How To Use Budget Variances In Managing Your Business Finances

You may be the Small Business Owner who is not comfortable with sitting at your desk and reviewing the numbers that mirror your business. You may think that reading of reports is a time-consuming exercise. Yet, you need a dashboard for you to monitor and control your business.

You need a report that can help you understand your business, and help you make better decisions about managing it. Beyond your overarching business plan, your monitoring and control starts with your budget, which contains your key financial goals; like making money, growing at a predetermined rate, hiring staff and expanding your customer base.

To increase the chances of success of your business, you must document these goals in the form of a budget that is complete with forecasts for best-case and worst-case scenarios.

While you cannot guarantee the rightness or wrongness of the predictions of your budget, your budget gives a unified direction to your business. It aligns the responsibilities of team members with the goals of the business. It also provides leading indicators that reveal what’s producing the profits, or losses, of the business. Simply stated, it helps you get smarter in running your business.

To achieve this result, you must line up your budget forecast alongside your real numbers over given financial periods. You must review your budget to see the items that performed as expected, those that performed above expectations, and those that under-performed. This exercise will tell you at a glance if the business met, exceeded or failed to meet its financial goals for the period under review. It will also provide the opportunity for you to act on the lessons you learn.

A periodic review of the budget with your management team, say quarterly, will immediately reveal where the business met, or deviated from, the original plan. This will enable you and your managers to decide whether to stay the course, tweak your forecast or take actions to steer the business in a new direction.

To obtain the actionable information to keep you and your team on top of your goals, in your continually changing marketplace, you must assess the four profit and loss line items of your budget, as listed below (Revenue, Cost of Goods Sold, Gross Profit and Expenses) and adjust future forecasts based on past performance.

  1. Variance in Revenue: Examine your total revenue. Look at each line item. What is the contribution of each item to the revenue basket? Are some items generating more revenue than others? If so, in what proportions? Is the revenue for the period less than, equal to or more than what was projected? What is the explanation for the match or mismatch? Do the results call for inaction or action?
  2. Variance in Cost of Goods Sold: Labour, materials and production, for examples, are some of the items relating to cost of goods sold. How did costs of these items tally with estimated costs? Were they higher or lower than what were expected? If they were higher, was this due to an increase in demand, and an indication of a possible upswing? If lower than expected, what caused it?

Going forward, is there any action that can be taken to lower the cost of goods sold? And, if costs were not as high as expected, how can the business put the unused cash into other productive uses?

  1. Variance in Gross Profit: This is the profit that the business earns on the product produced and/or service rendered. Was the gross profit of the business, if indeed there was, higher or lower than what was estimated? After determining whether the gross profit is positive or negative, you judge if the outcome is a reflection of the current market or pointer of a future trend.

If the business earned more than it expected, it will be instructive to figure out the things that it did right to earn the extra gross profit and, possibly, do more of those things. If it earned less than it expected, you should find out why, and determine the corrective actions to implement.

  1. Variance in General Expense: These include such general and administrative expenses like utilities and sales and marketing costs. Specific line by line interrogation of these items will reveal the one(s) that made the general expense to go under or above budget estimates. Your finding will show if the match or variance is a one-off or recurring cost, and suggest actions you may need to steer your business in the right direction.

Armed with these information from your budget performance review, you will be in a position to adjust your forecasts and growth projections. If you do this quarterly, based on performance of your business and you correct its course accordingly, you will be able to set clear and achievable goals for your business.

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