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The Operating Budget: A Step-by-Step Approach

by Kiley Arnold, CPA | Jan 16, 2024

What is the importance of the operating budget?

Operating budget vs. capital budget.

2. Creating operational budgeting goals

Increasing revenue

Cutting expenses.

3. Largest expenses of the operating budget

People expense

Rent expense.

4. Determining key performance indicators (KPI’s)

What are KPIs?

Examples of operational kpis.

5. Steps to create an operating budget template with examples

Step 1: Create an annual budget

Step 2: create a monthly budget from the annual budget figures, step 3: compare budgeted amounts to actual performance, operating budget defined.

The operating budget, also known as the corporate budget , is a comprehensive plan of an organization’s revenues and expenses for the upcoming fiscal year. The operating budget is created and approved annually and then compared to actual results throughout the year to track progress toward the organization’s financial goals. The budget should include expected revenues along with various types of expenses which may incorporate fixed, variable, and one-time costs.

The operating budget is critical to help organizations make informed decisions as well as to measure performance and growth. An annual operating budget should reflect the goals of an organization for the upcoming year. Depending on the stage a business is in and the nature of its operations, operating budgets can vary.

While this article is primarily focused on the operating budget, various types of budgets exist. A capital budget is similar to an operating budget in that it estimates future cash inflows and outflows. However, the key difference between an operating budget and a capital budget is that a capital budget is more focused on the long-term investment of resources and whether or not they’ll be worthwhile. The operating budget is focused on day-to-day operations and the immediate future.

Creating operational budgeting goals

Each organization’s operating budget is unique and should be created with specific goals in mind. Whether your organization is looking to increase revenue or reduce expenses, start with a good record of what happened in the past year and understand some of the organization’s strategic plans for the coming year.

Increasing revenue can be the primary objective of an organization for many reasons. If a company, such as a startup, is still in its early stages, increasing revenue is likely a primary objective to stay in business or entice investors. Companies belonging to high-growth industries, such as the SaaS sector , are always innovating and adapting with new strategies and products hoping to increase revenue and, as a result, market share.

When increasing revenue is a key aim of the operating budget, consider all sources of revenue. Many companies have multiple products and/or services, which means multiple streams of income. Additionally, both new customers and existing customers are sources from whom income can be earned. For example, a software company may sell subscriptions to net new customers to generate revenue while also increasing revenue through renewals and negotiating new rates with existing customers.

Some organizations prioritize increasing market share while others are focused on increasing profit margins through pricing changes. While bringing on new customers and grabbing market share is important, it is easier and less costly to keep an existing customer than to sign a new customer, so it is worthwhile to strategically focus efforts on existing customers in many cases.

Projecting revenue requires a balance – set a challenging or optimistic goal to be motivational, but at the same time it must be reasonably achievable. Some factors to consider when estimating revenue can be historical trends and past year-over-year growth. Many industries experience seasonal peaks and dips, so each month or quarter in the budget may look different. Prices of products or services will be another factor in this estimation – is your business strategy to keep prices competitive and predictable or are you planning any increases in the near future? Demand and competition are of course important in answering these questions. To be more precise in estimating revenue, many organizations utilize calculations and models ranging from simple to complex to assist with projections.

Examples of revenue estimation models include:

• Historical perspective – a simple but proven method
• Length of sales cycle approach – predicting how long it will take for a customer to purchase from you
• Test market analysis – determining if a market for a new product or service exists by testing it on a small scale first
• Multivariable analysis – a more complex model factoring supply and demand, kinds of promotions and marketing campaigns, seasonality and macroeconomic factors amongst other relevant considerations

Organizations may use one of these approaches, or more likely, a combination of approaches. Predicting revenue isn’t effortless, however with time, creating the annual revenue budget may come more efficiently.

Many organizations focus more on cutting expenses. Managing expenses can be overwhelming, as it is hard to track costs in an organized manner. To create the annual expense budget, it is essential to have a good system with accurate records of current costs. Consider any long-term goals of the organization in the event new expenses are to be expected. Leverage the capital budget to predict large purchases whether those be for machinery, equipment, or an acquisition.

First, ensure the list of the current year’s expenses is complete and accurate. Establish good interdepartmental communication so you are aware of costs being incurred throughout the business. An organized record keeping system is key, as well, whether it is managed in spreadsheets or a software program. New expenses may have been incurred since the last operating budget was created, so the finance team needs to have access to a full detail of all departments’ spending.

Additionally, sort expenses into different categories – fixed, variable and one-time. Fixed payments are generally more predictable. However, consider if there are any new fixed costs to expect. Variable expenses need to be estimated, but can be somewhat consistent, too. These are often based on factors like usage, so consider if usage is expected to stay the same, increase or decrease in the coming year. One-time expenses are usually situational. Understanding the company’s strategic plans is the best way to predict these expenses.

