3 ways budgets are used to measure performance.
Budgets are one of the most useful items that top management use to measure actual organisational performance. Budgets are commonly perceived to exist for financial purposes only presenting numbers and figures however budgets can be key tools to provide insight into how an organisation is performing. Analysing budgets can lead to discovering key insights into why an organisation is performing in a certain way.
So how are budgets used to measure performance? Here are 3 brief and simplified ways managers may use a budget to measure performance.
1. Identify significant variances.
A budget variance is the difference between a budgeted amount and an actual amount of expenses or revenue.
Budget variances could include a difference in expenses/costs and increase or decrease in sales/profits.
Variances can be good or bad. For example, if the budget variance in revenue is higher than the budgeted amount or if the actual expenses are less than the budgeted amount, the budget variance is a favourable outcome. If this scenario is reversed and revenue is less than the budgeted amount and the actual expenses are higher than the budgeted amount, this is not a good outcome, an unfavourable variance and it means the budgeted project needs to be reviewed as it is not running successfully or sustainably.
Budgets need to monitored and significant variances need to be identified so that they can be investigated and managed further.
2. Analyse budget variances.
Once some significant budget variances have been identified it is important for these variances to be analysed. Without analysing these variances no insights can be drawn from them and nothing can be done to improve or eliminate the variances to ensure the viability and sustainability of the budgeted project in question. The reasons or causes of a variance once identified are important for the organisation to address as it is an opportunity to improve their operations and performance.
For example, through analysing a budget variance the organisation will be able to determine if it is a long-term or short-term problem that may need a quick fix or a permanent solution. Perhaps the retail price of the organisation’s product or service may need to be increased to make up for an unfavourable variance. Perhaps sales have dropped due to economic conditions that have reduced consumer demands outside of the organisation’s control. Similarly input costs into a product or service may have increased due to economic conditions and therefore alternative arrangements may need to be made. Seasonal trends and buying patterns may also be identified if variances are monitored over a long period of time. Whatever the outcome it is important that these budget variances are analysed so that corrective action can be taken to improve the organisation's variances.
3. Determine if the budget needs to be revised during the year.
After identifying significant variances and analysing these variances to detail the issues behind them, it is then time to use the information from the analysis to revise the budget if necessary.
A budget revision is the process that allows a budget manager or a senior management team to make changes to an existing budget. A budget revision may need to be implemented in order to get a budget back on track depending on the issues identified.
For example, a budget revision may need to trim the expenses in a budget, re-allocate revenues or even incorporate finding new sources of income into the budget to satisfy the amount of expenses identified.
London Training for Excellence offers a course titled, The Essentials of Budgeting, that will teach you the steps discussed above as well as many other essential skills to increase your knowledge and understanding of the world of budgeting.
To find out more about the course please follow the link below or contact email@example.com with any questions you may have.
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