How to Use Your Business Budget to Improve Operating ResultsA variance analysis is the best place to start.
If you have an effective budget, aka rolling forecast or active projection, you’re a step ahead. In football terms, you can think of it as a game plan for the big matchup. But if you ignore the plan, you’re going to be winging it — and your team may get crushed. Needless to say, it’s not the type of strategy that is going to produce many “W’s” on the scoreboard.
How should you go about using your budget to improve your operating results?
There are countless ways. For instance, you can use it to help you establish compensation plans and navigate shifting economic conditions such as changes in minimum wage levels and the forthcoming new overtime rules.
But the primary use of the budget is to compare actual business operating results against projected results. In the accounting and finance world, this is best known as the variance analysis.
In its simplest form, the variance analysis is a periodic report designed to compare actual operating results against forecast operating results. For example, on a monthly basis a company may want to compare its actual versus forecast P&L to identify any variances of significance. If net sales revenue of $420,000 was forecast and actual net sales revenue of $389,000 was achieved, a negative variance of $31,000 is present, or roughly 7.4 percent of forecast net sales revenue.
Look for the “why”
Look beyond the numbers in your variance analysis to figure out the “why” so you can take corrective action if warranted.
For example, if payroll and wage expense for the month was budgeted at $73,500 and the actual was $70,000, the general conclusion is that a positive variance of $3,500 was present. But you need to dig deeper into the data to see what happened.
For instance, the variance may be a result of having paid a lower hourly pay rate than forecast, or more likely, the actual hours worked may have been below forecast due to an event such as having to close a store because of hurricane.
A reduction in hours worked or lower average pay per hour may at first appear to be a positive trend. But if production quality or sales decline as a result, you’re losing ground, not gaining it.
Understand relationships among key results and data points
Comparing numbers isn’t enough. To truly analyze your business you need to understand relationships between key operating results. That’s where a fluctuation analysis comes in. It evaluates operating results from a percentage perspective.
In our example, we budgeted net sales revenue of $420,000 and payroll and wage expense of $73,500, resulting in an expense ratio of 17.5 percent. Actual net sales revenue amounted to $389,000 compared to actual payroll and wage expense of $70,000, resulting in an expense ratio of 18 percent.
Even though a positive payroll and wage expense variance of $3,500 was realized, when compared on a percentage basis, a negative variance of 0.5 percent was also realized.
That is more revealing (in this situation) as it generally indicates either a labor “efficiency” problem that management needs to address or a one-off event that created the negative trend.
In summary, use your budget as a tool during the big game — but make adjustments at halftime as any coach would with the help of a variance analysis. If you wait til after the big game, it may be too late.
Editor’s note: Tage Tracy is a financial consultant and co-author of several books including “Cash Flow for Dummies,” “How to Read a Financial Report” and “Small Business Financial Management Kit for Dummies.”