Once current expenses are deemed complete, accurate and categorized, look for areas for improvement. Some approaches to cutting costs may include:

• Reduce usage, production costs or overhead where possible
• Identify potential waste such as spending money on underutilized equipment or services or unused software licenses , or “ zombie accounts “
• Explore cost efficiencies with alternative products or vendors for products or services used in everyday operations
• Automate processes or go paperless
• Consider whether leasing or buying assets used in day-to-day operations is more cost efficient
• Consider current economic climate, such as inflation and interest rates and plan accordingly whether those are advantageous or not

Largest expenses of the operating budget

Regardless of the goals of your organization, monitoring and accurately estimating expenses is important when creating the operating budget. Certain expenses are almost always the largest areas of a company’s spend.

People expense, or the costs a business incurs to compensate and retain employees, contractors, and temporary hires, is typically the largest expense of any organization. These expenses do not only include actual salaries and wages but also the various taxes and benefits employers are obligated to cover. When creating the operating budget, factor in potential new hires, employee retention rates, and raises, as well as overtime and bonuses. Also consider if you have a busy season or a significant event in the upcoming year like an acquisition.

Rent expense is the second largest expense for many organizations. The real estate market is very sensitive to macroeconomic factors, so monitoring those sorts of aspects is important for this particular expense estimate. Additionally, you may have leases for years into the future, so those contractual terms can be included in the operating budget. Therefore, it is important to have a central repository for lease agreements. Determine if any renewals are coming up and whether to expect any corresponding rent escalations.

Many leases have both fixed and variable components to be aware of, as well. Outside of base rent, common area maintenance (CAM) charges, property taxes, and insurance are common costs related to leases. Many companies have only just recently adopted ASC 842 which resulted in the obligations for operating leases being presented on the balance sheet. This resulted in finance teams paying more attention to leases than they did in the past and many looking for automated solutions for both tracking and accounting for their leases .

Saas spend is a fast-growing expense, rapidly expanding to earn a spot in the top operating expenses . As it continues to grow for companies across the globe, more scrutiny is being applied to the SaaS spend budget. While it is relatively new, these costs are climbing at an exponential rate for many organizations. As businesses are looking at ways to reduce costs and increase efficiency through automation, different departments are entering into various software subscriptions .

Many organizations have no current method of tracking their SaaS products outside of a spreadsheet manually maintained by IT. As different departments may use various software programs, communication between teams is critical to tracking these specific costs. The terms of these contracts are not usually long periods of time, so it is important to monitor upcoming renewals and potential related price increases. We recommend documenting more data than just a list of software program names. Track the number of licenses associated with each application and how often programs are actually being used to identify areas where SaaS spend can be reduced.

Determining key performance indicators (KPIs)

Once the annual budget is approved, you can refer to it throughout the year, updating it with actual revenues and expenses and then analyzing your budget to actual results.

Key performance indicators, or KPI s, are quantifiable metrics used to assess the performance of your operations. Many different types of KPIs exist, so determine which are most relevant to the nature of your business. Financial KPIs are always relevant in creating the operating budget, but consider other KPIs such as those related to logistics, manufacturing, sales, and marketing, depending on the goals and focus of the organization.

Some common examples of financial KPIs used to create and monitor the operating budget include:

• Gross Profit Margin – dividing gross profit by revenue in order to assess profitability
• Accounts Receivable Turnover – dividing net credit sales by average accounts receivable in order to assess efficiency
• Accounts Payable Turnover – dividing total purchases by average accounts payable balance in order to assess liquidity
• Working Capital – subtracting current liabilities from current assets to assess liquidity
• Operating Cash Flow – subtracting operating expenses from revenue/sales to focus strictly on cash flow/liquidity and ignore accrual basis items/non-cash expenses, such as depreciation or amortization

Outside of strictly financial KPIs, other metrics can be important to consider for operating budget estimates. Examples of these could include:

• Customer Retention and Satisfaction Rates – typically expressed as a percentage and found through CRM data analysis and reviews from online sources
• On-time Delivery – number of items delivered on time divided by the total number of items delivered times 100 to be expressed as a percentage
• Order Accuracy – number of accurately filled orders divided by the total number of orders x 100 to be expressed as a percentage
• Marketing ROI’s – monitoring website traffic and conversion rates from marketing lead sources
• Employee Turnover and Satisfaction Rates – measure turnover by dividing the number of employees who left by the average number of employees times 100 to be expressed as a percentage coupled with HR surveys and skip level meetings to assess satisfaction

Steps to create an operating budget template with examples

Start by creating an annual operating budget template that can be rolled forward with updated revenue and expense estimates each year. You may find an operating budget sample online, but be sure to include revenue streams and expense types relevant to your organization. If you are using the prior year’s operating budget as a starting point, update it annually to include new sources of revenue or costs. For example, any new products or services, acquisitions, or new types of expenses, such as SaaS spend.

