CHAPTER- SIX

6. Preparation of Operating Budgets

The operating budget is a detailed statement showing all the operational expenses to be incurred
and incomes to be generated during a particular period of time. Operating expenses such as
expenses on raw material purchases, processing cost, interest on a loan, the salary of the staff,
maintenance of the office, administrative expense is considered for the purpose of operating
budget. The operating income such as revenue from operations and income by sale of the by-
product is considered for the purpose of operating budget.

Depending on the size, structure, and nature of the organization, operating budget may be sub-
divided for the purpose of detailed understanding of the budget.

operating Budget is prepared by considering many factors and assumptions. Below are some of
the factors which are used for preparing a budget for the organization.

a. Past trend in sales

1. Past trends of the purchase price of the raw material
2. Changes in the tax laws and government regulation with respect to the industry
3. Overall economy
Based on the above factors, sales or income budget is developed at first. The reason is all the
expenses shall be based on the sales projection made by the organization.

Once the budget for sales or income is developed, the expense budget is prepared. The expenses
have to be estimated based on the sales and the past trends in the tax regulations, interest rates on
borrowing. There are three types of expenses;

a) Variable cost – these cost changes with the change in sales.

b) Fixed cost – the fixed overheads which remain fixed such as rent of factory or machinery
is fixed irrespective of the production.
c) Semi-variable cost – these are the cost which is fixed for certain level. However, it
becomes variable after reaching a certain point. For example, a minimum wage of the
marketing staff is USD 2,000 and if the sales increase above a certain limit, the
commission shall be based on a percentage of sales. Financial Accounting helps in
developing the operating budget in many ways.
 6.1. Cost Estimation
Cost estimating is the predictive process used to quantify, cost, and price the resources required
by the scope of the project, to better manage budgets and deliver projects that do not exceed the
identified scope, and that are on time throughout the development process.
The need to solidify the estimation process can be seen in four areas:
1) State financial plan
2) Creation of public satisfaction and a positive response
3) Project control
4) Problems currently being encountered
The state financial plan is affected as cost estimates are used to obtain and allocate funding for
the overruns of the estimated project costs. This leads to the second reason for the need for cost
estimates: influencing public opinion.

Public satisfaction is increased if transportation projects show and prove to the general public
that they are timely and within budget. Public declaration of the estimated cost of projects needs
to be thoughtfully provided only after care is taken to produce a well-documented, quality
estimate.

Project control relies on cost estimates to help keep projects within the appropriate fiscal
boundaries. Although not necessarily a ―check and balance‖ format, the existence of the original
estimate will keep the project from growing and expanding beyond its spending limit.

As projects encounter problems, and their estimates come ―under fire,‖ great scrutiny is given
to the project and its associated estimates. The ability to confront and solve problems and
obstacles relies in large part on the quality of the estimate and the documentation, which, if done
properly, will provide critical support to project.

The sequence of estimates throughout the life of a typical project is given below.
1) Preliminary
The quick estimate needed at the project identification stage, with no design available, and only
the barest statement of capacity or size.

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 2) Feasibility
Estimates or alternative schemes under consideration in the feasibility study stage of the project.
The essential property of these estimates is that they are directly comparable with each other and
therefore base estimates could suffice so long as the same estimating technique and price base
data are used. The differences between alternatives will not necessarily be absolute and the
danger of their use for forward budgeting must be avoided.
3) Design
The cost estimate for the selected scheme using the design (usually conceptual) and
specifications resulting from the design study and forming part of the project definition report.
This estimate would provide the figures for capital cost, cash flow and currency requirements
which would then be used in viability calculations for the project and in the submission for donor
aid, where appropriate. It must be a cash estimate.
4) Commitment
The proposal estimates as modified and approved for financing, together with the associated
modifications to the project definition and/or the program. This must be a cash estimate, and will
provide the basis for the cost control of the project.
5) Pre-tender
A refinement of the approved estimate in the light of further design work done during the tender
period and using the information given in the enquiry documents. This estimate therefore would
use the same information as is available to the tendering contractors and should be a good
basis for the assessment of bids.
6) Post contract award
A further refinement of the approved estimate in the light of the contract(s) awarded. It includes
redistribution of the monies within the approved total to allow more effective cost monitoring of
the project to completion.
7) Achieved cost
A record of the actual costs achieved in order to review the cost performance of the project and
for project evaluation. It should include a reconciliation of the actual use of contingencies and of
the use of tolerance for dealing with major risks.

