Comparing your actual spending against budget goals is a basic strategy for preparing for future growth. For instance, comparisons between budget and actual variances provide an accurate review of spending habits and income patterns. This review provides a valuable tool that business owners use every day to improve forecasting efforts and evaluate individual cost center performance.
Before you can benefit from the budget vs actual exercise, you'll need to understand a few terms. Review the short vocabulary list of terms you'll need to understand. Then, continue reading for more details.
Budget vs Actual Terms & Definitions
A department or division of an organization that incurs expenses, but does not produce income. Examples include Human Resource, Accounting Maintenance, and IT departments.
A division or branch of a business that is treated as a separate entity. Profit centers contribute to a company's profit or loss. And, these divisions are responsible for generating income for the organization, even though they do incur expenses that impact the bottom line. For example, profit center expenses include the cost of sales, while revenue is the income from sales.
A report that outlines future goals for income and spending. For example, the budget is a guideline for expected revenue (earnings) and expenditures for a defined period. Budgets are typically created for a future quarter or year.
Actual Variance Reports:
A detailed report that shows actual revenue and spending data. Variances may be positive or negative. For instance, actual spending may be less than budgeted or more than expected. And, revenue may exceed expectations, generating higher earnings and profit.
Seven Reasons Every Business Owner Should Regularly Create a Budget vs Actual Comparison Report
The budget vs actual comparison is a tool that helps owners identify errors in the original budget. For example, data entry errors occur, spreadsheet formulas may be incorrect and line items may be omitted or duplicated. Below are six ways that comparing forecasted revenue and expenses against real numbers is essential for operating a successful business.
- Actual revenue and earnings may be higher than expected. One example is when a new product goes viral and demand skyrockets.
- Sales projected may be lower than achieved. For instance, a historically popular product could peak and start to decline.
- Changes in the supply chain often impact the cost of sales. On the positive side, negotiating a better manufacturing contract reduces the cost of sales. On the other hand, disruptions in the supply chain increase delivery costs, delay delivery, and often reduce profit potential, if the disruption is lengthy.
- Market trends can positively and negatively affect customer demand. Consider niche products and services. Companies targeting a small subset of the population must continuously monitor their repeat customer numbers and client acquisition costs. Failure to do this may result in excess inventory that cannot quickly sell.
- Cost centers may experience a sharp increase in acquiring, training, and onboarding new talent. Everyone knows when the federal minimum wage increases, payroll costs go up. Talent pool shortages also mean higher acquisition costs.
- Creating a budget with unrealistic expectations is a common mistake many new business owners make. Comparing budget figures to actual numbers drive informed decisions that improve forecasting, and reduce the stress associated with trying to hit an unachievable benchmark.
How Budget Variance Analysis Drives Growth & Profitability
While any type of financial data analysis is beneficial for companies, budget vs actual variance how a unique set of benefits. A primary benefit is that the comparison informs wise business decisions. A side-by-side comparison creates a single form to review company performance, one division at a time.
This review empowers business leaders to identify areas where they can cut costs. A closer look at maintenance costs, for instance, may reveal excessive overtime spend. An even closer look may reveal process inefficiencies. In this case, reviewing department processes could lead to a streamlined workflow that reduces costs.
In addition, budget variance analysis allows an organization to:
- Explore ways to improve profitability
- Proactively identify product line expansion opportunities
- Reduce payroll hours and operating costs
- Identify opportunities of scale to lower purchasing and manufacturing costs
- Implement automation that eliminates data entry errors
- Acquire or retire equipment, such as computers, vehicles, and fixtures, promptly to improve company profit margins
Creating an annual budget that reflects your business is critical for success. Comparing your budget to actual variances is just as important. You may find that your actual variances do not require any changes to the working budget. However, most businesses gain positive benefits from the exercise.
The question is: Would you rather spend an entire year before you realize there were inaccuracies in your budget that have cost you hundreds or thousands of dollars? Or, would you rather have the extra money to do what you want to do -- grow your business with a streamlined approach that eliminates errors and opens opportunities for higher profit margins? The choice is yours.