Create a budget for each month or quarter of the year by distributing the annual budget amounts across the year. It may make sense to allocate total annual revenues and expenses evenly to each month and/or quarter. However, if your business is cyclical, experiences busier periods, or expects any significant events at certain points during the year, factor those items into your allocations.

On a periodic basis, compare the actual amounts earned and incurred to those included in the annual budget. This will help to measure performance and build a more accurate operating budget in the next fiscal year. Analyze the results using the KPIs pertinent to your organization.

Setting the operating budget for the year is an important process. The operating budget is focused on the day-to-day operations of the upcoming year and is based on the strategic goals of the company. Once these goals are initially created, the budget can be periodically compared to actual results and relevant KPIs can be used to track progress toward those goals and help the company measure success.

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CapEx vs. OpEx: Capital and Operating Expenses Explained

An operating budget is a tool that helps business owners and project managers alike to look at the long-term financial needs of their organization or project. It’s instrumental in forecasting the budget needed to run your business or project.

That alone should make you want to understand the definition and reasons to use an operating budget. We’ll explain that and go into what should be included in your operating budget. As an added bonus, we’ll also throw in a free operating budget template for Excel.

What Is an Operating Budget?

An operating budget is a tool that allows you to estimate the revenue and expenses you expect to have for the coming year. It provides a more detailed and accurate estimate by breaking down your expenses. This process is usually done at the fourth quarter or year’s end to have a picture of what to expect financially in the next year.

Forecasting your revenue and expenses does more than help create an accurate budget for the new year, as important as that is. It’s also used to set goals for companies so they have realistic expectations and targets. This makes it possible to hit the goals and still achieve profitability. For project managers, an operating budget is a great tool to track financial progress to stay on budget by ensuring their actual costs match their planned costs.

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Operating Budget Template

Use this free Operating Budget Template for Excel to manage your projects better.

  An operating budget doesn’t have to be an annual endeavor. As used in project management, it can be reviewed monthly and businesses have been known to do quarterly reports. Reviewing and revising the operating budget is important, too, as there will always be unexpected expenses that impact the forecast. Being able to use the operating budget as a living document means that businesses and projects can respond to market pressure and changes in scope and adjust accordingly to avoid overspending.

To review and revise your operating budget you need project management software. ProjectManager is award-winning project management software with real-time dashboards that give you a high-level overview of your project. Our live dashboard automatically collects data on costs and other metrics, which are then displayed in easy-to-read graphs and charts. You can get a look at your budget anytime and, best of all, there’s no time-consuming configuration required as with lightweight alternatives. Get started with ProjectManager today for free.

Why Should You Use an Operating Budget?

Operating budgets are used by everyone from businesspeople to project managers to estimate future revenue and expenses. But they’re also a great operations management tool, as we’ve noted, to capture if you’re keeping to that budget. They can help track day-to-day operations to stick you to your budget as you review your actual spending compared to what you expected to spend over a given period.

The use of operating budgets is also critical in making your company or project financially accountable. By tracking your revenue and expenses , you can more easily uncover areas in your budget that are wasteful and can be reduced to increase profitability. Beyond the important cost efficiency that this provides, an operating budget is a great asset for planning and managing your resources on a project. You can see how much you can spend over the coming year and plan accordingly.

When you’re planning your next operating budget, the prior operating budget is valuable. It provides you with historical data to better understand where your money went, which allows you to make more informed decisions when planning your new operating budget. Using that old operating budget with the knowledge you have of how the year actually panned out allows you to edit your operating budget to adjust for those issues. As you continue to make adjustments, your operating budget becomes more accurate.

What Should Be Included in an Operating Budget?

An operating budget helps you strategize and is part of what makes a business profitable or a project successful . It sets up your business or project for the year ahead and gives you the data you need to track whether you’re keeping to your budget.

This requires that you make a detailed operating budget. There are a number of sections that allow you to both estimate revenue and expenses for the coming year and be able to track them to keep to your budget. These sections include the sales budget, costs, operating expenses and unexpected expenses.

Related: Free Project Estimate Template for Excel

Sales Budget

If you’re making a project or a service, you need to start with a sales budget. This is a monthly estimate of how many products or services you’ll sell and what revenue those sales will bring into the business. By doing this monthly, you can better adjust for seasonal changes.

In order to make an accurate estimate of your sales budget, you need to list those products or services, including any variations, such as size, color, etc., that you might also be producing over the year. You’ll want to review last year’s sales as past financial data helps you create a more accurate sales budget.

Some things to think about when determining what your sales budget will include are what your monthly sales usually look like, if your product or service is impacted by seasonality, whether there’s going to be a new product or service launch for the coming year and how marketing will affect sales.

Costs are direct expenses from selling your product or service. These direct costs can include any materials that you use to make your product . The cost of labor involved in making your product or service is also part of your budget cost, even if you outsource your labor. Any merchandise you resell should also be added to your budget costs.

