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23.2 Prepare Operating Budgets

Operating Budget Components​

The operating budget includes:

  1. Sales Budget
  2. Production Budget (manufacturing) or Service Output Budget (services)
  3. Direct Materials Budget
  4. Direct Labor Budget
  5. Overhead Budget
  6. Selling and Administrative Budget
  7. Budgeted Income Statement

Sales Budget​

The sales budget estimates sales volume and revenue.

Formula: Budgeted Sales = Expected Unit Sales × Selling Price per Unit

Example (Restaurant):

  • Average daily meals: 120 weekdays, 180 weekends
  • Average price: €25 (excluding VAT)
  • Monthly sales:
    • Weekdays: 22 days × 120 × €25 = €66,000
    • Weekends: 8 days × 180 × €25 = €36,000
    • Total: €102,000 (excluding VAT)

Production Budget (Manufacturing)​

Determines units to produce to meet sales and inventory needs.

Formula: Required Production = Budgeted Sales + Desired Ending Inventory - Beginning Inventory

Example:

  • Budgeted sales: 5,000 units
  • Desired ending inventory: 600 units
  • Beginning inventory: 400 units
  • Required production: 5,000 + 600 - 400 = 5,200 units

Direct Materials Budget​

Plans materials purchases based on production needs.

Formula: Materials Needed = (Units to Produce × Materials per Unit) Materials to Purchase = Materials Needed + Desired Ending Inventory - Beginning Inventory

Example:

  • Units to produce: 5,200
  • Materials per unit: 2 kg
  • Materials needed: 10,400 kg
  • Desired ending inventory: 1,200 kg
  • Beginning inventory: 800 kg
  • Materials to purchase: 10,400 + 1,200 - 800 = 10,800 kg

Direct Labor Budget​

Plans labor hours and costs.

Formula: Labor Hours Needed = Units to Produce × Labor Hours per Unit Labor Cost = Labor Hours × Wage Rate

Example:

  • Units to produce: 5,200
  • Labor per unit: 0.5 hours
  • Labor hours: 2,600
  • Wage rate: €20/hour
  • Labor cost: 2,600 × €20 = €52,000

Overhead Budget​

Plans variable and fixed manufacturing overhead costs.

Variable Overhead:

  • Varies with activity level
  • Examples: Indirect materials, indirect labor (variable), utilities (variable portion)
  • Rate: Cost per unit of activity (e.g., per labor hour, per machine hour)

Fixed Overhead:

  • Remains constant regardless of activity
  • Examples: Rent, depreciation, insurance, supervisory salaries
  • Total amount per period

Structure:

  • Variable overhead (e.g., €5 per labor hour)
  • Fixed overhead (e.g., €30,000 per month)
  • Total overhead = Variable + Fixed

Example:

  • Budgeted production: 5,200 units
  • Labor hours: 2,600 hours
  • Variable overhead: €5 per labor hour
  • Fixed overhead: €30,000 per month

Overhead Budget:

  • Variable: 2,600 × €5 = €13,000
  • Fixed: €30,000
  • Total: €43,000

Selling and Administrative Budget​

Plans selling and administrative expenses:

  • Sales commissions
  • Marketing expenses
  • Administrative salaries
  • Office rent
  • Utilities

Example:

  • Sales commissions: 5% of sales (€102,000 × 5% = €5,100)
  • Marketing: €3,000
  • Admin salaries: €15,000
  • Office rent: €2,500
  • Utilities: €1,500
  • Total: €27,100

Budgeted Income Statement​

Summarizes revenues and expenses to calculate budgeted profit.

Structure:

  • Sales revenue
  • Less: Cost of goods sold (or cost of services)
  • Gross profit
  • Less: Selling & administrative expenses
  • Operating income
  • Less: Taxes and other expenses
  • Net income

Example (Monthly):

  • Sales revenue: €102,000
  • Cost of goods sold: €45,000
  • Gross profit: €57,000
  • Selling & admin: €27,100
  • Operating income: €29,900
  • Taxes (20%): €5,980
  • Net income: €23,920

Service Business Operating Budget​

Service companies don't have production budgets, but they plan service output, labor, and overhead.

Example (Consulting Firm):

  • Billable hours: 1,500
  • Rate: €120/hour
  • Revenue: €180,000
  • Labor cost: €80 × 1,500 = €120,000
  • Overhead: €30,000
  • Profit: €30,000

Luxembourg Compliance Note​

Operating budgets help Luxembourg SMEs plan for high fixed costs (rent, salaries, social charges) and ensure VAT and tax obligations can be met. Seasonal businesses (tourism, hospitality) rely on operating budgets to manage cash flows.

Think It Through​

How does the sales budget influence the rest of the operating budget? Why is accurate sales forecasting so important?