Operating Budgets

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Operating budgets determine the estimated profit or loss for the period. 

Enhance your understanding of operating budgets by watching the following 3:46-minute video.

Service industries obtain revenue by providing services to their customers and clients, e.g. professional, personal, building, marketing, and transport services. 

The different categories of expenses include:

  • Marketing expenses: selling and marketing functions, e.g. sales salaries, commission, depreciation, advertising, running of motor vehicles.
  • Financial expenses: the cost of financing the business, e.g. interest paid, borrowing costs, doubtful, and bad debts.
  • Administration expenses: all other expenses, namely printing and stationery, other staff salaries, insurance, electricity, telecommunications, and rent.

The operating budgets for service industries consist of the revenue budget and all expense budgets, including marketing, administration, and financial expenses.

Example

Surrey Hills Accounting and Book-keeping Services are preparing revenue and expense budgets for the financial year ended 30 June.

The following information is provided:

Estimated fees $ 600,000 per annum
Rent $ 8,000 per month
Bank charges $ 500 per month
Advertising $ 15,000 per annum
Interest paid $ 1,000 per month
Stationery $ 1,500 per month
Travelling expenses $ 3,000 per month
Miscellaneous office expenses $ 2,500 per month
Depreciation on office equipment $ 10,500 per annum
Telecommunications $ 2,500 per month
Total salaries $ 12,500 per month
  • Workcover payments 3% of total salaries
  • Superannuation 9% of total salaries    

Example 2: Revenue and expense budgets

For the service industry, the following budgets may need to be prepared:

  • Revenue
  • Marketing expenses
  • Financial expenses
  • Administration expenses
  • Income statement.

Examples:

Revenue budget

Fees $ 600,000
Total  $ 600,000

Marketing expenses budget

Advertising $ 15,000
Total  $ 15,000

Financial expenses budget

Interest paid $ 1,000 per month $ 12,000
Bank charges $ 500 per month $ 6,000
Total   $ 18,000

Administration expenses budget

Salaries $ 12,500 per month $ 150,000
Depreciation of office equipment   $ 10,500
Miscellaneous office expenses $ 2,500 per month $ 30,000
Rent $ 8,000 per month $ 96,000
Stationery $ 1,500 per month $ 18,000
Telecommunications $ 2,500 per month $ 30,000
Travelling expenses $ 3,000 per month $ 36,000
WorkCover 3% of total salaries $ 4,500
Superannuation 9% of total salaries $ 13,500
Total    $ 388,500$ 388,500

An income statement budget can also be prepared based on the revenue and expense budgets.

Income statement budget

  $ $ $
Fees     $600,000
Less marketing expenses    
Advertising 15,000    
Total marketing expenses   15,000  
Less financial expenses    
Interest paid 12,000    
Bank charges 6,000    
Total financial expenses   18,000  
Less Administration expenses    
Salaries 150,000    
Depreciation of office equipment 10,500    
Miscellaneous office expenses 30,000    
Rent 96,000    
Stationery 18,000    
Telecommunications 30,000    
Travelling expenses 36,000    
Workcover 4,500    
Superannuation 13,500    
Total administration expenses   388,500  
Total expenses     $421,500
Net profit before tax   $178,500

Trading industries include both retail and wholesale businesses. These businesses buy and sell goods to retailers and consumers, e.g. supermarkets, department stores, electrical stores and furniture stores. Therefore, as well as preparing marketing, financial and administration budgets, a trading business will also need to develop sales, purchase and a COGS budgets.

The format for a master budget for a trading business is set out below:1

A diagram outlining master budget for a trading business

Figure 2: Operating budgets for trading industries

Trading and manufacturing firms prepare sales budgets, which can be prepared by product, period, regional area or a combination. The sales figures in the ledger account should be shown exclusive of GST; therefore, GST is not included in the sales budget. 

The following is an example of a sales budget prepared by-product

Example 

Over-the-shoulder view of a pilot flying a Robinson R44 helicopter

Montgomery Aviation Supplies produces the following clothing and accessories for pilots, e.g. pilot shirts, jackets, sunglasses, and watches.

Estimated sales figures for the following year are 5,000 shirts, 4,000 jackets, 3,000 sunglasses, and 2,000 watches.

