Question

How do you prepare the operating budget and describe the relationships among its components?

Answer 1

An operating budget is prepared by forecasting revenues and expenses for the future periods for a company. The operating budget is based on the expected activity levels for the future years and the revenues and expenses are forecasted on the basis of expected activity levels. Thus an operating budget is prepared by forecasting a company’s expenses, expected costs, and estimated income. Operating budget is prepared by taking into account historical sales performance of the company, current trends that are emerging in the industry and factoring in for economic variables, seasonality and other variables that will directly affect the revenues and expenses.

The components of an operating budget are directly related and interlinked. For instance after forecasting the revenues for future years, the cost of goods sold, variable expenses, etc. are forecasted using the percentage of sales method. Interest expenses are forecasted as a percentage of debt, and capital expenses are forecasted as additions to fixed assets. Thus all components of income statement, balance sheet and cash flow statements are interlinked in some way or another.