All these costs that are related to your product or service over the year will amount to your budget costs. You’ll want to figure out how much the cost per unit is and then multiply it by how many units you’ve sold, which is the total cost. This amount is determined for each line item on the budget costs and should be added to get the total cost for the month.

Operating Expenses

Here you’ll want to list all your expenses, including variable costs and fixed costs . For example, variable costs are those that change from month to month, such as marketing costs, a one-time software purchase, hourly wages, shipping costs, supplies and more. Fixed costs are then those that are unchanged from month to month, which include rent, software subscriptions, salaries, insurance and so forth. You’ll add each of these as a line item and then add both fixed and variable costs together for a monthly total.

Unexpected Expenses

The last part of your operating budget is the unexpected expenses. There will always be something that comes up that impacts your budget. To not get sidetracked by these unexpected expenses, you need to provide a bit of a cushion in your budget to absorb them. There are two ways you can prepare for unexpected expenses; one is to set aside funds that you think will cover those expenses and, two is to increase your monthly expenses by a percentage, maybe 10 percent.

This data helps determine your net income by following this equation:

Revenue – Costs – Expenses – Unexpected Expenses = Net Income

Operating Budget Example & Template

All this information may be hard to process, which is why we have an operating budget example. In it, we’ve filled in a few examples with the generic widget, adding prices for sales, cost, operating expenses and unexpected expenses. You can see it all on our free operating budget template for Excel , which you can download and use for your next operating budget. It’s one of dozens of free project management templates for Excel and Word that you can use to help you estimate, plan and manage your projects.

ProjectManager Helps You Track Operating Budgets

An operating budget template can help you figure out your budget, but it’s not going to let you manage it easily. Project management software gives you the tools you need to keep track of your expenses and make sure you’re not overspending. ProjectManager is award-winning project management software that helps you plan, manage and track your budget in real time.

Plan and Manage Budgets With Robust Gantt Charts

Once you have a budget, add it to our software and organize those costs on our Gantt chart . You can assign costs to resources and tasks and filter for the critical path to see which of those tasks are essential to delivering your project. Then set a baseline to capture your plan and track your planned costs against your actual costs to identify any over expenditures and resolve them before they negatively impact your budget.

Track Resources With Workload Charts and Timesheets

Resources, such as labor, materials, etc., need to be managed. Our resource management features help you keep track of all your resources in real time. The Gantt chart tracks human and non-human resources, but that’s just the starting point. Toggle over to the color-coded workload chart to see who is overallocated and balance your team’s resources right from that chart to keep them working at capacity. Another way to track costs is with our secure timesheets, which automatically update to show the logged hours of each team member.

If you want more information, use our reporting tools . Each report is customizable so you can filter the results to show only what you want to see for timesheets, workload, project status and more. The reports can also be shared in a variety of formats to keep your stakeholders informed. Our software helps you keep your budget from getting out of control.

ProjectManager is online project management software that helps you create realistic budgets and manage them so you don’t overspend. Use our task management features to keep teams productive and our risk management tools to avoid potentially damaging issues from taking you off budget. Join teams at Avis, Nestle and Siemens who are using our software to deliver success. Get started with ProjectManager today for free.

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@media(min-width: 1024px){.css-hqxvux{max-width:100%;}} Understanding the basics of operating budgets: A beginner's guide

Components of an operating budget

The process of creating an operating budget, benefits of an operating budget, top 5 challenges in operating budget management, differences between operating budgets and capital budgets, 4 industry examples of an operating budget, best practices to follow for operating budget management, the budgeting move that will change your business forever.

@media(min-width: 1024px){.css-hqxvux{max-width:100%;}} Effortless expenses start here.

Introduction.

An operating budget serves as the financial backbone of any organization. This powerful tool guides resource allocation and also acts as a benchmark for performance evaluation and decision-making. Understanding the intricacies of operating budgets is core to business success today.

From small startups to multinational corporations, businesses of all sizes use operating budgets to navigate their fiscal year with clarity and purpose. These budgets offer a detailed projection of expected revenues and expenses, enabling companies to anticipate any new challenges, seize opportunities, and maintain a strong financial footing.

However, creating and managing a well-crafted operating budget requires a deep understanding of various financial components, collaboration across multiple departments, and the ability to adapt to changing market conditions. And not every business can do all of those things well. This article aims to provide practical insights into the implementation and management of an operating budget.

We'll explore the core components of operating budgets, dive into the creation process, and highlight the benefits every organization can reap. Additionally, we'll address common challenges in budget management and offer solutions to overcome them. You’ll walk away with a solid understanding of how operating budgets can drive your organization's financial health and contribute to long-term success.

What is an operating budget?

An operating budget is a comprehensive financial plan that outlines an organization's expected revenues and expenses for a specific period, typically one fiscal year. It serves as a detailed roadmap for managing day-to-day operations, allocating resources, and achieving short-term financial goals. This budget forecasts all anticipated income sources and regular expenditures necessary to run the business, including salaries, rent, utilities, supplies, and other operational costs.

