An operating budget consists of all revenuesSales RevenueSales revenue is the starting point of the income statement. Sales or revenue is the money earned from the company providing its goods or services, income and expensesExpensesAn expense is a type of expenditure that flows through the income statement and is deducted from revenue to arrive at net income. Expenses are considered over a period of time (typically a quarter or a year) which a corporationCorporationWhat is a corporation? A corporation is a legal entity created by individuals, stockholders, or shareholders, with the purpose of operating for profit. The creation involves a legal process called incorporation where legal documents containing the primary purpose of the business, name, and location, government (see the U.S. 2017 Budget), or organization uses to plan its operations. An operating budget is prepared in advance of a reporting period as a goal or plan that the business expects to achieve. Below is an example of a downloadable budget template and an explanation of how to prepare one.
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
Revenue is usually broken down into its drivers and components. It’s possible to forecast revenue on a year-over-yearYoY (Year over Year)YoY stands for Year over Year and is a type of financial analysis that's useful when comparing time series data. Analysts are able to deduce changes in the quantity or quality of certain business aspects with YoY analysis. In finance, investors usually compare the performance of financial instruments on basis, but usually, more detail is required by breaking revenue down into its underlying components.
RevenueRevenue StreamsRevenue Streams are the money a business earns from the sale of goods or provision of services. The types of revenue that a business records on its accounts depend on the types of activities carried out by the business. Learn about the different types, how to categorize them and drivers typically include:
Price (average price, per unit price, segment price, etc.)
#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 costsVariable CostsVariable costs are expenses that vary in proportion to the amount of goods or services that a business produces. In other words, variable costs are costs that vary depending on the volume of activity. Variable costs increase as the volume of activities increase and variable costs decrease as the volume of activities often include:
Cost of goods soldCost of Goods Sold (COGS)Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct labor cost, and direct factory overheads, and is directly proportional to revenue. As revenue increases, more resources are required to produce the goods or service. COGS is often
Direct selling costs
Sales commissionsCommissionCommission refers to the compensation paid to an employee after completing a task, which is, often, selling a certain number of products or services
Payment processing fees
Freight
Certain aspects of marketing
Direct labor
Read more about variable and fixed costsFixed and Variable CostsFixed and variable costs are important in management accounting and financial analysis. Fixed costs do not change with increases/decreases in units of production volume, while variable costs are solely dependent on the volume of units of production. This guide teaches an analyst the fixed vs variable cost methods.
#3 Fixed costs
After variable costs are deducted, fixed costs are usually next. 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 expensesNon Cash ExpensesNon cash expenses appear on an income statement because accounting principles require them to be recorded despite not actually being paid for with cash. The most common example of a non cash expense is depreciation, where the cost of an asset is spread out over time, such as depreciation and amortization. Even though these expenses don’t impact cash flowValuationFree valuation guides to learn the most important concepts at your own pace. These articles will teach you business valuation best practices and how to value a company using comparable company analysis, discounted cash flow (DCF) modeling, and precedent transactions, as used in investment banking, equity research, (other than taxes), they will impact financial reporting performance (i.e the figures a company reports at the end of the year on their income statement).
#5 Non-operating expenses
Non-operating expenses are those that fall below Earnings Before Interest and Taxes (EBITEBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income. EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue.) or Operating IncomeOperating IncomeOperating Income, also referred to as operating profit or Earnings Before Interest & Taxes (EBIT), is the amount of revenue left after deducting operational direct and indirect costs. Interest expense, interest income, and other non-operational revenue sources are not considered in computing operating income. Examples of expenses that may be included in a budget are:
InterestInterest ExpenseInterest expense arises out of a company that finances through debt or capital leases. Interest is found in the income statement, but can also be calculated through the debt schedule. The schedule should outline all the major pieces of debt a company has on its balance sheet, and calculate interest by multiplying the
Gains or Losses
TaxesAccounting For Income TaxesIncome taxes and its accounting is a key area of corporate finance. Having a conceptual understanding of accounting for income taxes will allow a company to to maintain financial flexibility. Tax is an intricate field to navigate and often confuses even the most skilled analysts.
#6 Capital costs in an operating budget
Capital costsHow to Calculate CapEx - FormulaThis guide shows how to calculate CapEx by deriving the CapEx formula from the income statement and balance sheet for use in financial modeling and analysis. To calculate capital expenditures, use depreciation on the income statement, add current period PP&E and subtract prior period PP&E are usually excluded from an operating budget. The term operating refers to a statement of operations (income statement) which does not include capital expenditures.
Most companies prepare a seperate budget for capital investmentsCapital Investment Model TemplateThis capital investment model template will help you calculate key valuation metrics of a capital investment including cash flows, NPV, IRR, and payback..
Budgeting and Forecasting course
To learn more about the budgeting and forecasting process at companies, check out CFI’s budgeting course! In the class, you will learn about the types of budgets (incremental, zero-basedZero-Based BudgetingZero-based budgeting (ZBB) is a budgeting technique that allocates funding based on efficiency and necessity rather than on budget history. Management starts from scratch and develops a budget that only includes operations and expenses essential to running the business; there are no expenses that are automatically added to the budget., value proposition, activity-basedActivity-Based CostingActivity-based costing is a more specific way of allocating overhead costs based on “activities” that actually contribute to overhead costs. An activity is an event, task, or unit of work with a specific purpose, whether it be designing products, setting up machines, operating machines, or distributing products. Therefore, activity-based costing considers all these potential activities, etc.), the pros and cons of each, and how to implement them.
Additional learning objectives include understanding financial management best practices, learning how to design a budgeting process, and explaining how the budgeting process fits into a company’s strategic frameworkStrategic PlanningStrategic planning is the art of formulating business strategies, implementing them, and evaluating their impact based on organizational objectives. The.
Download the Free Operating Budget Template
The best way to learn is by doing! To start working with an example on your own, download the completed operating budget template in Excel and change it to your own numbers.
The template is designed so it’s easy to edit. All hardcoded numbers are in blue, and all formulas are in black. Be sure to edit only the blue cells with your own numbers, unless you want to intentionally change the formulas.
Below is a short video that explains the various types of budgets, what they’re used for, and why they matter to corporations. You’ll quickly learn the differences between the three main types of budgets (operating, capital, and cash).
Additional Resources
Thank you for reading this guide to operating budgets. CFI’s mission is to help you become a world-class financial analyst. With that goal in mind, these additional resources will help you on your way:
Budgeting HeadBudget HeadThe person who is ultimately responsible for the framing and creation of the Budget for a project is known as the Budget Head for that project. The Budget itself is a document that lists the expected revenues and expenditures associated with a project.
Project BudgetProject BudgetThe Project Budget is a tool used by project managers to estimate the total cost of a project. A Project Budget template includes a detailed estimate of all costs that are likely to be incurred before the project is completed.
Budget HolderBudget HolderThe person who is ultimately responsible for ensuring that the budget is followed is known as the Budget Holder. Budget holders are usually the managers and operational directors of companies who are tasked by the owners/shareholders or the board of directors to ensure that the company follows its budget
Financial Modeling GuideFree Financial Modeling GuideThis financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, Excel modeling and much more. Designed to be the best free modeling guide for analysts by using examples and step by step instructions. Investment banking, FP&A, research
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Become a certified Financial Modeling and Valuation Analyst (FMVA)®FMVA™ CertificationThe Financial Modeling & Valueation Analyst (FMVA)™ accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. by completing CFI’s online financial modeling classes and training program!