THE ESTIMATOR
1) The estimator must have relevant experience in the type of project envisaged and,
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 wherever possible, in the costs and productivities of construction work at the proposed
construction and main supply locations.
2) The estimator must have a close working relationship with the project design
organization and will normally be part of that organization.

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 3) It is highly desirable that the same estimator is used on all the estimates required
during the life of the project and is responsible for the subsequent cost monitoring and
control.
4) The estimator should be accountable for his estimate and should be involved in the
subsequent monitoring of project costs against it. He should be responsible success.
6.2 Cost Allocation => Crosswalk

Cost allocation is the process of identifying, accumulating, and assigning costs to costs objects
such as departments, products, programs, or a branch of a company. It involves identifying the
costs objects in a company, identifying the costs incurred by the cost objects, and then assigning
the costs to the cost objects based on specific criteria.

When costs are allocated in the right way, the business is able to trace the specific cost objects
that are making profits or losses for the company. If costs are allocated to the wrong cost objects,
the company may be assigning more resources to cost objects that do not yield as much profits as
expected.

Types of Costs

There are several types of costs that an organization must define before allocating costs to their
specific cost objects. These costs include:

1. Direct costs

Direct costs are costs that can be attributed to a specific product or service, and they do not need
to be allocated to the specific cost object. It is because the organization knows what expenses go
to the specific departments that generate profits and the costs incurred in producing specific
products or services. For example, the salaries paid to factory workers assigned to a specific
division is known and does not need to be allocated again to that division.

2. Indirect costs

Indirect costs are costs that are not directly related to a specific cost object like a function,
product, or department. They are costs that are needed for the sake of the company ‘s operations
and health. Some common examples of indirect costs include security costs, administration costs,
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 etc. The costs are first identified, pooled, and then allocated to specific cost objects within the
organization.

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 Indirect costs can be divided into fixed and variable costs. Fixed costs are costs that are fixed for
a specific product or department. An example of a fixed cost is the remuneration of a project
supervisor assigned to a specific division. The other category of indirect cost is variable costs,
which vary with the level of output. Indirect costs increase or decrease with changes in the level
of output.

3. Overhead costs

Overhead costs are indirect costs that are not part of manufacturing costs. They are not related to
the labor or material costs that are incurred in the production of goods or services. They support
the production or selling processes of the goods or services. Overhead costs are charged to the
expense account, and they must be continually paid regardless of whether the company is selling
any good or not.

Some common examples of overhead costs are rental expenses, utilities, insurance, postage and
printing, administrative and legal expenses, and research and development costs.

Cost Allocation Mechanism

The following are the main steps involves when allocating costs to cost objects:

1) Identify cost objects

The first step when allocating costs is to identify the cost objects for which the organization
needs to separately estimate the associated cost. Identifying specific cost objects is important
because the organization cannot allocate costs to something that is not yet known.

The cost object can be a brand, project, product line, division/department, or a branch of the
company. The company should also determine the cost allocation base, which is the basis that it
uses to allocate the costs to cost objects.

2) Accumulate costs into a cost pool

After identifying the cost objects, the next step is to accumulate the costs into a cost pool,
pending allocation to the cost objects. When accumulating costs, you can create several
categories where the

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 costs will be pooled based on the cost allocation base used. Some examples of cost pools include
electricity usage, water usage, square footage, insurance, rent expenses, fuel consumption, and
motor vehicle maintenance.

What is a Cost Driver?

