Foundations of Production and Operations Management
Foundations of Production and Operations Management
Budgeting is the process of planning for expenditure to be incurred in future. Budgets are usually prepared for a period of one year. A company may have policies for budget review during the year to incorporate unexpected changes in the budget items. This paper will expound on the process of preparing an operating budget and the importance of operating budgets.
According to Najimi (2018), an operating budget is a critical planning and cost control tool for companies. The budget is prepared before the commencement of a reporting period and before any expenditure has been incurred. An operating budget gives a forecast of the company’s income and expenditure for a future financial period. Below is an example of an operating budget for Xample manufacturing limited.
Operating Budget (2019)
|Quarter 1||Quarter 2||Quarter 3||Quarter 4||TOTAL (add across)|
|PROJECTED TOTAL INCOME||1,632,500||1,632,500||1,632,500||1,632,500||6,530,000|
|Costs and Expenses|
|PROJECTED TOTAL EXPENSES||1,584,000||1,584,000||1,584,000||1,584,000||6,336,000|
|PROJECTED NET PROFIT/(LOSS)||48,500||48,500||48,500||48,500||194,000|
An operating budget have a number of benefits for the company. The most important benefit of preparing the operating budget is that it helps in managing current expenditure. The managers can control the current expenditure by reviewing the budgeted expenditure against the actual expenditure. If it is evident that the budgeted amount has been used up the manager may take measures to reduce the expenditure (Boyabatlı, Leng & Toktay, 2016).
- The first step in preparing an operating budget is preparation of a sales budget. The manager should project the monthly revenue expected from sales. He should prepare a list of all the products and services offered by the company. When projecting the monthly sales an allowance should be given for unforeseen circumstances that may lead to a shortfall in sales. The manager may use the previous years sales to predict the expected sales during the current year. This might be done by multiplying the sales by a predetermined percentage.
- The next step is to budget for the direct costs. These are costs which relate to the production process directly. The cost for producing each item should be determined and summed up for all the products. Direct costs are critical and lack of resources to fund the direct costs may slow down the production process.
- After budgeting for direct costs, the manager should the budget for operating expenses are grouped into fixed and variable operating expenses (Schmidgall & Kim, 2018). Fixed expenses Consist of expenses which remain constant throughout the financial period regardless of the level of production. Fixed expenses include rent, salaries and wages, software subscription and insurance. Variable expenses are the expenses that vary with the level of output like purchase of raw materials, direct labor,and commissions. When budgeting for fixed expenses the manager should add up the monthly fixed expenses to get the projected annual expenses. On the other hand, when budgeting for variable expenses the manager should estimate the monthly variable expenses and sum up the months to project the annual variable expenses.
- The final step in preparation of an operating budget is budgeting for Miscellaneous expenditures. The manager should budget for unexpected expenses which may arise during the period. This may be done by multiplying each cost center by a predetermined percentage. Availability of funds for miscellaneous expenses helps in ensuring that the money allocated for other expenditure is not diverted to other unplanned expenditure.
Operating budgets also help in setting goals and performance evaluation. The company starts the financial period with clearly set targets. The employees can be evaluated according to the expected results set out in the budget. For example, the marketing department can assign each employee a sales target for each month based on the budgeted sales.
Another benefit of operating budgets is that it helps in allocation of money. The expenses associated with each cost centers are known, and this makes it easy for allocation of resources. An operating budget helps the management in planning and formulation of policies as they may be needed to come up with new policies to endure that budget lines are adhered to.
When preparing the budget, it is important to group revenue and expenses correctly. Revenue is classified into two groups. the first classification is income from sales. sales income mainly consists of money received from sale of good or services which the company is registered to provide. The other classification of revenue is other incomes. This consists of income from other activities which are not among the core business of the company. Other income may include interest income, grant income, commission received etcetera.
Expenses are categorized into four groups. The first category is the cost of goods sold which comprises of all costs which are directly associated with production. This includes the cost of raw materials, direct labor and factory overheads. The second category is the finance cost which comprises of costs associated with the use of borrowed money. They include interest expenses and bank charges. The third categorization of expenses is sales and distribution cost which comprises of costs associated with marketing of the company’s products. It also includes expenses incurred in distribution of products to customers. The fourth classification of expenses is administrative expenses which comprises of cost not associated directly to production. The expenses include telephone bills, internet, professional and legal expenses etcetera. The last categorization of expenses is staff costs and it comprises of salaries and wages and other statutory deductions.
In conclusion manages should adopt the operational budgeting technique in order to control expenditure and maximize revenue. Also, for a company to reap al the benefits of budgeting the manager should be aware of the budgeting process and all the cost drivers of the company. The manager should also oversee the implementation of the budget throughout the financial period.
Boyabatlı, O., Leng, T., & Toktay, L. B. (2016). The impact of budget constraints on flexible vs. dedicated technology choice. Management Science, 62(1), 225-244.
Najimi, B. (2018). Budget and Budgeting Process. In Gender and Public Participation in Afghanistan (pp. 15-29). Palgrave Pivot, Cham.
Schmidgall, R., & Kim, M. (2018). Operating budget processes and practices of clubs: a repeated cross-sectional study over four decades. Journal of Quality Assurance in Hospitality & Tourism, 19(4), 476-494.