OPERATING AND CAPITAL BUDGETSA. before developing the pro forma income statement, the entrepreneur should prepareoperating and capital budgets.1. If the entrepreneur is a sole proprietor, he or she will be responsible for the budgetingdecisions.2. In a partnership, or where employees exist, the initial budgeting process may begin withone of these individuals.3. Final determination of budgets will ultimately rest with the owners or entrepreneurs.B. in the preparation of the pro forma income statement, the entrepreneur must firstdevelop a sales budget, an estimate of the expected volume of sales by month.1.2.From sales forecasts, the entrepreneur will determine the cost of these sales.Estimated ending inventory will also be included.C. Production or Manufacturing Budget.1.2.This budget provides a basis for projecting cash flows for the cost of goods produced.The important information in this budget is the actual production required each monthand the needed inventory to allow for changes in demand.3. This budget reflects seasonal demand or marketing programs, which can increase demandand inventory.4. The operating budget is an important document, as the pro forma income statement willonly reflect the actual costs of goods.D. Operating Budget.1.2.Next the entrepreneur can focus on operating costs.Fixed expenses (incurred regardless of sales volume) include rent, utilities, salaries,interest, depreciation, and insurance.3. The entrepreneur will need to calculate variable expenses, which may change from monthto month depending on sales volume, such as advertising and selling expenses.E. Capital budgets are intended to provide a basis for evaluating expenditures that willimpact the business for more than one year.1.2.A capital budget may project expenditures for new equipment, vehicles, or new facilities.These decisions can include the computation of the cost of capital and the anticipatedreturn on investment using present value methods.3. The entrepreneur should enlist the assistance of an accountant.PRO FORMA INCOME STATEMENTSA. Sales is the major source of revenue; since other activities relate to sales, it is usuallythe first item defined.B. In preparing the pro forma income statement, sales by month must be calculatedfirst.