Question

600 - 1000 words.

Describe the following types of budgets and how they differ from each other: Operating budgets, capital budgets, and financing budgets. Explain each in details with examples.

Answer 1

An operating budget covers a set period of time and lists an organization's planned revenue and expenses over that time frame. An operating budget includes three major sections: expenses, revenue and profits. The profit section combines expected revenue from all sources with budgeted expenses to determine whether the business will earn a profit or experience a loss over the budget period.

Components of an Operating Budget

The main components of an operations budget are outlined below. Each business is unique and every industry has its nuances, but these items are general enough to apply to most industries.

1 .Revenue is usually broken down into its drivers and components. It’s possible to forecast revenue on a year-over-year basis, but usually, more detail is required by breaking revenue down into its underlying components.

Revenue drivers typically include:

• Volume
• Price

2 Variable costs

After revenue, variable costs are typically deduced. These costs are called “variable” because they depend on revenue, and are often calculated as a percentage of sales.

Variable costs often include:

• Cost of goods sold
• Direct selling costs
• Sales commissions
• Payment processing fees
• Freight
• Certain aspects of marketing
• Direct labor

3 Fixed costs

After variable costs are deducted, These expenses do not vary as much with changes in revenue and are mostly constant, at least within the time frame of the operating budget.

Examples of fixed costs include:

• Rent
• Head office
• Insurance
• Telecommunication
• Management salaries and benefits
• Utilities

4 Non-cash expenses

An operating budget often includes non-cash expenses, such as depreciation and amortization. Even though these expenses don’t impact cash flow , they will impact financial reporting performance .

Capital Budgeting primarily refers to the decision making process related to investment in long term projects, an example of which includes the capital budgeting process conducted by an organization in order to decide that whether to continue with the existing machinery or buy a new one in place of the old machinery.

Examples of capital budgeting are

1.Payback period,

2.Accounting Rate of return,

3.NPV

4.Discounted pay back period etc

A financial budget includes information about how a business will go about acquiring cash in the future and how it will spend that cash across the same time frame. One of the major sections of a financial budget is a cash budget, which outlines upcoming cash expenses and earmarks incoming cash to cover it. A capital expenditure budget is another section of a financial budget that deals with major upcoming expenses, such as new buildings for expansion.

Similarities and Differences

Both operating budgets and financial budgets rely on the same expectations when it comes to revenue. In each case, an organization's financial leaders use past performance and market trends to determine the upcoming sales, investment revenue and income from selling off assets according to a budgeted plan.

Organizational budgets, however, balance that revenue against upcoming expenses, while a financial budget seeks ways to spend some or all of the revenue. A financial budget also includes a balance sheet, which notes the organization's assets and liabilities at a given point in time, independent of its revenue or projected expenses.

Operating budgets and financial budgets are useful in different scenarios because of their systematic differences. For example, when a business wants to know where to make money-saving cuts, it can refer to the discretionary spending in its operating budget. Businesses also use operating budgets to determine how much money to allocate to special projects. Financial budgets help businesses work toward long-term goals. They also are useful for financial investors, who need to gauge the business's health and understand its financial position relative to competitors.