A cost driver causes a change in the cost associated with an activity. Some examples of cost
drivers include the number of machine-hours, the number of direct labor hours worked, the
number of payments processed, the number of purchase orders, and the number of invoices sent
to customers.

Benefits of Cost Allocation

The following are some of the reasons why cost allocation is important to an organization:

1. Assists in the decision-making process

Cost allocation provides the management with important data about cost utilization that they can
use in making decisions. It shows the cost objects that take up most of the costs and helps
determine if the departments or products are profitable enough to justify the costs allocated. For
unprofitable cost objects, the company‘s management can cut the costs allocated and divert the
money to other more profitable cost objects.

2. Helps evaluate and motivate staff

Cost allocation helps determine if the cost assigned to specific departments returns the expected
revenues. If the cost object is not profitable, the company can evaluate the performance of the
staff members to determine if a decline in productivity is the cause of the non-profitability of the
cost objects.

On the other hand, if the company recognizes a specific department as the most profitable
department in the company, the employees assigned to that department will be motivated to work
hard and stay ahead of the rest in terms of performance.

6.3 Historical Analysis of Expenditures

Public expenditure in industrialized countries stands at very high levels. In Europe, in particular,
almost half of GDP is going through the hands of government. At the same time, the data exhibit
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 enormous cross-country divergence in terms of both expenditure levels and trends in recent
decades. Many countries reported public spending well above 50% of GDP at some point over
the past 25 years, with maxima above 60% in the Nordic countries and Belgium. By contrast, a
number of countries have never reported spending ratios in excess of 40% of GDP, notably the
US, Japan, Australia or Switzerland. Moreover, in recent years, a number of countries have
reversed very high spending ratios through ambitious expenditure reforms while others also
retreated from earlier peaks, albeit in a much timid fashion.

From a historic perspective, it is striking that, one century ago, public expenditure absorbed only
about 10% of GDP, with most spending going to the military and public investment. With World
War I, the expenditure ratio rose to over 20% of GDP and further to somewhat less than 30% by
the early 1960s. This was the period when (apart from military spending during World War II),
health, education and other goods and services began to be financed publicly. After this, public
spending growth accelerated when the modern welfare state was created and expanded. This
increase affected all advanced economies, though to varying degrees. By the early 1980s,
average public spending reached about 45% of GDP—four times as much as a century earlier.
(For more details, see Tanzi and Schuknecht 2000 and Peacock and Wiseman 1961.)

Since then, however, expenditure developments were rather diverse across industrialized
countries as more and more countries started reforming their public finances and reducing public
expenditure levels relative to GDP. The first countries where public expenditure peaked and
subsequently started to decline were Luxembourg and the United Kingdom in 1981, followed by
Ireland (1982), Belgium and the Netherlands (1983) and Australia and New Zealand (1985). In a
further large group of countries, public spending continued to increase until the early to mid-
1990s and then started coming down. Only Greece and Portugal experienced their expenditure
peaks in the past five years.

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 CHAPTER ELEVEN
Sources of Revenues

Meaning of Public Revenue

Public revenue could be defined as the funds acquired by the government to finance its activities.
Such funds are generally obtained from various sources, such as taxes, borrowing, fees, fines,
income from public undertakings, sales of government assets, rents, mining and royalties, etc. It
may be useful, however, to make a distinction between public revenue and public receipts. While
public receipt includes all sources of income available to the government, public revenue is of
much narrower part and does not include borrowing, sale of government assets or income from
―printing press‖.

11.1 Income Taxes

The income tax system follows a scheduler approach. These schedules are split into: employment
income, rental income, business income, other income and exempt income.
Employment Income – Schedule A
Employment income includes any payments in cash or in kind received by an individual as a
result of employment, including income from former employment or prospective employment.
Employment income is subject to tax at progressive rates ranging from 10% to 35%.

