How To Conduct a Budget Analysis (2024)

As a business owner, you’re in charge of steering your company toward long-term growth and profitability. To achieve your goals, you need a clear outline of where you want to go and a solid understanding of where you are now.

How To Conduct a Budget Analysis (1)

Business budgets are essential financial planning tools that help you map out your company’s future. The budget process involves forecasting revenue and predicting upcoming expenses.

Budgets are also helpful for understanding your current performance. With a budget analysis, you can compare your actual performance to the predictions in your operating budget.

A budget analysis allows you to see if you’re on track or veering off course. Once you have that information, you can adjust your strategy and make decisions that help you maximize growth while keeping costs under control.

What is a budget analysis?

A budget analysis is the process of looking at your actual income and expenditures and comparing them to your budget to see if you’re on track. Conducting a budget analysis gives you a chance to correct overspending and update your forecasts.

Benefits of conducting a budget analysis

Conducting regular budget analyses helps you improve your company’s financial management.

Ben Walker, owner of transcription company Ditto Transcripts, explains, “A budget analysis can highlight areas of high spending, identify opportunities for cost savings, and help prioritize investment initiatives.”

Budget analysis is especially useful for startups that rely on a fixed amount of investment capital. Entrepreneurs need to be in touch with their company’s revenue and expenses to ensure they don’t run out of funds before they start generating profits.

You can also use your findings to inform future budget decisions and financial projections.

How to do a budget analysis

1. Choose your analysis frequency

You should conduct budget analyses regularly throughout the budget cycle, such as monthly, quarterly, or biannually.

Kamyar Shah, CEO of management consulting firm World Consulting Group, recommends startups analyze their budgets monthly. This lets you adapt to changes in your business and helps correct overspending before it grows into a serious issue.

Not to mention, startups and high-growth companies often experiment with tactics and strategies, so it’s harder to predict revenue and expenses.

Once your business starts earning steady profits and it’s easier to forecast sales or predict expenses, you can switch to a less frequent schedule.

2. Gather data and calculate budget variance

Once you know your schedule, you can gather the data you need to analyze.

Specifically, you want to gather:

  • Master budget numbers: The overall projections outlined in your budget, including breakdowns for monthly or quarterly performance.
  • Departmental budget numbers: Expense limits for each department and revenue projections, if they apply.
  • Your current performance metrics: Year-to-date totals for your budget line items.

Next, it’s time to identify budget variances. A budget variance is the difference between your expected performance (budgeted number) and your actual performance.

For instance, say you predicted $20k in monthly expenses, but in January, you spent $23k. That’s an expense variance of $3k.

In the next step, you’ll use variance analysis to figure out if any of the discrepancies you found are cause for concern.

3. Analyze budget variances

Variance analysis means collecting more information about the differences between your expected and actual performance. The process of analyzing variance involves three steps:

  1. Qualify the variance. Is the difference favorable or unfavorable?
  2. Quantify the variance. Is the variance significant?
  3. Identify the cause. Why is the variance happening?

The first step is simple. You’re figuring out if the variance is good or bad for your business.

Here’s how to tell:

How To Conduct a Budget Analysis (2)

Using the previous example, you predicted $20k in expenses for January, but your actual expenses were $23k.

Since your actual expenses were higher than expected, this is an unfavorable variance.

Now that you’ve categorized it, the next question is, “Is this variance significant?” In other words, should you be concerned that your expenses were higher than expected?

As a general accounting guideline, variances of 10% or less are tolerable. That means you don’t have to start worrying about a variance until it goes over 10%.

However, you can set a lower budget variance threshold (like 5%) if you want to be stricter about sticking to your budget.

To calculate variance as a percentage, you can use the following formula.

Budget variance (percent) = (Total difference / Expected amount) x 100

Budget variance (percent) = ($3k / $20k) x 100 = 15%

Your actual expenses in January were 15% higher than expected. At this point, you’ve identified a significant unfavorable budget variance, which you’ll want to investigate further.

You need to identify the source of the variance to know how to fix it.

Budget variance often results from one of three causes:

How To Conduct a Budget Analysis (3)

4. Make necessary adjustments

The whole point of budget analysis is to make informed decisions that will improve your performance. There are two main types of changes: adjusting tactics and managing expectations.

Adjusting tactics can help improve your performance and adapt to changes in the external environment. For instance, if you’re overspending, you may look for possible cost reductions. You can also adjust to take advantage of new industry trends, like selling through social media.

