7 2 Prepare Operating Budgets Principles of Accounting, Volume 2: Managerial Accounting

There are a large variety of reasons budgeted income statements are important for businesses. Operating budgets are a primary component of the master budget and involve examining the expectations for the primary operations of the business. Assumptions such as sales in units, sales price, manufacturing costs per unit, and direct material needed per unit involve a significant amount of time and input from various parts of the organization. Analyzing operating income is helpful to investors because it doesn’t include taxes and other one-off items that might skew profit or net income.

1. If a company knows that its busiest sales period is in the fourth quarter, it may choose to distribute bonuses at the end of the year to motivate employees to meet or exceed their sales targets.
2. Management knows how much the materials will cost and integrates this information into the schedule of expected cash disbursements, which will be shown in Prepare Financial Budgets.
3. If Big Bad Bikes uses 3.2 pounds of material for each trainer it manufactures and each pound of material costs $1.25, we can create a direct materials budget.
4. The first step to producing a budgeted income statement is to subtract the cost of goods sold (COGS) from net sales.
5. If you already know your gross income and operating expenses, you can use this tool to quickly get your operating income.
6. The core activities are losing money, but equipment sales are making money.

Companies may choose from a variety of cost flow assumptions, which would make the calculations different, but we won’t delve into that here. Sales revenue or net sales is the monetary amount obtained from selling goods and services to business customers, excluding merchandise returned and any allowances/discounts offered to customers. Going back to your example, investors and creditors acknowledge the fact that Bill has a large loss from his truck, but that doesn’t impact his extremely profitable business activities selling sandwiches. Thus, Bill analyzes his accounting system and discovers that he sold $200,000 of subs during the year and had the following expenses. Bill’s Sandwich Shop makes some of the best subs and grinders in the Philadelphia area. Bill is working on refinancing his current loans with a new bank, so he has to prepare a multiple step income statement with a detailed operating section.

How to Use an Operating Income Formula to Determine Your Budget

These include interest expense, income tax expense, reorganization cost or pension expense. Subtract these from the total expenses to calculate the total operating expenses for the budget budgeted operating income formula period. Add these numbers together to calculate the total revenue for the budget period. Before you can determine your operating income, you need to calculate your operating expenses.

What is Operating Income?

This will help you determine how much money you can save or re-invest in your business. Ideally, we’d recommend you create your own operating income formula spreadsheet. That way, you can itemize all of your business’ specific operating expenses instead of bundling them together under predetermined values. This approach will also enable you to monitor changes in your expenses in more detail. As we said, every business is different, so the only way to determine what your operating costs are is to take a good hard look at your own setup. Double and triple check your itemized list of expenses, as any mistakes here will seriously skew your operating income formula results.

Operating Income vs. Other Financial Calculations

Estimating sales leads to identifying the desired quantity of inventory to meet the demand. Management wants to have enough inventory to meet production, but they do not want too much in the ending inventory to avoid paying for unnecessary storage. Management often uses a formula to estimate how much should remain in ending inventory. Management wants to be flexible with its budgeting, wants to create budgets that can grow or shrink as needed, and needs to have inventory on hand. So the amount of ending inventory often is a percentage of the next week’s, month’s, or quarter’s sales.

Operating Income Template

A business’s operating expenses are costs incurred from normal operating activities and include items such as office supplies and utilities. Business owners need to understand their future profitability when deciding whether to expand into new areas, reduce the business offerings or keep everything the same. A budgeted income statement provides useful information for making these decisions. Budgeted operating income and budgeted net income both appear on the budgeted income statement. The operating income refers to money earned through operational activities. Budgeted operating income provides more value to the business owner as she considers the income generated from the primary business rather than additional activities.