Think of an operating budget as a financial GPS for your business. Just as a GPS helps you navigate from point A to point B, an operating budget directs your financial journey through the fiscal year. It maps out where money is expected to come from (revenues) and where it needs to go (expenses) to keep operations humming.

In the realm of financial planning, an operating budget serves several critical functions:

It acts as a financial control mechanism to keep spending in check.

It provides a benchmark for evaluating actual performance against projections.

It facilitates informed decision-making about resource allocation.

It helps identify potential cash flow issues before they become problematic.

It aligns financial activities with larger organizational goals.

An operating budget helps businesses clearly visualize their operations, proactively manage their finances, make data-driven decisions, and act with confidence and clarity.

An operating budget has several key elements that together provide a view of an organization's expected financial performance:

Revenue projections

Fixed costs.

The expenses that remain constant regardless of production or sales volume are your fixed costs, which form a stable base in the operating budget. These costs typically include rent or mortgage payments for facilities, insurance premiums, salaries for permanent staff, property taxes, and depreciation of assets. For instance, a manufacturing company might have fixed costs of $200,000 per month for factory rent, $100,000 for equipment leases, and $500,000 for administrative staff salaries. Understanding and accurately forecasting these costs is essential for determining the bare minimum revenue needed to break even and for making long-term financial decisions.

Variable costs

Variable costs fluctuate directly with production or sales volume. These expenses typically include raw materials for production, direct labor costs tied to production, sales commissions, packaging and shipping costs, and credit card processing fees. As an example, a T-shirt printing company's variable costs might include $5 for blank shirts, $2 for ink, and $1 for packaging per shirt produced. Tracking and managing variable costs is crucial for maintaining profitability as production or sales volumes change. Many organizations have employees use a corporate credit card so that they can manage and track these variable expenses, providing real-time visibility into spending and simplifying expense categorization.

Semi-variable costs

Semi-variable costs are the gray areas between fixed and variable costs, having components of both. These costs change with production or sales volume but not in direct proportion. Examples include utilities (with a base rate plus usage), overtime labor, equipment maintenance, and some marketing expenses. For instance, a restaurant might have a base rate of $1,000 per month for electricity, plus $0.10 per kilowatt-hour used. These are definitely trickier to track, but understanding the nature of semi-variable costs allows organizations to make more nuanced financial projections and decisions, particularly when considering changes in production or service levels.

These components will give organizations a clear understanding of their cost structure and revenue sources. And such a detailed view enables more accurate forecasting, helps identify areas where costs can be controlled or revenues increased, and provides a foundation for making financial decisions throughout the fiscal year.

Creating an operating budget is a comprehensive and collaborative process that involves multiple steps and stakeholders across an organization. The process typically unfolds as follows:

Start by setting clear budget objectives that align with the organization's overall strategy and financial goals. This first step provides direction for the entire budgeting process. Once these objectives are established, the finance team can delve into historical data, analyzing past financial performance to identify trends and inform projections. This retrospective analysis serves as a foundation for future estimates.

Next, the process becomes more decentralized as each department provides input on its expected expenses and, where applicable, revenue projections. This bottom-up approach ensures that those closest to day-to-day operations contribute their expertise to the budget. Simultaneously, the sales and marketing teams work on forecasting revenues, basing their projections on market analysis, historical data, and current sales pipelines.

With departmental input in hand, the finance team compiles all anticipated costs, including fixed, variable, and semi-variable expenses. This comprehensive view of expenses is then combined with revenue projections to create an initial budget draft. This draft undergoes rigorous review by management, who make adjustments to align the budget with strategic goals and financial constraints.

After necessary revisions, the final budget is presented for approval by senior management or the board of directors. Once approved, the budget is communicated to relevant stakeholders across the organization, and implementation begins.

Throughout this process, accurate data collection and analysis play a crucial role. Finance teams often leverage various data sources, including financial statements, sales reports, market research, and industry benchmarks to ensure the budget is based on the most current and relevant information available. Startup banking solutions often provide integrated financial tools that can streamline this data collection process for new businesses.

Gaining buy-in from different departments is key to creating a realistic and achievable budget. While finance oversees the entire process, sales provides revenue projections, operations estimates production costs, human resources forecasts labor expenses, and marketing outlines promotional spending. This collaborative approach not only produces a more accurate budget but also increases the likelihood of successful budget implementation and adherence throughout the fiscal year.

Here are five key benefits that organizations of all sizes stand to gain from using an operating budget:

Improved financial control

An operating budget ultimately helps organizations maintain control over their spending. By setting clear financial targets and regularly comparing actual performance against budgeted figures, companies can quickly identify and address variances. This proactive approach helps prevent overspending, ensures resources are allocated efficiently, and maintains financial stability. It enables management to make timely adjustments, preventing small issues from escalating into major problems. Moreover, an operating budget facilitates the identification and implementation of cost reduction strategies by providing a clear view of where money is being spent, enabling organizations to target areas for potential savings and efficiency improvements.

