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An HR Glossary for HR Terms

Glossary of Human Resources Management and Employee Benefit Terms

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Operating Budget

What Is an Operating Budget?

An operating budget is a detailed projection of what a company expects its revenue and expenses will be over a period of time. Companies usually formulate an operating budget near the end of the year to show expected activity during the following year.

How Is an Operating Budget Used?

An operating budget helps organizations set and achieve business goals. Each month or quarter, managers can compare actual results to the operating budget and analyze the outcome, asking such questions as:

  • Are sales more or less than projected?

  • Were there unexpected expenses?

  • Do figures for the rest of the year need to be adjusted?

Analyzing the results can help companies adapt to changing conditions, update their actions and strategies if necessary, and achieve better performance.

What Are the Parts of an Operating Budget?

The more detailed an operating budget is, the more relevant and valuable it becomes. An operating budget may include a high-level summary along with several supporting sub-budgets that provide greater detail. Here are the most common components of an operating budget:

Revenue

This includes all the different ways a company makes money by selling goods or services. Projected revenue can be based on a simple year-over-year forecast, but breaking revenue down into its underlying components, such as unit volume and average price, can yield greater insights.

Variable Costs

These are costs that rise or fall in lockstep with sales volume. Examples include expenses for raw materials, labor, freight, and sales commissions. 

Fixed Costs

Fixed costs are expenses that remain fairly constant; they have to be paid whether sales are up or down. Examples include rent, utilities, equipment leases, and insurance.

Non-Cash Expenses

The most common non-cash expenses include depreciation, amortization, unrealized gains or losses, stock-based compensation, and deferred income taxes.

Non-Operating Expenses

These are costs that are not directly related to a business’s main activity. The most common non-operating expenses include interest payments, losses on the disposition of assets, and costs from currency exchanges.

Some industries or organizations may include other items in their operating budgets. However, capital expenses are not ordinarily part of an operating budget because they are long-term costs and an operating budget is a short-term budget.

How Do You Create an Operating Budget?

Creating an operating budget is a collaborative effort involving executives and managers. First, they must estimate the coming year’s revenue. This involves checking the firm’s historical performance and then considering market variables that could affect next year’s sales for better or worse. Among them:

  • Changing trends in the industry or sector

  • New products the company will launch

  • Competitors’ actions

  • Seasonal changes in sales

  • Changes in the economy

Next, executives and managers must estimate projected expenses for each part of the business. Managers can account for their own departments. For example, HR’s budget might include recruiting expenses, changing benefit costs, the cost of replacing the department’s aging laptops, and a host of other outlays. The CFO and other executives may be in the best position to tally projected expenses that affect the entire company, such as rent and taxes. 

As with revenue estimates, considering historical data and market variables can help build sound expense estimates. 

Gathering all of the needed figures can be a big job for all but the smallest organizations. But it’s essential for creating an accurate operating budget—and enjoying the clarity and guidance this document will provide.

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