Budget Variance Managing Budgets and Keeping Within Essay

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Budget Variance

Managing budgets and keeping within those boundaries is a difficult task and requires a steadfast approach with practical strategy. Budget forecasts often are used as important guidelines that are used to keep organizations in line with their corporate strategy. Although this seems rather simple, it is not. The purpose of this essay is to discuss and highlight specific strategies that can be applied to assist in managing a budget within a given set of forecasts. This essay will also compare some expense results that have fallen out of the variance range and discuss the possible reasons for this occurrence. This essay will conclude by discussing benchmarking techniques that will eventually contribute to improving budgeting techniques including forecasting.

Budgeting and Forecasting

Nayab (2011) suggested that "both budgets and forecasts provide estimates, and construct models of how a business might perform financially if the expected events and plans play out as desired. The difference between forecasts and budgets is that forecasts gaze into an uncertain future whereas a budget bases itself on planned events." Establishing a relationship between these two figures requires management to look beyond the face value and dive deep into what these number are really saying about the performance of that firm.

The most important aspect about budgeting and forecasting is that they align with corporate strategy presented by the leadership of that organization or firm. Because the budget expresses how resources will be allocated and what measures will be used to evaluate progress, budget development is more effective when linked to overall corporate strategy. Linking the two gives all managers and employees a clearer understanding of strategic goals. This understanding, in turn, leads to greater support for goals, better coordination of tactics, and, ultimately, to stronger companywide performance.

Setting goals before budgeting begins makes it easier for budget developers at all levels. When this happens, budget developers create from the start budgets that support strategic goals and that, therefore, need fewer revisions. Budget development then becomes not only faster and less costly but also far less frustrating. The purpose and strategy behind the budget is what drives it and the forecasting methods that are used to support the strategy, not dictate it.

Westland (2011) provided four solid ways for managers to take control of this problem and use the budget and forecasting to their advantage. He suggested that the budget should be continually forecasted to provide a sense of direction. " A project run without frequent budget management and reforecasting will likely be headed for failure. Why? Because frequent budget oversight prevents the budget from getting too far out of hand. A 10% budget overrun is far easier to correct than a 50% overrun."

Many companies evaluate managers primarily on how closely they hit budget targets. While this may seem logical, in reality this type of one-dimensional evaluation tempts managers to "win" by playing games with budget targets. Such game playing isn't always in the company's best interest. For successful companies, meeting budget targets is secondary to other performance measures. Such companies use a balanced set of performance measures to chart progress toward strategic goals, and use the same measures in their incentive programs. This reinforces the importance of key strategies and communicates what results will be rewarded.

By developing budgets that accommodate change, companies can respond to competitive threats or opportunities more quickly and with greater precision. They can use resources efficiently to take advantage of the most promising opportunities. Furthermore, knowing that budgets have some flexibility frees budget developers from the need to pad budgets to cover a wide variety of possible developments. This leads to leaner, more realistic budgets. One way in which companies can build flexibility into budgets is to prioritize according to strategic importance action plans that were rejected due to resource limitations. By doing this, they can act swiftly and decisively if additional resources become available.

Companies typically review budgets quarterly, monthly, or even weekly. By including in these reviews reports on changes in business conditions, companies alert managers that new tactics may be called for, if they are to meet their targets for the year. While it is important that budgets not be revised to cover up for poor performance or poor planning, well managed companies choose to revise budgets rather than adhere to budgets that do not reflect current conditions.

The best strategy to help keep budgets and forecasts working in a useful way is to communicate. Communication is the most important aspect of all business interactions and should be taken as the primary method in discussing ways of improvement for the firm. Westland (2011) agreed when wrote" An informed team is an empowered team that takes ownership of the project. By keeping the team informed of the budget status, they will be more likely to watch their project charges and far less likely to charge extra 'gray area' hours to your project (those are the hours that they know they worked by aren't sure what they were working on.)."

Variances

To truly understand the importance of budgeting and forecasting it is necessary to look at variance within a budget and describe possible sources of that discrepancy. A variance arises when there is a difference between actual and budget figures. Some are favorable others are not. Cost variance can monitor the financial progression of whatever it is you are doing in your business. When cost variances are low, you know you have controlled your risks well. You also know you have retrieved and analyzed data related to operations sufficiently. Ideally, your actual costs should match what you budgeted and your cost variance should be zero, but in practice this is fairly difficult to achieve.

Example 1

A standard variance in many instances is direct material variance. Direct material variance shows the difference between the actual cost of material of actual units and standard cost of material of standard units. This problem may be resolved by implementing better purchasing techniques.

Example 2

Labor Variance is another type of variance that may affect a budget. Labor variance shows the variance of labor cost. It is the difference between standard cost of labor for actual production and the actual cost of labor for actual production. This is a difficult issue to resolve due to the human error associated with labor costs, but experience mixed with technology should best dictate forecasting for labor costs.

Example 3

Overhead variance can also distort a budget forecaster. Overhead Variance shows the variance of all indirect cost. It is the difference between standard cost of overhead for actual output and actual cost of overhead for actual output. Market fluctuations are most responsible for this type of discrepancy.

Example 4

Sales variance also can affect how a budget is construed. Sales variance is that type of variance which shows the difference between actual sales and standard sales. But in unfavorable sales variance, a standard sale is less than actual sale. This is caused by many factors that take into account the sales performance numbers.

Example 5

' Miscellaneous variances occur when certain and total unpredictable events significantly affect the budget. There is little to nothing that can be done about these types of discrepancies as they are mysterious and out of human control.

Benchmarking

Benchmarking has proven to be a very useful method in improving budget accuracy. According to Burke (nd) there are four basic type of benchmarking: Internal, competitive, functional and generic. Within these groups are other benchmarking techniques that can help determine the progress of the project and whether or not it is varying from the budget. To successfully accomplish this task some preliminary steps need to be taken.

Benchmarking begins with identifying what is to be benchmarked. This can be a serviee, process or practice. It is important for leadership to understand just what…[continue]

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