Better decision-making

With a comprehensive operating budget in place, management gains a clear picture of the organization's financial capacity and constraints. This insight is invaluable when making critical business decisions. Whether it's determining whether the company can afford to hire additional staff, invest in new equipment, or expand into new markets, the budget provides a solid baseline for these choices. It helps answer crucial questions like "Can we afford this investment?" or "How will this decision impact our bottom line?" by providing context and financial implications for each option.

Enhanced performance evaluation

An operating budget serves as a benchmark against which actual performance can be measured. It allows organizations to set specific, measurable financial goals for different departments or business units. By comparing actual results to budgeted figures, management can objectively evaluate performance, identify areas of excellence, and pinpoint where improvements are needed. This data-driven approach to performance evaluation promotes accountability and helps in setting realistic targets for future periods.

Increased coordination

Corporate alignment is another benefit of an operating budget because the process fosters communication and collaboration across different departments. As various teams contribute their input and work toward common financial goals, it enhances interdepartmental coordination. This improved alignment can lead to more efficient operations, better resource allocation, and a shared sense of purpose.

Improved cash flow management

By forecasting both income and expenses, an operating budget helps organizations anticipate their cash flow needs throughout the year. This foresight is crucial for maintaining adequate liquidity, avoiding cash crunches, and deciding on the timing of major expenses or investments. Strategic cash flow management , guided by the operating budget, can improve business cash flow by reducing the need for short-term borrowing, potentially lowering interest expenses and enhancing the overall health of the organization.

These benefits collectively contribute to a culture of financial discipline and serve as a north star for organizations to navigate challenges, seize opportunities, and achieve their strategic objectives. An operating budget is not just a financial tool; it's a strategic asset that provides the foundation for informed decision-making, performance improvement, and long-term success.

While operating budgets are invaluable tools for financial planning and control, there are several challenges that can derail their success:

1. Inaccurate forecasting

Even with careful analysis and historical data, predicting future revenues and expenses with precision remains a complex task, often leading to discrepancies between budgeted and actual figures. Volatile market conditions, unexpected economic shifts, or internal changes within the organization are primary drivers of inaccurate forecasts, which can significantly impact liquidity management and potentially lead to cash shortages or missed investment opportunities.

Solution: Implement rolling forecasts and leverage advanced analytics tools. Regularly update projections based on the most recent data and market trends. Use statistical models and machine learning algorithms to improve prediction accuracy. Conduct sensitivity analysis to understand the impact of various factors on your models.

2. Budget inflexibility

Once established, budgets can become rigid frameworks that struggle to accommodate unexpected changes in the business environment. A lack of adaptability can lead to outdated or irrelevant financial plans, especially in rapidly evolving industries or during times of economic uncertainty.

Solution: Adopt a flexible budgeting approach. Use scenario planning to prepare for different outcomes. Incorporate contingency funds into the budget to handle unexpected changes. Implement a process for periodic budget reviews and adjustments to ensure the budget remains relevant and aligned with current business conditions.

3. Time-consuming processes

The budget creation process itself can be lengthy and resource-intensive, potentially diverting attention from other important tasks and creating resistance among employees who view it as a burdensome exercise.

Solution: Transform your budgeting process by embracing advanced budgeting and accounting automation software . Such tools can handle the heavy lifting of data collection and routine tasks, saving time and improving accuracy. Set up standardized templates for each department and implement a centralized system that integrates with your automated accounting tools, enabling real-time updates and collaboration. Also, consider adopting a driver-based budgeting approach to focus on key business factors rather than every line item. This combination of automation and strategic thinking can turn budgeting from a time-consuming chore into an efficient, insights-driven process that delivers more accurate and useful financial plans.

4. Balancing short-term and long-term goals

Another organizational challenge is rationalizing short-term budget adherence with long-term strategic goals. Strict budget constraints might lead managers to make decisions that meet immediate financial targets but could be detrimental to the company's long-term growth and competitiveness. Finding this balance often involves identifying ways to improve operational efficiency to meet short-term targets without compromising long-term strategic investments.

Solution: Align the budgeting process with the company's strategic planning. Incorporate both short-term targets and long-term strategic objectives into the budget. Use balanced scorecards or similar tools to ensure a holistic view of performance that includes both financial and non-financial metrics. Educate managers on the importance of balancing immediate budget targets with long-term value creation.

5. Overlooking non-financial factors

Focusing solely on financial metrics can lead to overlooking other harder-to-measure factors for business success, such as customer satisfaction or employee morale.

Solution: Integrate non-financial key performance indicators (KPIs) into the budgeting process. These might include customer satisfaction scores, employee engagement metrics, or sustainability targets. Develop a comprehensive performance measurement process that weighs financial and non-financial factors. Encourage cross-functional input during the budgeting process to ensure all aspects of the business are considered.

