Question

600 -800 words

Describe the components of an operating budget and how the different components contribute to the overall budget. Explain in details with examples.

Answer 1

Meaning of operating budget

An operating budget shows the company's projected revenue and associated expenses for an upcoming period , usually the next year . And is often presented in an income statement format. Usually, management goes through the process of compiling the budget before the start of each year, and then makes ongoing updates each month.  It is used by corporation, government , or organization to plan its operations

Components of operating budget

The main components of an operations budget are ;

1) REVENUE

  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 (units, contracts, customers, products, etc.)
• Price (average price, per unit price, segment price, etc.)

2) VARIABLE COST

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

Variable costs include:

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

3) FIXED COST

After variable costs are deducted, fixed costs are next. These expenses typically do not vary 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 (other than taxes), they will impact financial reporting performance .

5) Non-operating expenses

Non-operating expenses are those that fall below Earnings Before Interest and Taxes (EBIT) or Operating Income. Examples of expenses that may be included in a budget are:

• Interest
• Gains or Losses
• Taxes