An operating budget is one of the critical elements of organizations' profitable business performance. According to Penner (2004), "the operating budget is an itemized summary of the revenues and expenses generated by a program, department, or institution over a specified period of time related to the generation of goods or services (operations)" (Penner, 2004, p.71). Not surprisingly, the process of creating and monitoring an operating budget requires a great deal of patience, skills, knowledge, and a perfect understanding of the best financial management procedures. Needless to say, not all financial management models and approaches are perfectly suitable for creating and monitoring an operating budget. Any organization or business owner must be prepared to regularly review and adjust the operating budget to meet changing organizational needs. A good operating budget is that, which is dynamic and represents actual revenues and costs, thus creating a realistic picture of the organization's financial performance.
Financial Management Tools That Are Effective for Creating and Monitoring an Operating Budget
Any operating budget includes the operating expense budget and the operating revenue budget (Penner, 2004). The former comprises personnel and non-personnel expenses, whereas the latter consists of service revenue and non-service revenue (Penner, 2004). One of the best financial management approaches to creating an operating budget is to analyze all information that is available from the prior year numbers and develop assumptions, based on the estimated changes in the economic, social, business, and personnel conditions. In other words, any financial manager working on an operating budget will have to review the historical data on revenues and expenses, consider the internal and external factors impacting them, and develop forecasts that will govern the process of budget creation and monitoring. The most difficult is to determine the external and internal factors, which impact the organization's revenues and expenses. These indicators will vary depending on the type and nature of the organization. In the hospitality industry, the growing number of competitors may change the scope of advertising expenses, while in the hospital and health care industry, the types and volume of programs may impact patient acuity, occupancy rates, and the number of paid hours (Rowland & Rowland, 1997). The success of operating budget planning greatly depends upon the quality of assumptions made at this stage of the budgeting process, and financial managers are expected to incorporate complete financial and operational knowledge into their areas of responsibility.
Another effective measure for creating an operating budget is through departmentalization and involvement. These concepts seem to be mutually exclusive but, when it comes to the operating budget, they become complementary. On the one hand, departmentalization implies that the operating budget covers one department and includes a limited scope of activities (Penner, 2004). Through departmentalization, financial managers can ensure greater transparency and accountability across various organizational departments. At the same time, it has become quite common for organizations to engage managers and employees in the budgeting process (Griffin, 2010). This way, the organization can create a balanced picture of the expected operating revenues and expenses at all levels of its performance. Moreover, it is through active involvement in the process of creating an operating budget that managers can create a complete picture of the organization's financial needs and avoid problems with allocating limited financial resources.
The best way to monitor the operating budget is to create monthly reports that compare the organization's or unit's actual performance to the standards fixed in the budget. It is the analysis of variances, which must be regular, while its results will be used to judge and evaluate the changes in budget forecasts and their implications for the organization's financial performance. Variance analysis is the primary and, probably, best financial management tool used to monitor the extent and causes of differences between the budget and the unit's actual performance (Penner, 2004). One of the central measures of budget estimation is monitoring profit variance, as it is important to understand whether such variances are due to revenue deficits or excessive budget expenses (Penner, 2004). The analysis of variances can enable financial managers to adjust the preliminary budget figures to meet the emerging financial needs of the organization.
Financial Management Tools That Are Ineffective for Creating and Monitoring an Operating Budget
Not all budgeting activities are equally effective, especially when it comes to dealing with operating budgets. One of the least effective approaches to operating budgeting is setting the operating budget without establishing explicit program objectives. Simply stated, any financial manager working on the operating budget must have a clear idea of the operating budget's intent and function. Some operating budgets are created to support specific programs, while others are developed to set the boundaries of the organization's financial operations for the next financial period. In all cases, the operating budget must be tied to the strategic goals of the organization, for which it is created, and it is the financial manager's task to choose and pursue the desired budgeting direction.
Another ineffective procedure is making operating budgeting decisions, based solely on prior year numbers. Organization's prior-year operating budget results make up only part of the operating budgeting process, and financial managers who base their observations on prior-year data only develop a very limited picture of the organization's financial performance. Prior year data loses its relevance if it is not reassessed taking into account current financial conditions, and assumptions about the organization's future budget needs are not incorporated into their strategy. Overall, financial managers have regular access to numerous operating budgeting techniques, and their choice depends mainly on the goals of the budgeting process and the way financial managers approach their budgeting tasks.
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The operating budget is an itemized list of the organization's or unit's revenues and expenses over a definite period of time, which are related to operations. Creating and monitoring an operating budget is not an easy task. The best financial managers can do, while working with operating budgets, is develop explicit assumptions about the organization's future performance and apply them to departmentalization and involvement at all stages of the budgeting process. Variance analysis remains the best tool for operating budget monitoring when the budget numbers are compared to the unit's actual performance. The least effective is developing operating budgets based solely on prior year numbers. As a result, the financial manager may fail to account for the numerous external and internal factors of the organization's financial performance.