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Why Operating Budgets?
Operating budget concepts are not all that difficult to understand. The basic idea is that businesses, just like households, need to control their spending habits. This control is gained by putting together an operating budget, one of the most fundamental and simplest types of budgets that exists. Operating budgets help business owners and managers forecast sales and expenses in order to determine if they will be operating at a net profit or loss. The term net profit and net loss simply refers to the number that is left over (the difference) when deducting expenses from revenues.
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Types of Operating Budgets
You guessed it. Operating budget concepts come in a variety just like the businesses who use them. Owners and managers can feel free to use operating budgets to look at any time frame they want to analyze. For example, they can put together a budget for a week, a month, a quarter, six months and even a full year. It just depends on what kind of information is sought.
Sometimes we need to know if we can afford to add some additional expenses (such as a faster Internet connection or cell phones for employees in the field). One of the best ways to figure out if we can afford these extra costs is to put together an operating budget for a month or a quarter.
A lot of times, managers will put together conservative, moderate, and aggressive operating budgets and look at them side by side. This is a nifty way to see worse case and best case financial scenarios. It does wonders for planning business strategies and also serves as an awesome motivator for bringing in more sales. Just tell the employees what kind of perks that a growth in sales would give them, say for example, pay raises. If you're a business owner, growth in the bottom line is really all the motivation that you need.
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The Art of Projecting
The method we use to project revenue really depends on the size and type of business. Most small business owners will use a simple method to make their projections. For example, one method called the run rate, simply means multiplying one month's revenue (December for example) x 12 to arrive at an estimated annual revenue for the next year. However, this really does not take seasonal trends into account. Other methods that could be used include:
- An average of last year's revenue (monthly revenue added up then divided by 12 months).
- Last year's annual revenue plus or minus some %. For example, last year's revenue plus 10% to show estimated increase in sales.
Any reasonable method of estimating revenues and expenses is acceptable for developing an operating budget. The idea behind an operating budget concept is to estimate as accurately as possible how much money you will earn and how much money you will spend. Most of the time, you'll need to review prior year profit and loss statements to arrive at these estimations. After you have three years of active business data behind you, your projections will become a little easier because you'll be able to recognize trends in seasonality, growth rates, and months where certain expenses tend to increase. Still think that projecting sales may be too challenging? Well head on over to Michele McDonough's article entitled Developing a Sales Forecast in Excel for a little extra help.
Operating budgets are just one type of budget that businesses use. For more information on budgets in general read 1vision's article What are the Different Types of Budgeting?
Operating Budgets: Basic Concepts & Explanations
Stop! Were you about to start the new year without an operating budget for your business? If you don't know what an operating budget is or just need to brush up on your budgeting skills in general, then this series is for you. Learn about the purpose and basic concepts behind operating budgets.