The sales budget for the following year is as follows:

Product Sales volume Sale price Sales $
Pilot shirts 5,000 34 170,000
Pilot jackets 4,000 100 400,000
Sunglasses 3,000 170 510,000
Watches 2,000 360 720,000
      1,800,000

Example 3: Sales budgets looking forward

In the above example, estimated sales were based on previous figures and adjusted according to current market trends.

Sales can also be estimated based on previous figures and a change in market conditions, as demonstrated in the example below.

Example

Mitchell Evans imports and sells genuine Swiss alarm clocks. Mitchell’s sales for the previous year were 1,060. Due to an increase in the Australian dollar, Mitchell believes he can reduce the price of his products by 5% and estimates his sales will increase by 15%. 

Total sales for previous year: 1,060 x $260 = $275,600
Estimated increase in sales: 1,060 x 1.15 =1,219
Reduced price per item: $260 x .95 = $247

The sales budget for the following year can be prepared as follows:2

  Sales Cost Total sales
Alarm clocks 1,219 $247 $301,093

Example 4: Sales budgets based on history

COGS relate to all costs directly attributed to purchasing or manufacturing goods that are then on-sold. This amount is then deducted from the total sales figure to determine the gross profit for the period. 

Enhance your understanding by watching the following 2:17-minute video.

The following formula can be used to calculate the selling price, COGS, and mark-up % provided estimates are provided.

Selling price/COGS -1 = mark-up %

Example

If the selling price amounts to $350,000 and the COGS at $200,000 are known, the markup on cost can be estimated as follows:

$350,000/$200,000-1 = 75% (mark-up)    

Alternatively, where the markup % and selling price are known, the COGS can be calculated as follows:

$350,000/1.75 = $200,000 (COGS)

If the COGS and mark-up on cost are known, the selling price can be calculated as follows:

$200,000 x (1 + 0.75) = $350,000 (selling price)

Example 5: COGS Budget

If sales estimates are given for the following year, and the mark-up on COGS is provided, COGS and gross profit can be estimated as follows:

Example

COGS budget

  Sales $ Mark-up $ Calculation $ COGS $
Product A 500,000 75% 500,000/1.75 285,714
Product B 420,000 80% 420,000/1.9 221,053
Product C 350,000 50% 350,000/1.5 233,333
Total 1,270,000     740,100

Gross profit is calculated as follows:

Sales $1,270,000
Fewer COGS $740,100
Gross Profit $529,900

Example 6: COGS Budget and gross profit calculated

An alternative method can be used to calculate COGS by using the number of items sold.

Example

A close view of a group of scooters parked on a street

Metropolitan Scooters has sold 800 scooters in the financial year. Total sales were $240,000. The cost of each item was $300.

COGS = $300 x 800 = $240,0001

Example 7: COGS Budget based on numbers sold

The purchase budget is the estimated value of the purchases expense for the period. 

The purchases budget will differ from the COGS budget as the purchase of goods may include opening and closing stock.

The COGS is usually presented in the income statement as:

Opening inventory + purchases – closing inventory = COGS

Purchases for the year can be estimated as follows:

Example

A top down view of multiple cameras and lenses

Kosta Cameras buys its inventory and marks it up by 70%. The business sold goods to the value of $550,000 in the last financial year. The opening stock was $45,000, and the closing stock was $22,000. What is the cost of purchases for that period?

COGS: $550,000/1.7 = $323,529

The closing inventory amount is less than the opening inventory. Therefore, some sales have come from the opening inventory and purchases made throughout the year

  $ $
Sales   550,000
Less COGS    
Opening inventory 45,000  
Plus purchases 300,529  
Less closing inventory 22,000 323,529
Gross profit   $226,471

Purchases: ($323,529 + $22,000) - $45,000 = $300,529

Example 8: Purchases budget

Most trading businesses must maintain a minimum level of stock on hand to cover expected sales in the next period. Therefore, the purchases for the month must be sufficient to meet expected sales and maintain inventory levels for the next period.1

Using this method, the closing stock of one period becomes the opening stock for the following period.

Example

Kosta Cameras expects to sell 400 cameras in November and 700 in December. As a result, the business estimates that 20% of the stock will need to be kept on hand at the end of each month to fill sales expected in the next month.

The purchases budget for November is estimated as follows:

Closing inventory at 31 October is 20% of 400 = 80
Closing inventory at 30 November is 20% of 700 = 140

The number of cameras to be purchased in November is estimated as follows:2

Sales Inventory Purchases
  Closing Opening  
400 140 80 460

Example 9: Inventory levels

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