Here is the final part of this series of blogs on the subject of budgeting. I have discussed setting up the budget, communicating it and now you need to report on your performance against it. In part 3 I covered how to approach the reporting and some general tips. Finally I want to cover how to make your commentary more useful to your managers who have requested your input.
Types of Variance
There are 3 types of variance – volume, price/cost and timing. The first 2 are fairly straightforward. Volume variances examples could be that you have used more or less of something than was budgeted or activity levels are higher or lower than budgeted. Price variances could be something cost more or less than budgeted or we sold something at a higher or lower price. Both these variances are permanent i.e. they have happened and will therefore affect the overall results for the year. Timing variances are different. This is where you have budgeted something in one month but say it is delayed, so the cost is not actually incurred until the following month. Your results for this month will show a favourable variance – you are underspent against your budget. However next month you will have no budget for this item but you will have the cost! The technical term I use to describe this is –it comes back to bite you in the bum!!
So BEWARE! The good news is that this type of variance is temporary so on its own it should not affect the result for the year.
Explain the reasons and the consequences
Another aspect of the commentary could be to provide a breakdown of the variance i.e. provide more detail. This can be very helpful but do not forget to cover the reasons for the variance – back to our cost drivers! For example, our transport costs are down this month. You provide further details to show that this is due to there be less transport between the various stores than budgeted. OK that is helpful but I am left wondering why? Has there been a change in policy regarding transfers between stores, was the budget put together on a different assumption?
I was reviewing a monthly commentary for one client where they compared the monthly figures to budget and to the same month in the previous year. In a couple of areas at least, this month’s numbers were closer to the previous year than they were to the budget. Again, I was left wondering if they had budgeted for a different strategy or using a wrong assumption.
Another aspect to variance analysis should be to detail any corrective action for unfavourable variances. Can anything be done? Provide in your commentary some information to allow the reader to assess the likely impact on the year’s results. Is this something that is outside of your control, if not what steps have been taken or are planned? Remember that the role of the reporting is really one of continuous improvement – to monitor progress and look for opportunities to improve or should I say, build on the success to date!
One question to ask yourself when you are writing commentaries is “Does it pass the ‘So What?’ test?”
Try to put yourself in the shoes of the reader of this report. What are they going to want to know?
Most organisations will carry out a 6 month review and reforecast, using the actuals to date plus budget numbers, revised where necessary, for the remainder of the year. In my experience only significant differences are picked up in these budget revisions. This is an opportunity to recognise those permanent variances and possibly correct some wrong assumptions. The original budget is usually left unaltered, but the forecast numbers provide a better guide as to the likely full year outcomes. If you have a record of the assumptions used in the original budget, then this reforecast will be made easier, since you can check that these assumptions remain valid.
Finally are there some lessons for the next year’s budget? Are there any trends emerging? Make sure you capture them before next year’s budget planning starts!!
So in summary
· Identify variances by budget heading
· Provide an explanation of:
· The reason for the variance
· Action being taken to correct any adverse variance
· Time required to effect corrective action
· Show a revised annual forecast
I hope this proves helpful in assisting you with the budgeting process. I would love to hear your views.