While both operating budgets and capital budgets are important planning tools, they serve distinct purposes and differ in several key aspects. Operating budgets focus on short-term, day-to-day financial activities, typically covering one fiscal year and including recurring expenses like salaries, rent, and utilities. They directly impact the income statement and are funded through regular revenue streams. In contrast, capital budgets have a long-term perspective, often spanning several years, and plan for significant investments in assets or projects that will contribute to the company's future growth.

Capital budgets often cover large, one-time expenditures such as purchasing buildings or implementing major software initiatives. These items primarily affect the balance sheet, with expenses capitalized and depreciated over time. Due to the substantial funds needed, capital budgets often require special financing arrangements and typically involve a higher risk profile compared to operating budgets.

The creation and approval processes for these budgets also vary. Operating budgets are usually created annually with frequent updates, while capital budgets may align with longer-term strategic planning cycles. While senior management typically approves operating budgets, capital budgets often require board approval due to their significant financial commitments and long-term implications.

In a nutshell, operating budgets ensure smooth day-to-day operations and short-term financial health, while capital budgets drive long-term growth and strategic positioning.

Those leaders who can skillfully balance the immediate needs addressed in the operating budget with the future-oriented investments outlined in the capital budget will gain a strategic advantage.

Operating budgets are as diverse as the businesses they serve, reflecting the unique financial position of every industry. The following four examples illustrate how different types of organizations structure their operating budgets, highlighting the varying revenue sources, cost structures, and financial priorities across retail, manufacturing, software, and food service sectors.

1. Retail store operating budget

A retail store's operating budget would typically include projected sales revenue from various product categories, such as clothing, accessories, and home goods. Fixed costs would encompass rent for the store location, insurance premiums, and base salaries for full-time staff. Variable costs might include the cost of goods sold, sales commissions for employees, and packaging materials. Semi-variable costs could cover utilities (with a base rate plus usage) and wages for part-time staff that fluctuate by season and with store traffic. The budget might also include marketing expenses for local advertising and seasonal promotions.

2. Manufacturing company operating budget

For a manufacturing company, the operating budget would start with projected sales of manufactured goods, possibly broken down by product lines or customer segments. Fixed costs would include equipment leases, property taxes for the factory, and salaries for management and core production staff. Variable costs would cover raw materials, direct labor tied to production volume, and shipping costs. Semi-variable costs might include machine maintenance (with regular servicing plus usage-based repairs) and energy costs for running the production line. The budget would also factor in quality-control expenses and inventory management costs.

3. Software as a Service (SaaS) company operating budget

A SaaS company's operating budget would primarily focus on subscription revenue projections, possibly including different tiers of service and expected customer churn rates. Fixed costs would cover office rent, core development team salaries, and software licenses for internal use. Variable costs might include cloud hosting fees (think AWS services) that scale with user activity and customer support staff wages. Semi-variable costs could encompass marketing expenses (with a base budget plus performance-based spending) and sales team compensation (base salary plus commissions). The budget would also include expenses for continuous product development and cybersecurity protections.

4. Restaurant operating budget

A restaurant's operating budget would begin with projected food and beverage sales, possibly broken down by meal times or menu categories. Fixed costs would include rent for the restaurant space, kitchen equipment leases, and salaries for management and key kitchen staff. Variable costs would cover food ingredients, hourly wages for servers, and disposable items like napkins and takeout containers. Semi-variable costs might include utilities (with higher usage during peak hours) and maintenance for kitchen equipment. The budget would also account for marketing expenses, such as local advertising and menu printing, as well as licensing fees and regular health inspections.

These examples illustrate how operating budgets can be tailored to meet the specific needs and challenges of different industries. Despite their differences, each budget serves as a crucial financial roadmap, helping businesses manage resources effectively, control costs, and ultimately drive profitability in their respective sectors.

Now that you have an idea of how to build an operating budget, it’s time to operationalize it. The following best practices offer a roadmap for creating, implementing, and maintaining an operating budget that can withstand evolving business conditions while driving strategic objectives.

Use historical data wisely

While past performance provides valuable insights, avoid over-relying on historical data. Instead, combine historical trends with forward-looking analysis. Consider market trends, economic forecasts, planned strategic initiatives, and the performance of liquid assets when projecting future performance. Regularly update your historical data analysis to reflect the most recent patterns and changes in your business environment.

Involve key stakeholders

Engage department heads, managers, and frontline staff in the budgeting process. Their insights can provide realistic input and increase organizational buy-in. Conduct budget workshops or planning sessions to gather diverse perspectives. Clearly communicate the budget's importance and how it aligns with overall company goals to foster a sense of ownership among all participants.

Implement zero-based budgeting periodically

Instead of always building on the previous year's budget, occasionally start from zero. This approach challenges assumptions and can identify unnecessary expenses. Conduct a thorough review of all expenses, justifying each line item. This process can uncover inefficiencies, eliminate redundant costs, promote resource optimization , and reallocate resources to areas with the highest return on investment.

