What is Operational Budgeting

By Sean Stevenson – Latest Revision March 28th, 2021

Defining Operational Budgeting

Operational budgeting is a method of accounting for all business-related expenses and revenue during a specific period of time.  Quarterly or annual reports are commonly used to define an operational budget period. 

Moreover, these reports can be used to accurately assess the financial requirements and strengths of a given business model well in advance.  This includes metrics such as key revenue streams, variable and fixed costs, along with non-operating expenditures (amongst others).

The use of operational budgeting allows for an organization to effectively plan ahead.  Business activities can be accurately accounted for.  Following this, considerations can be made toward new and existing opportunities for growth. 

An operational budget report is typically prepared by analysts well in advance of a given financial period.  This allows the business to lay out its own objectives in detail.  The allocation of internal funding can then be accomplished through meticulous and fact-driven methods.

Primary Components of an Operational Budget

Every business has its own particular needs to address.  Comparatively, one industry can be vastly different from another in several respects. 

Despite these varied nuances, there are topical similarities that can be applied when considering how to execute an effective operational budgeting plan.

The primary concepts that typical outline of an operational budgeting plan are defined below:

Revenue

The income earned by a business is often forecasted year-over-year.  However, analysis into the nature of the revenue streams themselves is integral. 

This analysis allows for greater assessment of the factors and details involved in procuring a profit from a business model.  By better understanding the strengths and weaknesses of existing revenue streams, a company can improve the drivers that lead to higher overall profitability.

These revenue drivers are normally made up of:

  • Price Averages – The average price paid per unit, portion, segment, or service.
  • Volume Amounts – The amount of customers, contracts, products, units, or otherwise, which make up the amounts being purchased.

Example

The average price paid for a car model is approximately $40,000.  The volume of the items sold nationally last year, was 41,090. 

This represents an excellent revenue stream for a car manufacturing company.  Assuming there were no significant recalls, the reasonable price range and high volume would suggest a healthy profit is being made. 

This sort of revenue stream would be ideal for many car manufacturers worldwide.

What is Operational Budgeting

"Every business must carefully consider both the price on goods or services being sold, and the sustainable sales volumes taking place."

-Anon

Variable Costs Involved

Once revenue has been established, variable costs may come to the fore.

During analysis of revenue streams, it is integral to determine and understand the nature of the variable costs involved.  These costs are noted as “variable” due to the fact that they are ingrained in the revenue itself.

Analysts will often calculate a percentile of the variable costs involved per capita of revenue.  This gives them a better idea of what sort of profits they can expect in the future.  Some of these may include:

  • Direct sales costs.
  • Marketing.
  • Labor.
  • Cost of goods sold.
  • Commissions on sales.
  • Processing of fees.
  • Logistics.

Example

A tech company uses sales commissions to spur its employees toward selling more of their product.

The cost of these sales commissions would represent a variable cost that the company must account for and pay.

Fixed Costs

Once variable costs have been accounted for, analysts often then turn to any outstanding fixed costs.

Fixed costs typically remain constant in any operational budget.  Some types of fixed costs to consider are:

  • Office space.
  • Utilities.
  • Telecommunication.
  • Important salaries and benefits.
  • Rent.
  • Insurance.

Example

An office in Minneapolis is analyzing its revenue streams.  Once it combs over its fixed costs, it notices that its utility bills have risen sharply in recent months.

Unfortunately, this is a very difficult problem to surmount.  Utilities are a consistent necessity and considered a fixed cost in any operational budget.

The company therefore puts out a missive to its employees, asking them to turn off the lights when they are finished their daily tasks.

Non-Operating Expenditure

Expenditures of a non-operational nature occur under EBIT (Earning Before Interest and Taxes), or operating income.  Some examples of these include:

  • Gains or losses.
  • Taxes.
  • Interest.

Example

A non-operating expenditure has been noted for a Startup company as a growing concern. 

Due to a series of missteps early in the company’s existence, a significant debt load was taken on.  These loans persist to this day.

The outstanding interest paid on these loans would represent a non-operating expenditure.

Capital Costs as an Operational Budgeting Concern

Capital costs are typically not considered in an operational budget.  Instead, they are usually viewed as an investment or alternative budgetary concern.

The primary focus of the operational budget has to do with the primary income statement of a business model.  Ergo, this does not involve any capital costs.

In fact, the majority of business organizations today, prefer to create an entirely separate budget for capital costs or investments.

Example

The capital costs (investments) of a publicly traded company were significant enough to attract many retail investors.

However, despite the exuberance around these new investments being made, they still do not represent an operational budgeting concern.

What is Operational Budgeting

"Do not plan for ventures before finishing what's at hand."

-Euripides

Understanding Cash Budgets

A cash budget is not far removed from an operation budget.  Yet there is some distinction to be noted.

A cash budget is by design, an approximate estimation of the inbound and outbound flows of cash during a specific period of time.

It is typically used to determine the financial solvency of a company’s regular operations.

If the cash budget is weak, there may be a significant financial issue at play.  This could even mean that a company may have to shut down some -or all- of its operations.

A cash budget is typically used for identifying “dead money” which is not being used in a productive way. 

Generally, cash budgets offer insight into numerical strategies a business might implement.  This allows them to make proposed expenditures towards new projects safely, without threatening the operational budget in the process.

Example

A business is enjoying a flurry of profitability after scaling-up and redefining its existing product line. 

A cash budget notes that much of the available finances on hand are being left in the business account (unused at this time).  This would represent a great opportunity for further analysis.

Consideration towards using these additional cash reserves for spurring the company’s growth by funding development projects, would be highly advisable.

Making Effective Use of an Operational Budget

Creating an operational budgeting scheme is a demanding and time-sensitive process; especially for larger (and more complex) organizations.

By its nature, an operational budget is objectively forward-looking.  If you are the preparer of said budget, it is your responsibility to carefully forecast future performance, based on existing historical records and trends.

A complete operational budget and analysis can offer a business deeper insight into its prospects.  Accountants will often refer to the operational budget on a monthly basis, while comparing the actual performance with the forecasted variant.

Some questions that are typically considered during the comparison studies are:

  • Are we meeting our financial objectives?
  • Was our initial operational budget accurate – why or why not?
  • Can any outstanding issues be mitigated or eliminated entirely?
  • Are there any additional expenditures that we failed to foresee?
  • Do we face any significant changes in our industry that are having an effect on our business practice?

By better understanding these existing trends, a company can pivot towards a better future outcome.  Conversely, it may also improve upon existing actions that have already produced success.

The Danger of Forecasting Too Far Ahead

The further into the future a company creates its operational budgeting forecast, the more likely errors will ensue.

For optimal outcomes, it is advisable to plan ahead for no more than one to two years at a time.  Any further ahead, and you run the risk of losing sight of your own operational circumstances.

Of course, there is nothing wrong with making plans for future expansions on a longer time horizon.  Just remember to keep your operational budgets closer to your present timeline.  This will allow you to remain “on top” of existing issues and encourage adaptability in the face of sudden changes.

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