Planning assists every organization in setting targets for the upcoming period so that all employees working across the organization can work towards the achievement of planned targets.
Such assistance an organization gets in the planning phase through the formulation of the budget. Through the budget, an organization has a plan in hand about the number of goods that are going to be produced and the number of units that will be sold, etc. in the coming year.
Budgeting is essential for decision making as it gives the business a sense of direction, an approximation of revenues, cost, and resources.
Each employee in the organization wants to know what his role is in the organization. Via budget organizational goals are communicated to the employees. Budgets form a key to communicate the organization’s goals to its employees.
If an employee has been told that the organization wants to raise shareholder’s wealth, then he must ask what he needs to do in order to achieve this. It is the budget that translates it and defines his work and responsibilities.
Difference Between Operating and Financial Budget
The operating budget is a statement that shows all the operational incomes and expenses of the company. Expenses such as the cost of raw material, cost of labor (skilled, semi-skilled, and unskilled), overheads (variable and fixed), processing cost, etc. are shown in this type of budget. It merely deals with items from income and expense statements.
While the financial budget is the plan in which inflow and outflow of cash are considered. It includes a budgeted balance sheet, sources of funds and capital expenditures, budgeted cash flows, etc. in a detailed form.
The financial budget’s dealing is mainly with shareholder’s equity and the possible liabilities which arise in order to create an expected asset.
If the sequence of preparation of these two budgets is considered, the operating budget is the first which needs to be prepared. It forms the basis for the financial budgets to be formed by a business organization.
Hence, the financial budget is prepared after the operating budget with some critical information to be taken from the initially formed operating budget.
3) Responsibility and the requirement for implementation
Implementation of the operating budget will be successful if the respective managers would play their part with full responsibility and it depends on the respective functional leaders.
This can be better understood with this example like if the sales manager efficaciously manages sales, the budget will be easily achievable. On the contrary, if the manager in the production department is not able to meet the production target, it will become a chokepoint for the department of sales.
Although the chief obligation lies with the top management, the successful implementation of the financial budget is dependent on all the departments of the organization.
If any of the department does not perform up to the mark, there shall be a deviation in the financial budget.
Let this understand through an example, if the production department overstock is not obeying the budgets, and the sales department is not able to achieve the sales target. the overall finance cost shall go high.
Revenue budget, production budget, and other costs budget are the major elements of operating budget. While in the financial budget, budgeted balance sheet and cash flows are the main constituents.
5) Requirements for preparation of budget
The operating budget needs more quantitative detail of analysis for preparation. The sales and production budget requires the planning of the number of selling units and the production of a number of units respectively.
In contrast, the financial budget is developed based on the expected receipts and the expected payments. Therefore, the financial budget does not require quantitative analysis.
6) Main Areas
Under operating budget, the areas which are mainly covered are three i-e revenue, expenses and profits while financial budget covers capital budget expenditure, cash budget and budgeted balance sheet.
Revenues from expected sources are balanced with the expected expenses under operating budget. By this way both the revenue and the expenses have to be aligned and there must be a surplus profit / gain.
The financial budget shows the balance sheet indicating the assets and liabilities at any time during the year. However, It also has a relation with the income and expenditure of the organization.
As aforementioned, the operating budget deals with the revenue and expenditure areas. Therefore, it can be observed that the approach adopted in the preparation of the operating budget is short-term.
It assists the management of a company in taking short-term decisions. While the financial budget deals with the balance sheet, cash budget, and capital budgeting.
Therefore, the approach adopted under this budgeting process can be termed as long term since it helps the management in taking long-term decisions.
9) Oftenness of change
The sales and production targets are determined based on past trends and future market factors. Hence, the operating budget does not require to change frequently.
While the financial budget needs to be changed more frequently than the operating budget as it is impacted by many external factors.
These factors include but not limited to the prevailing rate of interest of borrowing, accounts receivables collection ratios. Therefore, the financial budget of the organization is overall affected by the operating cycle.
10) Which organization prepares which budget?
Whether an organization is small or large, it has to prepare the operating budget for improving productivity. However, small organizations pay not too much attention towards the preparation of financial budget.
Small organizations prepare the financial plan for almost one to two years while large organizations prepare the financial plan for at least 8-10 years in order to maintain current and future infrastructure.
11) Clear Picture
The operating budget gives the complete picture of the business of an organization in the small run. Operational efficiency of the organization can be presented on the basis of operating budgets.
However, an organization cannot depend on operating budget in order to get to know about financial efficiency of an organization. In financial budget, clear picture of the business in long run is shown.
Operational and financial efficiency of the organization can be seen through financial budget analysis.
All in all, it can be said that both financial budget and operating budget have their own significance. Both the operating budgets and financial budgets are interlinked and worked in parallel to each other.
Hence, an organization cannot afford to avoid the preparation of any of these budgets.