As the Chief Number Cruncher at Half A CFO, one question I hear fairly often is: “How frequently do I need to review my small business budget?”
Excellent question! Probably you already made a budget for your business for 2018, and you put a lot of hard work into it. To get the most of your effort you need to review your budget against your actual income and expenditures. But, how often should you do it? And, above all, how do you do that?
Almost everyone recommends you review your budget every month. They are correct, but there is a little more to it.
In this article, we will observe the steps you have to follow to ensure an efficient review. When you do it, you will see that the Variance Report is extremely important in the process. We will also take into account the possibility for errors, problems or discrepancies during your monthly review. Finally, we will guide you through the steps to follow when you need to add an unexpected expense to the budget you have already created.
Steps for Your Budget Monthly Review
Step 1: Post all invoices, receipts, income, and reconcile bank statements. Whether you use a bookkeeper or do it all yourself, you need to make sure all of your receipts and invoices have been posted correctly in your accounting system. There is no point in running the Variance Report until this has been done.
Hot tip – Most business owners find this tedious and, frankly, a bit confusing. If that’s your case, then give some serious thought to hiring a part-time bookkeeper. You don’t need to increase your payroll: there are many outsourced bookkeeping services who will do this at a very reasonable price.
Step 2: Run a Variance Report. In both Xero and QBO, it’s under Month End Reports. Wait until posting for the month that has been completed. Ideally, this will be finished no later than the 3rd or 4th day of the following month. For example, you should be able to run the Variance Report for January by February 5th at the latest.
Step 3: Look for the red! Let’s say I own an imaginary restaurant, which I made a budget for. I’m expecting an average $5,000 per month in sales in 2018. But I adjusted that down to $4,000 for January because people spend a little less going out after the holidays. Figure 3 shows what my Variance Report will look like in mid-January.
Notice the red on my Sales line! That’s because no sales have yet been posted to my Xero account for January 2018, so it doesn’t reflect a problem. However, if we were looking at this report on Feb 5th or so, after everything had been posted, the low sales figure would indicate a serious problem.
Step 4: Look at the Variance columns. Check both the Monthly and Year To Date variance columns. The YTD numbers will show you if there’s a trend or unusual figure you need to fix. If you’re looking at the January report, the monthly and YTD values will be exactly the same, so you won’t be able to pinpoint any problem yet. But later in the year, the YTD columns will make it clear if you have a serious deviation from your plan.
Steps to Follow When There’s a Problem in Your Budget
Let’s say you are a painter and you see your Cost of Goods Sold (2nd blue heading on the left side) is in red: that means you’ve been spending more on paint than you planned when you created the budget.
That could be good or it could be bad. If you are painting twice as many houses than you planned, then it makes sense you are buying a lot more paint. But if sales are around where you expected, and Cost of Goods Sold is 25 or 50 percent higher, then something is wrong. What to do now?
Step 1: Check the Cost of Goods Sold category. The first thing to do is double check the ledger entries in the Cost of Goods Sold category. Click the dollar amount in the Actual column to see a list of all of the purchases recorded for the current month. Or click the dollar amount in the YTD Actual column to see all of the purchases recorded under Cost of Goods Sold for the current year.
Are there any unusually large amounts? That might be your problem.
Step 2: Check each amount in detail. Click each figure to open a detail page. If your bookkeeper is doing things right, there should always be an image of the original receipt attached. If not, you might have to do some hunting.
Does the receipt amount match the unusually high amount that was posted in your accounting app? If not, and the real amount was actually lower, you found the error. It’s an easy fix, and you’re back on track. But if both figures match and both are high, you might be spending more on materials than you initially anticipated.
Step 3: Re-evaluate the situation and make adjustments. It is possible that you underestimated the cost of doing business when you made your budget. It’s time to sit down and review your cost assumptions. If necessary, find an accountant or business advisor to help you review your assumptions and get back on track.
Steps to Add Unexpected Expenses to Your Budget
Before making big or unusual purchases look at your budget and ask yourself:
- What category does this purchase go in?
- How much is it going to cost you? Did you budget for it?
- What are your options if you don’t have the budget for that expense at this time?
Let’s turn each of these questions into steps you should follow when an unexpected expense affects your budget.
Step 1: Find the Category.You need to know which category the potential expense goes in. Are you replacing equipment? Purchasing a new vehicle? Repairing a roof after a storm, or water damage from a pipe burst? New artwork from a sculptor that you just have to have in your lobby? Each of these goes into a different category. Get more information on this post about How to Make a Budget for Your Business).
Step 2: Consider the price of the new expense. Let’s say you want to buy a new pickup truck. Your old one has a few too many dents and doesn’t convey the image of prosperous business owner that you want. Your budget has a category for Vehicles and Equipment. If, for example, you’re thinking of taking a bank loan of $20,000 for 3 years at 4 percent interest, that means a monthly payment of $591. Did you budget in $591 per month, plus a little extra for maintenance? If so, congratulations, go get your truck!
On the other hand, let’s say you budgeted $500 per month for your Vehicles and Equipment category. We’ll deal with that in step 3!
Step 3: Consider the possibilities if you don’t have enough budget. OK, when you created your 2018 budget you allocated $500 per month, or $6000 per year, for Vehicles and Equipment. But the monthly payment plus maintenance of your new truck comes out to $650 per month, and that’s $150 more than what you budgeted.
There are 3 possibilities here:
Possibility 1: Let’s say it’s June when you want to buy your truck, and you spent very little money on a vehicle so far this year. Your old truck is paid off and you’ve only had to shell out for oil changes and new wiper blades. Your bookkeeper has been entering all of these expenses into your accounting system and correctly categorizing them in the Vehicles and Equipment category. So when you look at the actuals in your accounting system, you can see that so far you have only spent a total of $250 on Vehicles & Equipment. You’re way under budget! Even though $650 is over your monthly budget, $650 x 6 months left this year = $3,900 which is $2,100 under the $6,000 you budgeted for the year. Congratulations! Go get your truck!
Possibility 2: It’s January 1 when you want to buy a new truck.. $650 per month for 12 months = $7,800. That is definitely a budget buster. One option is to extend your financing to 4 years. At 4 percent, you would have to make 48 monthly payments of $452. Including maintenance of $59 per month, you are now just $11 per month over budget. It’s not the ideal situation, but, you still can get your truck!
Possibility 3: It’s January, just like in the previous possibility, but you don’t want to have monthly payments for 4 years. Understandable. But the money has to come from somewhere. Unless you find another category where you can reduce your business expenditures, you will end up paying yourself $2,800 less in 2018. There is no magic bullet here. Did you budget for something that can wait another year? Maybe you planned to paint your interior of your offices. Can that wait, so you can get instead a new truck?
It takes a little extra time to get used to looking at your Variance Report on a regular basis. But it’s like anything else – the more you do it the easier it gets. And like many things that don’t always feel so great in the beginning, once you get over the hump you feel a lot better. Staying on top of your budget is a major step towards running your business, instead of having your business run you. Make your business work for you, not the other way around.