All income from employment is taxed in accordance with the rates below:

Taxable income per Rate of tax

month (ETB)
0 – 600 0%
601-1,650 10%
1,651-3,200 15%
3,201-5,250 20%
5,251-7,800 25%
7,801-10,900 30%
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 over 10,900 35%

Social security
Over and above employment taxes, the employer must contribute to the social security scheme
on behalf of the employee at a rate of 7% of the basic salary. The employer ‘s contribution is
11%.

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 Rental income from buildings – Schedule B
Rental income from buildings derived by individuals is subject to tax at progressive rates ranging
from 10% to 35% as per the table below:

Taxable income (ETB) from

rental (per year) Rate of income tax payable
0 -7,200 exempt threshold
7,201 – 19,800 10%
19,801 – 38,400 15%
38,402 – 63,000 20%
63,001 – 93,600 25%
93,601 – 130,800 30%
Over 130,800 35%

Business income – Schedule C

Income from business shall be taxed based on Schedule C of the Income Tax Proclamation.
Business is any industrial, commercial, professional or vocational activity conducted for profit
and whether conducted continuously or short term. Business does not include the rendering of
services as an employee or the rental of buildings.
Business income of individuals is taxed as per the rates provided below:

Taxable income (ETB) from Rate of income tax payable

rental (per year)
0 -7,200 exempt threshold
7,201 – 19,800 10%
19,801 – 38,400 15%
38,402 – 63,000 20%
63,001 – 93,600 25%
93,601 – 130,800 30%
Over 130,800 35%

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 11.2 Consumption Taxes
Consumption taxes, by and large, set out to tax consumption of goods and services within the
jurisdiction where the consumption takes place. However, determining this place of consumption
is not a literal exercise and most value added taxes adopt proxies for determining a geographical
definition of ―consumption‖. Almost without exception, jurisdictions impose tax on goods at the
place at which delivery takes place. Under this approach imports are taxed and exports are
relieved from tax. Thus, a customer, resident in Jurisdiction A might buy a portable computer in
that jurisdiction, incurring VAT at the rate applicable there, but use it temporarily in Jurisdiction
B. In these circumstances it might be said that some consumption takes place in both
jurisdictions, and that Jurisdiction B would have entitlement to some tax on the consumption that
takes place there. However, such an approach would be virtually impossible to administer and so
jurisdictions generally rely on proxies to determine the place of consumption of goods.

11.3 Property Taxes

Property tax is an annual tax on real property. It is usually, but not always, a local tax. It is most
commonly founded on the concept of market value.
The tax base may be the land only, the land and buildings, or various permutations of these
factors. For the purposes of this guide, property tax is restricted to annual taxes and excludes
one-off taxes on transfers, on realized capital gains or betterment, or on annual wealth taxes.
Uses of property taxes
 A source of local revenue
 Basis for local autonomy and facilitates decentralization
 It provides a revenue base for single function authorities
 It is cheap to administer
 It encourages the economic use of land

11.4 Other sources: Fees and Charges

(i) Non-Tax Revenue: This is made up of all revenues, other than taxes, that are generated by
government to finance its expenditures. These include fines, fees and rates, licenses, earnings
from sales, rent from government properties, interest payment and repayment of loans, re-
imbursement, statutory grant and miscellaneous revenue.
a) Fines, Fees and Rates: This includes fines imposed on individual, school fees collected
from students, water rate collected from consumers, etc.
b) Licenses: These cover amount received for issuance of licenses of various types by the
government, e.g. vehicle licenses, business premises and registration fees in urban and
rural areas.
c) Earnings from Sales: These cover monies realized from the sale of government
properties e.g. sale of government vehicles, houses, earnings from oil sales, etc.
d) Rent of Government Properties: These include rent of government houses / quarters
and land etc.
e) Interest Payment and Repayment of Loan: These are interest payments by government
employees and government companies, on loans granted by the government, e.g.
payment of interest on motor vehicle loan and the repayment of the loan itself.
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 f) Re-imbursements: These are refunds for services rendered to another tier of
Government, public corporations and other statutory bodies by the Government.
g) Statutory Grant: This is the share received from the Federation Account and value
added tax.
h) Miscellaneous: These are sources other than the sources mentioned above, e.g. dividend
from investment, stamp duties, business premises and registration fees, streets name
registration fees and fees for right of occupancy on urban land, mining, rents and
royalties.

