Financial Management Forecast vs. Actual Expenses: Mitigating Risks

In Financial Management Part 1: Budgeting, we talked about key resources of effectively managing finances for a business organization. Most noteworthy, to tailor a budget based on the business forecasts. In Financial Management Part 2: Analyzing Actuals, we will cover how to track the actual numbers against the planned ones. This helps evaluate business performances periodically against planned expenses in order to make informed decisions to maximize profits. Also, operators can take evasive actions against any downfall in business due to a host of external factors.

Furthermore, continuously evaluating actual financial numbers against projected ones is beneficial. Mainly, it helps benchmark the organization’s performance over a considerable time period.

Evaluating actual figures against the proposed budget focuses on two key areas:

  1. Analyzing Actual Income: over a defined period of time (typically monthly) against the proposed sales budgets::
    1. Analyzing the reasons for any shortfall
    2. Identifying reasons for an abrupt high turnover
    3. Comparing the timing of your income with your projections and checking that they fit
  1. Analyzing Actual Expenses: evaluating the pattern of the actual expenses is one of the keys to analyzing business performance. This is achieved by studying the expenditure patterns across the following areas:
    1. Analyzing the deviations in fixed costs against the projected cost in the budget
    2. Check that your variable costs were in line with your budget
    3. Predictive Analysis of changes in the relationship between costs and turnover
    4. Analyze any differences in the timing of your expenditure

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Making effective business decisions on Budget Variances

This brings us to the next important aspect of a financially successful business: the art of making financial decisions. This is done to keep variances between the budget and actual to a minimum. The success of a business depends upon the ability and agility of the management team in learning from past mistakes and taking corrective action to stop any such failure points in the future. Use proven methods to analyze income and expense business performance in order to identify failure points.

Financial decisions can keep the variances between the budget and actual to a minimum. First, a budget variance is the difference between actual figures and projected figures of business income and expenses. The variance that acts as a precursor or “red flag” to notify you that there is an operational gap in the business plan. Budget Variance is a key indicator to help identify the reasons for a financial deficit or a surplus so that:

  1. Take corrective action to eliminate future financial variances
  2. Identify the Root Causes for financial variance
  3. Plan future course of action in order to eliminate future possibilities of financial variances

Conclusion

Remember, a faulty root cause analysis and identifying future course of action thereafter can prove even more disastrous for an organization than a financial variance. This is why it’s important that business owners are advised to use proper empirical models to calculate the variance and take any corrective action thereafter. For example, an organization having a surplus of ~75% against its projected earnings over a year needs to re-orient its sales numbers to achieve for a better productivity. Similarly an under-performing company should go for a thorough retrospection to underline the key contributors to such a performance.

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In conclusion, a financial manager’s prime responsibility is to effectively analyze the deviations between a forecasted budget and the actual expenses incurred during daily operations. Any substantial deviations need to be discussed and acted upon, before it had a larger impact on the annual revenues. The use of advanced software, smart planning methods and well informed managerial decisions holds the key to success in financial management and mitigating financial risks.