Definition or Purpose of an Operating Budge

An operating budget is a projected and, it is hoped, realistic number
picture of income and cost objectives for a period.
Usually operating budgets are constructed for a year, by months.
Some people construct five-year operating budgets with varying
reporting periods. Such budgets are often constructed monthly for
the first two years, quarterly for the next two years, and annually or
semiannually for the remaining year. However, a one-year budget
that is extended quarterly so that it again projects a full year is probably
adequate for most uses.
As with any plan, the ensuing actual performance can be compared
with the operating budget to detect “off-target” performances
and to direct attention to troubled areas. In this way, the
operating budget serves both as a planning tool and a control
device. All functions of the business should be included when

structuring the operating budget. By including all of the operating

costs, more performance measures and controls are possible. The
costs incurred to increase the level of preparation detail will relate
favorably to realization of cost savings through better control.

Since measurements of performance may be devised according
to an operating budget, there is a natural tendency for people to
“adjust” the budget process. The potential consequences should be
considered: Sales managers may make overly optimistic assessments
of the market, thus reducing the reliability of the cash allocations
and expenses anticipated for that level of production and
sales. Some manufacturing managers may “pad” a budget to build
in a safety margin or premium. In a tight market or competitive
sales conditions, this pad could make a product look less attractive
than competing products. The concern should be to make the budget
as realistic and accurate as possible because a reasonable budget
based on a reasonable plan encourages reasonable performance.