What on earth does it mean to be "out of budget"? We hear this pretty often, but for many business owners, it’s not always clear. It can be a frustrating and confusing situation especially when you're juggling so many different financial reports. As a business owner, you might know how to read a P&L report, but it's sometimes harder to know how your budget aligns to your balance sheet and cash flow reports. But you know understanding where the numbers come from and how to interpret them is essential for making informed decisions that keep your business financially rock solid.
So, how do you spot issues with your budget before they become bigger headaches later? And what are the common types of variances you'll see in your financial reports? When you're done reading this article, you'll have a clearer sense of how to interpret variances with ease and stay on track with your budget.
How do I know when I’m really "out of budget"?
Being "out of budget" basically means there’s a variance or difference between your projected budget and actual spending. This could either mean being out of budget for the current month or year-to-date. The key here is understanding the 10% rule: if a line item is off by more than 10% from the projected budget, you should figure out what’s throwing your number(s) off.
Tracking your budget versus actuals is very important because it’s like your check engine light for your numbers. If this does happen, here are some good questions to ask yourself when this happens: Are your expenses creeping up faster than you initially expected? Is your revenue lower than anticipated? If you catch these discrepancies in your budget early enough you can make the necessary adjustments, so they don’t eat into your bottom line.
Can all my financial reports inform me about my business's health?
Many business owners we speak to are familiar with the P&L (profit and loss) statement but might not realize that the balance sheet and cash flow statement are just as important. Each of these reports provides a different snapshot of how well your business is financially performing:
- P&L statement: This report shows your revenues and expenses over a specific period or year-to-date. It helps you understand profitability but doesn’t give the full picture.
- Balance sheet: This report outlines your assets, liabilities, and equity at a particular moment in time. It shows your company’s overall financial position.
- Cash flow statement: This is crucial for understanding how money moves in and out of your business. It helps you identify liquidity issues and forecast future cash needs.
By reviewing these three reports together, you gain a more comprehensive view of your business’s financial health. It’s not just about profit, it’s understanding how cash flow and asset management are key to long-term stability. It's a good idea to check in on your financial reports every month to make sure your business stays on track and keeps moving forward.
What are some common types of variances in my financial reports?
Budget variances typically fall into two categories: favorable and unfavorable.
- Favorable variances: When your actual income is higher than expected, or your expenses are lower than anticipated.
- Unfavorable variances: When your actual income falls short, or your expenses exceed what was budgeted.
Let’s dive deeper into three common types of variances you’ll encounter:
- Volume variance: This occurs when the number of units sold is different from what was expected. For example, if your sales team sells fewer products than anticipated, it may result in lower revenue.
- Price variance: This happens when the price you receive for a product or service is different from what you budgeted. A price increase from suppliers could cause this type of variance.
- Efficiency variance: Efficiency variances occur when the resources used differ from the projected amounts. For example, spending more hours on a project than budgeted for will result in an unfavorable variance.
Understanding these variances helps you pinpoint the underlying causes of budget discrepancies, so you can adjust your strategies moving forward.
How can I interpret variances without getting overwhelmed?
Let’s face it, financial data and numbers can be so overwhelming. That’s why it’s important to simplify it wherever possible, and sometimes it’s a lot easier to visualize your numbers instead. Visualization tools such as graphs and financial dashboards can help you easily see where your budget is being met or exceeded.
We recommend starting by focusing on the variances that have the biggest impact. Not every discrepancy will require immediate action, so it’s helpful to prioritize. When you find a significant variance from budget to actuals, it’s best to dig deeper to understand the "why" behind it. Did supplier costs increase? Was there a drop in sales volume? When you take the time to look into these variances and address them quickly, it helps you stay on top of your budget and make better financial decisions.
When line items don’t add up
Let’s look at an example: Suppose your revenue line item shows a budgeted amount of $50,000, but actual revenue comes in at $45,000. This would be known as a $5,000 unfavorable variance, sometimes called a shortfall. After looking at this, you might be worried. After all, revenue is cash coming into your business, but after "popping the hood" and diving deeper into your numbers, you realize one of your product lines has been underperforming, while another is exceeding expectations. The important thing to remember here is that even though individual lines are off, the overall section might still be within an acceptable range.
Not all variances are created equal, nor will they require your immediate action; some will offset each other, while others will need to be investigated further. But you wouldn’t have known this if you hadn’t reviewed your financial reports against your budget to figure out the cause of the unfavorable variance.
What should I do when a section is within range, but line items are off?
When individual line items don’t align but the section as a whole is within range, it’s known as an offsetting variance. For example, one expense may come in higher than expected, but another comes in lower, keeping the overall total on budget. While this might seem like a win, it’s important not to ignore these variances.
Misaligned line items can signal inefficiencies or missed opportunities. Reviewing and managing these variances is essential to maintain accuracy in your financial reporting and ensure that your budget is as tight as possible.
The bottom line
Understanding variances in your financial reports isn’t just about fixing numbers; it’s about making sure your business is running as smoothly as a well-tuned engine. By regularly comparing your budget to actuals and addressing discrepancies early, you can avoid breakdowns and keep your business on the right track.
At DiMercurio Advisors, we specialize in helping business owners make sense of their financial reports, manage variances, and stay on top of their budgets. Whether it's spotting issues before they escalate or ensuring your financial health is in check, our team is here to support you every step of the way. Contact us today to see how we can help keep your business running efficiently and financially sound.
