Running a business comes with many responsibilities. One of the more challenging aspects is being able to forecast future performance and being able to plan and prepare to achieve the business goals correctly.
More often than not, budgeting and forecasting concepts are associated with larger enterprises where multiple departments need to work together, and a detailed budget can help facilitate their interactions and efforts.
Another area where business models (e.g., annual forecasts) are pretty standard is startups. Startups are often engaged in fundraising, and a robust business model is one of the key elements an investor is looking to see, especially in later-stage companies.
As a process, budgeting typically happens before the financial period has started. Especially in larger enterprises, the budgeting process often involves many people from different functions working together to define assumptions and business goals that everyone can aim towards.
It is crucial to involve all relevant people in the budgeting process. After all, a budget’s primary purpose is to ensure that all decision-makers within the company are on the same page.
It is also important to note a significant distinction between a formal annual budget and a rolling 12-month forecast. While we update the forecast each month by rolling it forward, budgets (especially in larger enterprises) are mostly fixed. As the preparation of budgets in big organizations is time-consuming, it makes little sense to iterate on it throughout the year. The idea is to have a framework of where the company plans to go and how it intends to get there. We can then compare this to the company’s actual performance and analyze the significant deviations.
Additionally, in larger companies, this comparison between budget and actual performance is often the ground for calculating annual performance bonuses for department heads and team leads.
Conversely, a rolling forecast is a simplified and more dynamic structure that we can update with less effort. In larger enterprises, these are often created and maintained at the function level for internal purposes, but the overall goal is always the same. As reality unfolds, we can track the actual business performance and adjust the relevant strategy to meet the overall business goals for the period.
Budgets do not aim to be 100% correct. That’s never the end goal of the budgeting process. Instead, budgets are supposed to be a ‘guiding light’ for the company’s management on the main business goals for the period and the overall plan to achieve them.
In short, the purpose of a budget is to help the company be as prepared as possible for the future.
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Budget vs. Actuals Analysis
In essence, the Budget vs. Actual Analysis compares the two sets of numbers (what we budgeted and what the business achieved). We can then analyze the deviations and explore the reasons behind them.
Therefore, preparing our budget in a format that allows us to compare to the actual performance easily is extremely important. Such a blueprint will enable us to identify discrepancies early and respond with relevant course corrections faster. In short, having a consistent structure between our actual and budgeted financial statements is critical for smooth Budget vs. Actuals Analysis.
When it comes to budgeting, most people only think of revenue and expenses, which are the areas we spend most of our time performing our analysis. However, we can draw substantial additional benefits in almost all cases by including the Balance Sheet and Cash Flow Statement in our analysis.
Balances rarely matter when evaluating Budget vs. Actuals, but they are essential in allowing us to include the Cash Flow Statement in our analysis. This allows us to ensure that the business case we have budgeted would enable the company to maintain the required liquidity to stay afloat.
The Budget vs. Actuals Analysis serves two primary purposes. On the one hand, it shows management and employees that the company is either performing well or some aspects need attention and adjustments, essentially highlighting the areas that need attention.
The real value of the Budget vs. Actuals Analysis comes from the ability to identify follow-up questions and actions.
Speed is another essential aspect of running Budget vs. Actuals comparisons. One of the inherent problems with such analysis is that it is reactive rather than proactive, making it necessary for us to perform the examination as soon as the books are closed to minimize the time it would take to arrive at valuable insights.
As part of our Budget vs. Actuals Analysis, we use two basic formulas to calculate deviations:
- Dollar Variance ($)
- Difference between the Actual value and the Budget value
- Percentage Variance (%)
- (Difference between Actual value and Budget value) divided over the Budget value
Once we get to analyzing the variances, we distinguish two types:
- Favorable – those that have a positive economic effect on the business
- Unfavorable – those that have a negative financial impact on the business
Starting with the Income Statement variances, we split those into two main types:
- Revenue variances – when our projected sales differ from the actual sales generated (these can be in terms of revenue, volumes, and average prices)
- Expense variances – when actual expenses deviate from what we projected
- These directly affect costs, which are typically easier to control and predict than revenue.
- Regarding follow-up actions, we generally focus our efforts on optimizing the business performance (e.g., fixed production costs, overheads, admin expenses, selling expenses, etc.)
Suppose you want to learn more about performing a variance analysis. In that case, you can look at my 2-part article that discussed different variances in detail and build a variance analysis model.
Theoretical Overview: Creating a Variance Analysis Model – Part 1
Practical Model Build: Creating a Variance Analysis Model – Part 2
After the Budget
Creating a budget requires substantial effort and work from all departments. Still, it ultimately becomes the roadmap for the next year, quantifying the business objectives and keeping all decision-makers on the same page.
Additionally, building the budget is only one part of the story. The more challenging part comes afterward: executing it and meeting the business goals.
When we analyze Budget vs. Actuals deviations, we aim to figure out why the deviation occurred and how we could’ve mitigated it.
The annual budget sets consistent expectations for all company stakeholders and acts as a baseline to compare all year.
As discussed above, a budget is a form of a roadmap for the company, helping bring every decision-maker to the same page. It also facilitates channeling the company’s limited resources towards reaching defined business goals. Additionally, performing regular Budget vs. Actuals Analyses allows us to course correct timely and steer the business clear of serious pitfalls.
A budget and the subsequent regular comparison between budget and actuals guide the business towards stability, growth, and improved financial performance.
Hi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with.
In my spare time, I am into skiing, hiking and running. I am also active on Instagram and YouTube, where I try different ways to express my creative side.
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