Budgets tend to be one of the more grueling parts of starting and running a business, but this critical document helps entrepreneurs set financial goals and review actual performance against these goals.
Because a budget is an estimate of future numbers based on current information, your business’s actual performance should be similar to the budgeted amounts. Actual performance, however, will never be exactly the same as the budget. It will come close, fall short or exceed the budget.
Your job is to monitor the budget to answer these questions:
- How close did the business come to the budgeted figures?
- What adjustments, if any, should be made to the current year’s budget?
- What adjustments, if any, should be made to budgets in future years?
- What changes, if any, should be implemented to improve performance?
The budget should be monitored regularly throughout the year: quarterly, monthly or even weekly. Reviewing the budget will help you identify problems before they cost the business too much time or money.
How often you review the budget depends on your confidence in the figures and the risk associated with not meeting the budget. For example, if you must meet a certain budget in order to meet your loan obligations, the risk of falling short is high.
You might consider adjusting the current year’s budget at various intervals throughout the year. Many businesses re-evaluate their budgets halfway through the year. This way they can assess the actual results so far and adjust the budget to more accurately represent real expectations.
FALLING SHORT OF BUDGETED FIGURES
When your business does not meet budgeted figures, start by reviewing the business strategy that formed the basis for the budget. Some aspect of implementing your business strategy did not happen as expected.
- Did you misunderstand the market?
- Did you have too little information?
- What do you know now that will change the budget in the future?
- Can you still plan for profitable performance based on this business strategy?
You also need to take a hard look at the budget figures, paying close attention to the major components of profitability — sales, cost of goods sold and operating expenses. Maybe you met your sales goals and understood the cost of goods sold, but misjudged operating expenses. Evaluate the changes you must make to future budgets to include this new knowledge.
EXCEEDING BUDGETED FIGURES
Entrepreneurs would prefer to exceed the budget, rather than fall short. A considerable variation between forecasted amounts and actual amounts, however, places doubt in the budgeting process. Exceeding the budget by a great deal implies that the budget was either too easy or inaccurate.
In either case, review each of the major components of profitability to determine where the variations occurred. When you discover the reasons for your discrepancies, form a more accurate future budget that will be more helpful in guiding your financial plans.