To Fix Budget Problems Investigate the Causes
Oh No – it doesn’t look like I thought it would!!!
You built a budget, and took the time to get some actual information entered as well, and now you’re looking at your Profit: what you expected, against what your business is doing are far apart; you can see there are big differences between the two, but what next?
And don’t just stare at your Budget Report forlornly,
The power of a budget is in giving you the opportunity to find out what is really going on (versus what you hope is going on) – once you know the truth you can take action and prevent yourself from sailing on blindly into any storm.
Solution: Get your Sherlock Holmes hat on and
Do Some Analysis!
‘Analysis’ is just another word for ‘Investigation’ – this means you dig deep into the business activities to uncover the causes of this “Budget Problem“.
Variance Analysis is the financial term used for “Investigating Budget Problems” – narrowing down (analysis) exactly what has changed in relation to what you predicted in the budget (variance), so you can understand any impacts on your business and what, if anything, you need to do about it.
Many many things in business can change on a daily basis; to fix budget problems you need to ask and answer questions such as:
- Was there a good/bad decision?
- Did the market change?
- Have prices moved?
- Are customers’ needs different?
Once you have made an investigation, asked and answered the right questions, and drawn some conclusions, you are able to make tweaks and changes to get (or keep) your business on track and back inline with your budget – BUDGET PROBLEMS FIXED!
The following 5 tips walk you through the analysis path so you can pinpoint your “Budget Problem” and work out what to do next.
Tip 1. First and foremost – not all differences are bad things some can actually be good.
Up to here I have used the term “Budget Problem” in quote marks, because some variances aren’t actually due to business problems – they can be business advantages too. It is important to consider the “Budget Problem” in terms of how it has impacted the business profits:
1. POSITIVE VARIANCES – anything that boosts profits
- Better than expected result
- Costs lower than expected
- Revenue higher than expected
2. NEGATIVE VARIANCES – anything that reduces profit
- Worse than expected result
- Costs higher than expected
- Revenue lower than expected
NOTE: Budget Variances, and Variance Analysis can be VERY confusing if you simply think of negative numbers as bad and positive numbers as good – different reports will set things out in different ways and it can be easy to get caught-out. So stick to the above guidelines and always double-check:
- Is your positive variance good or bad? Knowing will really help ensure you always take action when you need to.
- Is your negative variance good or bad? Knowing will really help ensure you don’t worry unnecessarily.
i.e. You always want to be INCREASING your Revenue and DECREASING your expenses – this may sound like telling you to ‘suck eggs’ – but it is the key goal to keep in mind when looking at a variance. Don’t let the fact you are looking at numbers overwhelm you, remember the numbers are records of actual occurrences and the activities behind the numbers are trying to tell you their story.
How to Fix Budget Problems:
Once you are clear there is a “budget problem” you want to fix, – using your 4 x W’s – Where? When? Why? and What to do next? will help you sort things out
Tip 2. FIND your variance – ask the question “WHERE is there a difference?”
So you can see your bottom line isn’t right, but the devil is in the detail. Somewhere in your revenues and costs, departments and locations, things have changed. Establishing exactly where there is a variance is critical to knowing where to investigate further. So get some more reports, and start drilling down into the detail.
Variance analysis is most useful when you undertake a variety of comparisons:
A. Specific variances – actual figures v expected figures – this includes
- Actual v budget
- Actual v Forecast
It is unlikely that you will be perfect at budgeting (unless you have a crystal ball), so you are bound to get variances at least occasionally. Generally, small variances are simply part of doing business, large variances need investigating – but don’t get complacent; think of it like testing for lumps, or checking moles – you need to get an understanding of what is NORMALLY a bit over or a bit under before you can understand WHAT IS ODD… and this only comes with practice. (As you practice it is best to err on the side of caution, over-investigating a few small things to start with is less dangerous to your business than letting a few big things slide – and although it might be a bit of extra work, it will make you wiser, and more accurate, as you progress)
B. Trend variances – small, continual changes over time, that incrementally diverge from expected.
- This month’s v last month’s
- August 2014 v August 2015 – both acutals and budgets
What can seem normal, can seem so because we are used to it. Trend analysis is a bit like watching your weight; when you check your scales each day, it only seems like tiny changes, but if you look at this birthday compared to your weight last birthday that is when you notice the few extra kilos have snuck on … Trend analysis puts a spotlight on the changes that creep up little by little, that may not have been obvious in the month to month reviews. A good example of a creeping cost is Electricity Usage, – month by month it vary with the season and productivity etc, but reviewing this year against last year is where any increases become clear.
Tip 3. Understand the TIMING – ask the question “WHEN is there a difference?”
Sometimes differences arise simply because of a lack of information entered into your systems.
What typically happens is that a relevant invoice has not yet been received or a payment relating to this period was made in an earlier period. In either case variances will arise in both the month the invoice was expected and not received, and the later month when the invoice is entered but not expected.
The idea of ‘Accrual accounting’ is to recognise all the income and outgoings for the period in that same period, irrespective of whether or not cash has actually passed between customer and supplier. If you are not using accrual accounting, or something went haywire with the timing of the data entry a budget problem can arise.
The good thing about timing variances is they “reverse” because what was short this period will appear in the next, or what was extra in this period will be missing next period. i.e. when the two months are added together, you end up in the right spot overall. As long as the variance is explainable as “reversing” in the next period, other than ensuring the expected reversal takes place then no further action need be taken.
Tip 4. ANALYSE the reason for the Variance – asking the question “WHY is there a difference?”
Once you know the source of the budget problem, the most powerful question you have at your disposal is WHY did this occur?. The difference could simply have arisen because of a data entry typo – so don’t panic or start by yelling and the wrong people for the wrong things! Begin by making sure what you are looking at is accurate.
Apart from errors, in all other cases a Budget Variance is the result of either:
* A price that was different from expected/budgeted
* A volume (amount) that was different from expected/budgeted
To be able to take any corrective action you must work out which element, or both, are involved…
TRICK: Ask “WHY” more than once, it can take up to seven times of asking WHY to drill down to the real cause that needs to be addressed – stopping too soon may mean you don’t get to the bottom of the issue and this will mean that any changes you try to make will be targeting an incorrect area. This part requires quite a bit of patience from both the questioner and the answerer, a bit of lateral thinking and investigation, and also an understanding that “I don’t know” simply means more research is needed.
Tip 5. Take Action – ask the question “WHAT do I need to do next?”
So once the root cause of each variance is understood the final step is to take action. What you need to do will be guided by the Where, When and Why of each variance. Things to consider include:
- BUDGET – Do you need to adjust your projections because your budget was overly optimistic?
- REVENUE – Do you need to change your prices, volumes or sales process?
- CUSTOMERS – Do you need to increase your marketing, change product mix, focus on quality?
- WASTAGE – Do you need to adjust your processes to make them more efficient and effective?
In some cases, especially with trend variances, no action needs to be taken until a pre-determined ‘tipping point’ is reached.
The value of variance analysis lies in your ability to isolate changes and take remedial action quickly. Every business report exists to help you make better decisions; your budget is no different – if your business is not working as planned analysing your budget acts as a window enabling you to see what is going on and take the appropriate actions.
How have you used Budget Variances to empower your decisions?
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