Question

• Describe the difference in Capital and Operational budgeting. How does the manager go about "justifying" them? Is there a difference in how to justify?

Answer 1

Capital budget

capital budget is the plan that companies put together for raising large sums of money to invest in long-term assets. The capital budget term usually exceeds one year, often spanning two or more fiscal years; the operating budget term generally covers one fiscal year. Companies use methods distinctly different from their regular budgeting method to calculate their capital budget. Methods used include net present value, internal rate of return and return on investment.

Operational budget

An operating budget provides the company that creates it with a detailed forecast of its revenue, expenses and net income over a given accounting period, typically a calendar or fiscal year. Many companies use their current or prior-year income statements to create the next year's operating budget. Smaller companies may prepare company-wide operating budgets while larger companies often prepare operating budgets by department, then roll these sub-budgets into one overall company budget.

Differences Between Budgets

Capital budgets are paid out of future cash flows from the projects, and they represent the sources of funding and the purchases of the fixed assets. Planning for capital acquisitions is generally done for one to three years.

Operational budgets project the activities of the firm in buying, selling and paying bills, and usually, is done on an annual basis.

Justification for them

Both types of budgets force the owner to figure out how he intends to pay the bills and how he will find the money to purchase additional assets, as the business grows. The process of setting up a budget and laying out a roadmap is preferable to leaving everything to chance, in the hopes that you not only will make a profit and but also that you will have enough money left so that you can expand the company.

Purchases of fixed assets as projected by the capital budget will have an impact on the operational budget. New equipment may reduce maintenance costs and increase revenues because the production processes are more efficient. These changes must be coordinated with the capital budget and reflected on the operations budget.

If the company wants to purchase fixed assets, some of the cash needed may have to come from the firm's normal operations and cash flow. If so, an operational budget has to incorporate this requirement for cash in addition to paying normal expenses.

Budgets are essential management tools for all small business owners. Although most people think only about operational budgets, capital budgets are also important. As your company grows, you will need additional fixed assets, and you must make preparations to fund these acquisitions. Operational and capital budgets are related, and a business owner must balance the effects they have on each other.