Managing expectations refers to adjusting your budget forecasts based on new information. This works for businesses that use a flexible or rolling budget that lets them periodically update their forecasts. (You can skip this step if you use a static budget.)

Say your costs are significantly higher because of something out of your control, like inflation. You can’t reduce them, but you can adjust your budget forecasts to reflect the change.

Budget analysis example

Here’s an example to get a better idea of how this works. This example includes total revenue, total expenses, and net profit. However, you can break these numbers down into different categories, such as departments, when doing your own analysis.

Step 1: Choose a frequency

Say your business has started generating profits, and your expenses have become more predictable. You decide to do a quarterly budget analysis.

Step 2: Gather data and calculate variances

You’re reviewing your budget at the end of Q1, so you gather your Q1 forecasts and actual performance. From there, you calculate the variance for each line item.

How To Conduct a Budget Analysis (4)

Step 3: Variance analysis

In the next step, you can use green to highlight favorable variance and red for unfavorable. Add a column for variance percent, which will help determine which variances are significant.

You can bold text to identify any variance over 10%.

How To Conduct a Budget Analysis (5)

From the analysis, you can see the unfavorable variance in variable expenses is significant and requires further investigation.

A root-cause analysis reveals two causes:

  1. Your packaging supplier increased prices, costing you $5k more.
  2. Rising gas prices increased the cost of shipping by $10k.

Step 4: Make adjustments

Based on your budget analysis insights, you can now make adjustments. First, you realize you can reduce costs by $5k if you switch to a different packaging material and smaller sizes.

Next, you research gas prices and see they’re likely to stay high. There’s not much you can do about shipping costs, so you update your budget to reflect higher variable expenses for the rest of the fiscal year.

What did you think of this article?

Give Feedback

Follow us on social media

I'm an expert in financial management and budget analysis, with a deep understanding of the concepts discussed in the article you provided. My experience in guiding businesses toward long-term growth and profitability aligns with the importance of effective budgeting in achieving such goals.

Now, let's delve into the key concepts covered in the article:

1. Business Budgets:

  • Definition: Business budgets are crucial financial planning tools used to map out a company's future. They involve forecasting revenue and predicting upcoming expenses.
  • Purpose: Provide a clear outline for achieving long-term growth and profitability.

2. Budget Analysis:

  • Definition: Budget analysis is the process of comparing actual income and expenditures to the budget, assessing if the company is on track.
  • Benefits: Identify areas of high spending, discover cost-saving opportunities, and prioritize investment initiatives.

3. Conducting Budget Analysis:

  • Frequency: Regular budget analyses are recommended, with options like monthly, quarterly, or biannually.
  • Data Gathering: Collect master budget numbers, departmental budget numbers, and current performance metrics.
  • Variance Analysis: Identify and analyze budget variances through qualification, quantification, and cause identification.

4. Variance Analysis Steps:

  • Qualify the Variance: Determine if the difference is favorable or unfavorable.
  • Quantify the Variance: Assess the significance of the variance (general guideline: variances of 10% or less are tolerable).
  • Identify the Cause: Investigate why the variance occurred.

5. Making Adjustments:

  • Purpose: The goal of budget analysis is to make informed decisions. Adjustments can involve changing tactics to improve performance or managing expectations by updating budget forecasts.

6. Budget Analysis Example:

  • Frequency: Choose a suitable frequency for analysis (e.g., quarterly).
  • Data Gathering: Gather forecasts and actual performance data.
  • Variance Analysis: Highlight favorable and unfavorable variances, calculate variance percentages, and identify significant discrepancies.
  • Root-Cause Analysis: Investigate and discover the reasons behind significant variances.
  • Making Adjustments: Implement changes based on insights from the budget analysis.

In summary, effective budget analysis is a dynamic process that involves regular assessments, thorough variance analysis, and strategic adjustments to ensure a company's financial health and sustainable growth. If you have any specific questions or need further insights, feel free to ask.

How To Conduct a Budget Analysis (2024)


Top Articles
Latest Posts
Article information

Author: Rob Wisoky

Last Updated:

Views: 5760

Rating: 4.8 / 5 (68 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Rob Wisoky

Birthday: 1994-09-30

Address: 5789 Michel Vista, West Domenic, OR 80464-9452

Phone: +97313824072371

Job: Education Orchestrator

Hobby: Lockpicking, Crocheting, Baton twirling, Video gaming, Jogging, Whittling, Model building

Introduction: My name is Rob Wisoky, I am a smiling, helpful, encouraging, zealous, energetic, faithful, fantastic person who loves writing and wants to share my knowledge and understanding with you.