Companies that need to make capital expenditures to support growth or to replace old assets use capital budgets to plan what, when and how to fund those investments. Companies create operating budgets to plan, monitor and adjust operational resources. Although often created independently, the two budgets overlap. For example, capitalizing some large expenses can move them from the operating budget to the capital budget, increasing profits and the company's value over time.
A 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.
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.
Because an operating budget covers a one-year time period, it typically excludes the capital budget, which has a longer time span. In addition, operating budgets show expenses as they affect the income statement. Capital budgets cover capital expenses, which are capitalized and appear as long-term assets on the balance sheet. As these long-term assets depreciate over their useful lives, the depreciation for a given year shows up on the income statement as a depreciation expense in that year. Therefore, capital expenditures impact the income statement significantly less than they impact the balance sheet. Capital expenditures also impact cash and the cash flow statement, both of which do not appear in a typical operating budget.
The capital budget does impact the operational budget in other ways. Most debt financing used to fund investment in capital assets requires principal and interest payments. The operating budget reflects the interest portion of these payments. The operations budget also reflects the maintenance and upkeep required on the acquired assets. Companies may also opt to make large multiple purchases at one time in order to capitalize the expense, removing it from the operating budget. This reduces operating expenses and increase company profits.