Conduct regular reviews

Don't treat the budget as a static document. Review it regularly (monthly or quarterly) and be prepared to make adjustments based on actual performance. Establish a formal review process that includes variance analysis and action planning. Use these reviews as opportunities to refine cash flow forecasts and realign resources as needed.

Use variance analysis

Speaking of variance analysis, you’ll want to regularly compare actual results to budgeted figures. Investigate any standout variances to understand their causes and take corrective action if necessary. Develop a process for tracking and reporting variances in real time. Train managers to interpret variance reports and take appropriate actions based on the findings.

Leverage technology

Budgeting and forecasting software will streamline the process, improve accuracy, and enable real-time updates and analysis. Invest in integrated financial planning software that can pull data from various sources automatically. Explore AI and machine learning capabilities to enhance forecasting accuracy and identify trends or anomalies in financial data. Incorporating spend management software into your budgeting process can provide insights into spending patterns, automate expense reports , and help ensure adherence to budget constraints

Align with strategic goals

Ensure the operating budget reflects and supports the organization's overall strategic objectives. Each line item should contribute to achieving these goals. Create clear links between budget allocations and strategic initiatives. Use the budget as a tool to communicate and reinforce the company's strategic priorities across all levels of the organization.

These are just a few best practices that can help companies create more accurate, useful operating budgets that drive better financial decision-making and performance. Remember, great budgeting is an ongoing process of planning, execution, monitoring, and adjustment, always aligned with your strategic direction and responsive to changing business conditions.

Operating budgets are essential tools for financial management, offering organizations a clear path to navigate their fiscal landscape. They provide a structured approach to planning, controlling, and evaluating performance, enabling businesses large and small to make informed decisions and adapt to changing market conditions.

In an era where technology continues to reshape business practices, it's no surprise that budgeting processes are also evolving. Many organizations are now turning to advanced software solutions to uplevel their financial management. One such tool making waves in this space is Brex's spend management and budget management software . This software addresses many of the challenges we've discussed, offering features like real-time spending visibility, automated expense categorization, and customizable budgets. These capabilities can automate much of the workload and help you create, monitor, and adjust your operating budgets with agility.

If you're intrigued by the potential of such tools to enhance your budgeting process, it might be worth taking a closer look. Consider scheduling a demo with Brex to see their platform in action and understand how it could align with your specific needs and goals.

After all, the best operating budget is one that evolves with your business, leveraging sound financial principles and cutting-edge technology. By combining the insights from this article with powerful tools like those offered by Brex, you can turn your operating budget into a true strategic asset, driving your organization toward greater financial health and success.

@media(min-width: 1024px){.css-hqxvux{max-width:100%;}} See what Brex can do for you.

Learn how our spend platform can increase the strategic impact of your finance team and future-proof your company.

What is an Operating Budget?

Download the operating budget template, components of an operating budget, video explanation of types of budgets, additional resources, operating budget.

Download an operating budget template

An operating budget consists of all revenues and expenses over a period of time (typically a quarter or a year) that a corporation , 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.

Download the free Excel template now to advance your finance knowledge.

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.

Revenue is usually broken down into its drivers and components.  It’s possible to forecast revenue on a year-over-year basis, but usually, more detail is required by breaking revenue down into its underlying components.

Revenue drivers typically include:

• Volume (units, contracts, customers, products, etc.)
• Price (average price, per unit price, segment price, etc.)

#2 Variable costs

After revenue, variable costs are determined.  These costs are called “variable” because they depend on revenue and are often calculated as a percentage of sales.

Variable costs often include:

• Cost of goods sold
• Direct selling costs
• Sales commissions
• Payment processing fees
• Certain aspects of marketing
• Direct labor

Read more about variable and fixed costs .

#3 Fixed costs

After variable costs are deducted, fixed costs are usually next.  These expenses typically do not vary with changes in revenue and are mostly constant, at least within the time frame of the operating budget.

Examples of fixed costs include:

• Head office
• Telecommunication
• Management salaries and benefits

#4 Non-cash expenses

An operating budget often includes non-cash expenses , such as depreciation and amortization.  Even though these expenses don’t impact cash flow (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 ( EBIT ) or Operating Income .  Examples of expenses that may be included in a budget are:

• Gains or Losses

#6 Capital costs in an operating budget

Capital costs are usually excluded from an operating budget.  The term operating refers to a statement of operations (income statement) that does not include capital expenditures.

Most companies prepare a separate budget for capital investments .

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).

Budgeting & Forecasting Course

Budgeting Head

Capital Expenditure

Project Budget

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CFI is a global provider of financial modeling courses and of the  FMVA Certification . CFI’s mission is to help all professionals improve their technical skills. If you are a student or looking for a career change, the CFI website has many free resources to help you jumpstart your Career in Finance. If you are seeking to improve your technical skills, check out some of our most popular courses.  Below are some additional resources for you to further explore:

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