Budget monitoring is a critically important process that enables managers to stay on top of their budget objectives. Do you share with your managers how much room they have left in their budget? Is your variance explanation process decentralized?
1. Telling managers about their current budget consumption and remaining leeway
The start of the new year is a good time to tell your managers what their current budget consumption is. In order to have a good grasp of the situation, they must be able to view monthly or quarterly Budget to Actual reports when needed, as well as a report showing their remaining leeway until year end. This second report should also stress the fact that managers must commit to this task, as actual leeway cannot be calculated unless committed but unspent funds are factored in. Once this is done, the Finance Department can produce and distribute a report showing Budget, Actual to Date, Commitments and then Budget Balance (or Remainder, or another meaningful name) that make up the following formula: Budget – Actual to Date – Commitments.
Ideally, these reports would have fixed versions for tracking actuals after month end, and would be available and accessible at any time, since financial decisions are not only made at month end! If it’s not technically possible to generate a report with near-real-time numbers, managers should receive this information on a regular basis.
2. Variance Justification
At set times of the year, organizations must take stock of their fiscal performance and explain any significant variances. Effective variance justification must abide by the principles of management by exception (MBE) and accountability. The results must also be easily consolidated for financial reporting purposes.
The practice of MBE should only be used for significant variances that are above or below previously established amounts or percentages. Setting these relative thresholds ensures that financial managers will only spend time on variances that actually affect the organization, rather than on amounts that have little impact on performance.
For example, variance thresholds can be set so that only those above or below $20,000, or 20% of budgeted amounts and volumes require explanation. Organizations often only require that unfavourable variances be explained, as these are what prevent them from achieving their financial objectives. However, budget experts recommend explaining ALL variances pertaining to the set threshold, including the positive ones, as this can achieve several objectives: shedding light on flaws in the budgeting process or potentially harmful behaviour (such as deliberately over-budgeting, knowing that the actual expense will be less and earning the manager a bonus for being on budget). It also makes it possible to highlight and communicate a manager’s achievements throughout the year, and possibly apply them to other departments. In short, both favourable and unfavourable variance analysis generates a wealth of valuable information, and organizations would do be well to maximize its benefits.
In accordance with the principles of accountability, the people who budgeted the expense must be the same ones who explain the variances. All too often, the Finance Department ends up collecting and recording the evidence for variances in order to save each individual team from having to perform this task. However, in practice, this means that managers tend to review their budget less often, thereby diminishing their sense of ownership over it. It’s important that managers take responsibility for their budget as this motivates them to explain their own variances.
Finally, when designing the variance justification process, organizations must ensure that the time spent by Finance on collecting and consolidating that data is kept to an absolute minimum to avoid burdening that department with non-value added tasks. Specialized software that can generate a list of justifications and reconcile them in the database in real time is the best tool for the job. Organizations that don’t have access to these features should ensure that the process of generating variances to be explained, as well as deploying data collection templates, is as automated as possible. As in a standard database, the template should tab the justifications so they are easy to find and there is less consolidation.
3. Entering end-of-year forecasts
The third component of a budget process is having managers confirm that the budget proposed at the beginning of the year has been reached. If this is not the case, they should enter an alternate forecast, from the data collection templates, that takes into account changes to the yearly budget. As with the annual budget, managers enter their forecast based on specific budget monitoring comparables: Annual Budget, Actual to Date, Actual for the Same Date Last Year, Commitments, etc. However, it’s important that managers not be asked to enter the same information twice. If the amounts and volumes entered for the budget are seasonally adjusted, it’s helpful for managers entering their data if the same breakdown is presented in the budget forecast template. This enables them to confirm that the budgeted amount is correct, or else re-enter the amount that should be seasonally adjusted in the same way as the previously budgeted amount (or otherwise, as desired) so that they can achieve their objective as quickly as possible.
As with budgeting , since variance justification is a decentralized process that enables the organization to communicate with all managers, it needs to compile as much relevant financial data as possible – updates on billable hour forecasts, sales volumes and revenue productivity (as shown in BOMs) – as this will simplify variance analysis in the coming months and quarters.
Note that when an organization is designing its budget review process, each of the aforementioned steps can either take place at different times of the year or simultaneously. For instance, an organization could decide to not require any variance justification before the end of the second quarter, because employees were too busy in the first quarter with end-of-year reporting. Alternately, they could only require justifications of targeted activities, because a first-quarter peak period has just ended. However, reports on actual performance and leeway should be generated each month, and forecasts need only be entered mid-year … or after busy periods that usually end after the 4th and 8th month. Basically, the idea is to find out when each of these budget monitoring tasks brings the most value to the organization and to managers, and then schedule it accordingly.
Equipping partners with better management tools should be a key part of designing the budget review process. If we want them to use the tools (and thereby deliver the value that we know this process is capable of generating), it’s important that they be effective and easy-to-use. These simple steps will go a long way towards improving an organization's bottom line because they are simple, practical and concrete.