As we enter the last few months of the year, annual planning activities like creating budgets and forecasts become the focus for most leaders and finance teams. Budgets are drawn before starting any financial period, most commonly before the start of the fiscal or calendar year. And while it requires a major up-front effort with input from all departments, your budget is your roadmap for the year, setting the expectations for what the company needs to achieve and a way to keep all decision-makers on the same page.
With the budget in place, you can check how the company is doing compared to the plan over the course of the year. But, budgets are static, and don’t take variations like economic conditions, accounting errors, or any other deviations from the plan into account. That’s where variance analysis comes into play.
What is budget vs. actual?
As you may have already realized, creating a budget is only half of the story. The other half lies in the execution of those plans.
The budget is simply the roadmap to your destination. Throughout the year and at important milestones, it tells you where you should be going. But achieving your goals as a manager and as a company requires actually getting in the car and driving to where you want to go.
To help you check your progress along the way is a valuable tool called variance analysis. It takes several different forms, but one of the most useful is the budget vs. actual report.
As we mentioned, deviations from your budget will always occur—that’s life! But because they happen, it’s important to analyze why they happened, as well as the extent of their effect on the business so you can be better informed in your planning moving forward. Your finance team (or your accountant) should be regularly providing these essential reports along with insights on how your performance measures up against your goals. Ideally, budget vs. actual reports should be done monthly to improve your budget accuracy and ensure your organization is able to quickly correct course.
Components of budget vs. actual
The budget vs. actual report is a simple comparison of how the company is performing against the defined budget figures over a fixed time period. Gaps should be shown both as absolute values and as percentages. This allows for easy targeting of the biggest problem areas - i.e. areas with both the largest value gaps or the largest percentage gaps.
For the analysis to be useful, you’ll need to see the major P&L blocks:
- Revenue (sales)
- Cost of goods sold
- Gross profit (or gross margin)
- Regular or operating expenses (grouped in useful sub-categories)
- Other expenses
- Net income
The exact layout depends on your company structure and what’s critical to the business. However, cost and revenue blocks should be shown with enough granularity that you can start making decisions without needing to drill down each time.
For example, it might be helpful to look at both gross revenue and net revenue. If discounts are a necessity in your industry, clearly seeing their impact can help ensure the sales team isn’t giving away too much to get the sales. By only showing one or the other you would miss this valuable information.
Budget vs. actual analysis
Why is this analysis even important?
By creating a budget for the year, you’ve set the expectations for all company stakeholders. Over the year, nearly all aspects of the company can be measured against this baseline.
As such, the budget vs. actual analysis serves two main purposes:
- Shows the management and the employees that the company is either performing well or some aspects are in need of an adjustment.
- Highlights which areas especially need focus.
Variance analysis
The real value of the budget vs. actual variance analysis comes from the resulting actions. The report should highlight areas that need attention—cost blocks with big variations or KPIs not on target—and the team should define how to address those areas.
The best way to maintain a solid variance analysis is to set it up in your reporting system. This system should be robust enough to create a high-level macro view, yet also accommodate the need to drill down into the details.
Using the outcome of the analysis, the team can then determine which actions need to be taken next.
Imagine that sales are much higher than the budget, but gross profit is stable and net income is down as a result of higher than expected labor costs. Upon further investigation, you discover two issues:
- The gross profit impact is due to skyrocketing material costs resulting from semiconductor shortages. The sales increase is merely passing the higher material cost on to the customer.
- The labor variance is caused by personnel shortages. Some of the staff recently resigned and the remainder is working tons of overtime, including on Saturdays and Sundays. Premium pay is keeping them motivated until additional staff can be hired.
Tips and recommendations for analyzing budget vs. actual
Speed is key. The sooner you know that you are missing your budget, the faster you can make adjustments. Your variance report should be available as soon as possible after a period is closed. Jirav can link with all of your data sources to automatically keep your variance reports and charts updated.
Visualizing your data can also help you and your team quickly recognize where the issues are. This speed in recognition allows for swift, decisive action.
Your variance analysis is the true link between the vision for the company and reporting in the real world. Thus, it’s critical for you (or your accountant) to have systems in place to efficiently provide this reporting.
Time spent compiling data and building spreadsheets is not a high value-add activity. A system can work much more efficiently to give you the information necessary to run your business. Your budget is your vision for the year, using a system to quickly make the necessary link to reality is critical for taking action.
Use a driver-based model for best results. Many of your KPIs will be dependent on non-financial metrics. These should also be included in your budget and can ensure you’re looking at the whole scope of the business.
Reports that complement budgets
Visual reporting, especially automated dashboards, can help your analysis be better understood by the team.
Beyond the budget, there are a few key reports for owners and managers to keep an eye on. These are especially powerful when looked at graphically and not simply spreadsheet tables.
- Cash flow statement: an overview of the business’s cash flows and its cash position.
- Forecast: visualize where the company is headed. While it’s critical to understand your actual figures, controlling where you’re going is crucial.
- Key KPIs: a dashboard showing your most important key figures and metrics can give you an overview of the business at a glance.
Ready to see budget variance in real-time?
Building a budget for your business is a great step towards building a successful company. You’ve created a roadmap for bringing the company to the next level and now you need to execute that plan.
Keeping a close eye on the variances that inevitably pop up can help you ensure that bumps in the road aren’t going to throw you off track.
Jirav is a one-stop platform for all of your budgeting, analysis, forecasting and reporting needs. It readily links with all of your data sources and does the analysis heavy lifting for you. This frees you up to focus on building your company and enacting the plans built into your budget.
Are you ready to see it in action?
