The operating budget It is an excellent tool that allows you to plan the income and expenses that your business must make during a certain period. Lean on these tips to improve the management of your resources to operate.
What is the operating budget? Surely you have heard or read about this concept, but without being clear about why you should make one for your business, and most importantly, how it benefits you.
If this is your case, you are in the right place because in this article I will explain the importance of preparing an operating budget for your business, as well as some good practices that you must take into account to achieve it.
Something very important that you should know is that you do not need to be a financial expert to make one; it is enough to have attention to detail and follow some basic steps. All ready? Here we go.
What is the operating budget?
In its most basic definition, the operating budget It is a document that establishes the income and expenses that a business must make during a certain period. This document allows you to project, in detail, the sales that your business expects to generate, for example, in a year, as well as the expenses that it will have to make to operate and meet its income goal.
In a nutshell, you can know how you are spending money and in which areas or activities you need to make adjustments.
The most important thing is that with an operating budget you will know, in advance, key aspects of your operation. For example, the inputs that you will require to meet your production quota or maintain your product inventory at the optimal level.
It is also useful to determine if you need to hire more employees or, in any case, where the resources will come from to guarantee your cash flow during the entire period. Beyond the theoretical part, the most important thing is to consider the usefulness of the operating budget to improve the management of your business.
What are the goals of an operating budget?
The operating budget It is a very useful tool for your company to establish operational and sales goals.. In addition, you can have stricter control over your expenses, as it allows you to establish budget items in detail, either by department or activity.
With this you can make adjustments if sales go below what you planned. It is also possible to detect and react in advance to unexpected expenses that complicate the financial situation of your business.
Thanks to this information, you will have the ability to assign items according to the needs of each area or activity of your business, as well as anticipate variable scenarios.
As you can see, information is power and, without a doubt, the operating budget It will allow you to make better business decisions.
đź’ˇType: Although your operating budget reflects an annual projection, it gives you the guideline to make periodic reviews of the results that your business obtains as you go.
Tips for preparing an operating budget
Although at the beginning of this blog I commented that you do not need to be a financial expert to prepare an operating budget, the truth is that the more detailed you make it, the more relevant and strategic it will be for your operation. To create it, I recommend you take into account the following points:
- Prepare it at the end of the year
- build on sales
- Accurately details the activities
I explain each point to make it clearer.
1. Prepare it at the end of the year
Generally, the operating budget is established at the end of the year (to implement the next one) in order to foresee the scenario that awaits your business. Set goals by quarter and by areas, so that you can do regular reviews and project whether your business is spending and selling according to plan.
It’s like going on a diet: if you’ve ever done it, then you know that you always set a goal to lose weight by a certain time, but you don’t wait until the deadline to see if you achieved it. Normally, every week or fortnight you get on a scale and measure your progress.
2. Build on sales
It all starts with the sales projection that you expect for your business in that period, because this will tell you how much money you will be earning month by month, until you reach the goal. It may sound obvious to you, but understanding that you simply can’t spend more than you sell is key for a business that doesn’t want to go into debt. It’s that easy.
If you have a commercial manager, he must make the projection of the number of units of products or services that your business will sell, as well as their price. Also, being clear about what your business will sell gives you the guideline to know what you need to meet that sales quota (inputs, personnel, indirect expenses, etc.).
3. Punctually details the activities
Start by reviewing what you have sold and spent over the past three years. In this way you will validate the sales behavior of your business —for example, the highest income peaks and the factors that originated them—. This will give you a better idea of ​​what you can earn the following year.
In the case of expenses, It is key that you gather your team and review in detail, cost by cost, what your business needs to reach its sales goal. This includes administrative expenses, rent of your premises, marketing, supplies, logistics, etc. If your company has a manufacturing operation, the complexity of this point is greater because you must include more detailed costs such as raw materials, labor, electricity and maintenance, among others.
Advantages and disadvantages of an operating budget
An operating budget is a tool that gives you control and visibility over your business and has very clear advantages, among which are:
- Better planning.
- Tighter financial control.
- Visibility to make decisions.
But it must be said, it also has disadvantages, the most notable being:
- Risk of inaccuracy.
- Make rash decisions.
- Discomfort among your collaborators.
What do I mean by each? I’ll explain it to you and start with the advantages.
better planning
By establishing a sales goal, you will have more control over the objectives of other areas, such as production, logistics, administration, sales, etc. Also, you will clearly know what goals you should focus on and you will have greater visibility over your day-to-day operations.
More efficient financial control.
With the operating budget you will assign items for each area and always based on the needs and activities. With this reduce the possibility of spending on things that your business does not need and, on the contrary, you will focus on what will really help you reach your sales goal.
Visibility to make decisions
With this level of information, you will undoubtedly be in a better position to make the right decisions and implement measures if your sales are not turning out according to what you planned at the beginning. For example, you can make budget adjustments in areas that won’t have a significant impact and strengthen others that can help you meet your goals.
I already told you that there are also disadvantages. Now I explain how these situations can be generated:
Risk of inaccuracy
Let’s face it: when you create your operating budget, there will be the possibility of using projections and data that can generate inaccuracies due to dependencies on volatile factors. For example: “if we sold this last year, and given the growth trend that we have been reporting, we estimate that we will sell X at the end of the following year”.
Relying on assumptions is not a bad thing. Even the most modern artificial intelligence systems work more or less like this. But you should not do it lightly. You have to rely on realistic numbers that justify your projections. Still, he reckons any change in the business environment — a sudden economic downturn, a new regulation, a virus escaping from a faraway region — could affect any spending and revenue projections.
make rash decisions
Imagine that a certain department is not executing its spending budget as planned. But somehow they know the money is there, ready to be spent.
This situation could lead the managers or those responsible for the area approve projects that are meaningless or simply do not add value to the business, solely with the aim of executing the budget before the end of the year. Something very common in medium and large companies.
Discomfort between your collaborators
When you check what an area spends for specific activities, you will make more than one uncomfortable. A manager might feel that you don’t trust him and that his work is losing value.
This situation can worsen when you review their sales projections and discover that they are being too cautious in their estimates —of course, feeling watched, more than one will want to risk little and play it safe.
Nevertheless, it is necessary to have the greatest transparency and dedicate enough time to have the operating budget closest to the reality of your business.
Operating budget: example to learn how to do it correctly
As I told you, you do not need to be a financial expert to prepare a operating budget and next, I will give you an example so that you can make one in a simple way. Excel is enough for it. The steps that we will follow will be the following:
- Prepare a sales budget.
- Stick to the production budget.
- Develop a budget for materials and supplies.
- Define the labor budget.
- Prepare a sales and administration budget.
In this case, I will use the case of a company that manufactures and sells children’s beds through an ecommerce platform. This example that I will address includes the projection of an entire year, but the ideal is that you break down these same concepts on a monthly basis. Now let’s go point by point:
1. Create a sales budget
The first thing this company must do is establish the total sales budget, which is obtained by multiplying the number of beds by the value of each one. The company in our example estimates to sell 120 beds at a price of $15,000 MXN. The is the basic tool of this exercise, so you must learn to do it properly.
2. Follow the production budget
The next step is to define the production budget. In this part, we define the units that the company plans to sell and consider both the beginning inventory —that is, the number of beds the company has in stock— and the ending inventory —the beds it expects to end up with in its warehouse.
In this case, if the company wants to sell 120 beds, it must add the 15 it already has and subtract the stock with which it expects to end the year —in this exercise, our bed manufacturer should have in reserve the inventory equivalent to one month of sales, that is, 12 beds, but this varies according to the needs of the business. The result will indicate the…
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