Chapter- 12
Revenue Estimation and Forecasting
Your business revenue forecast is an essential part of future business planning. You need to
know approximately how much you can make throughout the year, your expected cash flow and
how much growth your business may experience. Revenue forecasting is not intended to give
you exact figures for yearly earnings. Instead, it does provide several methods that will help you
forecast your revenue as accurately as possible. Here are three things to keep in mind to assist
you in forecasting your company's revenue.
1. Research thoroughly
It takes a significant amount of data to forecast revenue. In addition to your standard expenses
and recurring payments, look at data from competitors in similar growth stages as your business,
predicted seasonal trends and other increased revenue periods. Pull data from your analytics and
financial reports, industry case studies and reports, and other data sources for a compilation.
2. Provide a thorough breakdown of expenses
Obtain a full accounting of your yearly expenses. After all, figuring out your revenue is trickier
than anticipating your fixed costs. Look beyond your regular costs and estimate the amount of
occasional expense costs. Estimate irregular costs on the high side. It's better to plan for higher
costs and be pleasantly surprised if you have a budget surplus.
3. Review your company's cash flow history
You can't predict sudden growth phases, but you can estimate your future revenue based on your
company's performance during the last few years. If you are planning big changes, such as a new
product line or a major company announcement, look at revenue trends from similar events in
the past to guide you for the direction your business may be headed.
Entrepreneur recommends taking a look at revenue forecasting with two specific mindsets: the
optimistic approach and a more conservative estimate. You always want to hope for a high level
of success for your company, so the optimistic estimation looks at a best-case scenario for your
business. The conservative revenue forecast takes a more measured approach to determine how
much your company will bring in during the coming year.

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 12.1 The Economy and Revenues
The economy of Ethiopia is a mixed and transition economy with a large public sector. The
government of Ethiopia is in the process of privatizing many of the state-owned businesses and
moving toward a market economy. However, the banking, telecommunication and transportation
sectors of the economy are dominated by government-owned companies.
Ethiopia has one of the fastest-growing economies in the world and is Africa's second most
populous country. Many properties owned by the government during the previous regime have
now been privatized and are in the process of privatization. However, certain sectors such as
telecommunications, financial and insurance services, air and land transportation services, and
retail, are considered as strategic sectors and are expected to remain under state control for the
foreseeable future. Almost 50% of Ethiopia's population is under the age of 18, and even though
education enrollment at primary and tertiary level has increased significantly, job creation has
not caught up with the increased output from educational institutes. The country must create
hundreds of thousands of jobs every year just to keep up with population growth.

- Gross domestic product (GDP) is the value of the goods and services produced by the nation ‘s
economy less the value of the goods and services used up in production. GDP is also equal to the
sum of personal consumption expenditures, gross private domestic investment, net exports of
goods and services, and government consumption expenditures and gross investment.

12.2 Forecasting Techniques

Revenue forecasting is key to successful budgeting in the public sector. Just as demand analysis
and forecasting in the private sector is of critical importance because sales sustain the financial
health of business, adequate and predictable tax and non-tax revenues underpin the financial
sustainability and stability of government. The importance of revenue forecasting in public
budgeting has increased with governments shifting from annual cash-based budgets to medium-
term budgeting as fiscal policy design and implementation have paid more attention to medium-
term constraints and the importance of budgeting for multiyear financial commitments (e.g., to
subnational governments in the context of fiscal decentralization and to private sector partners
for infrastructure development and public service delivery) has been increasingly recognized.
Added emphasis on the sophistication of revenue forecasting has also come from governments
moving to account for tax expenditures and to budget for them over the medium term.

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