Another key difference is that you update operating budgets much more frequently.  

In the simplest terms, operating budgets are how you focus on the day-to-day, with projections never more than a year ahead. Capital budgets help you focus on large, expensive projects with projections over many years.

What Are the Advantages of an Operating Budget?

There are many benefits to creating and tracking an operating budget. By systematically looking at past data and projected trends, you can create realistic expectations for future expenses that help you decide how best to manage your resources. Over time, by periodically re-examining your budget, you can find where you under or overestimated revenues or costs, creating opportunities to proactively move money where you need it more. This sort of budgeting also helps you create an overall culture of accountability because everyone in the organization knows their spending decisions are scrutinized. Instead of spending simply to meet immediate needs, spending becomes tightly tied to meeting the company's clearly stated goals.       

The operating budget gives business leaders the needed visibility to accurately plan as well as develop new scenarios for how the company could operate. As long as the financials going into the budget are accurate, the budget can provide true guidance on future business decisions as well as how they might play out.       

How Do You Calculate an Operating Budget?

Creating an operating budget is a multi-step, cross-departmental project that often requires input from those a bit higher up in the org chart.

Start with research. Here, you're looking to build an understanding of the various trends and events set to influence your industry. So, ask yourself:

• What are the big trends?
• What new products or services will your company or other companies launch in the coming year?
• Are there any changes in the overall economy that could affect sales?
• What seasonal changes can you predict for sales?
• Are your costs expected to rise or fall? Materials and labor, for example.

1. This first step is critical because the more you understand about how internal and external forces are likely to influence your organization, the better you can complete the remaining steps.

2. Next, start to look at your historic sales numbers so you can make accurate revenue forecasts. It might be the case that you don't have any numbers to look at, in which case you can look up the sales numbers for some of the public companies in your industry. Look for trends, including rises or falls tied to specific times. For example, are things generally up in summer and then quieter in fall?

3. At the third step, you need to think about all your costs. What does your company need to do business, and how much are those goods and services going to cost you over the next four quarters? A simple way to calculate future costs is to take your current costs and add the rate of inflation. It's not a perfect solution, though, because inflation doesn't affect all goods and services at the same rate, but it can help you get in the ballpark.

To ensure you have everything you need, work systematically through the departments, collecting information from department heads about their projected expenses. So, the IT department can tell you how much they want to spend upgrading the company servers, while marketing can share how much they need for agency work.

4. Once you have all the numbers, you need to add them together to get your operating budget. However, this is not the final step. An operating budget is a "living document," which means you need to establish procedures and processes for reviewing and updating the budget. This all requires accurate financial reporting to get true visibility into actual spend vs. the proposed spend.

How Decimal Can Help

If your operating budget is too broad and the financials being fed into the model aren’t trusted, it might be time to get some assistance on the financial operations. With accurate financial data around the company, it’s much easier to develop forecasts and imagine new approaches to your market. Without that visibility, the budget is going to have a hard time lining up with the actual performance of the business. Offload the bookkeeping to Decimal and focus on building the budget for your business’s success.

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