Feb. 23 2007 04:33 PM

Why are we over budget? A simple five-word question. And your boss expects a simple answer. Responding with, "Because we spent more than we budgeted," won't be considered appropriate. To be a successful manager, you need to know the answer to that simple question, and its opposite, "Why are we under budget?" before your boss asks. You have to understand how to track variances and explain what caused the variances.


A variance is "an instance of varying; difference; discrepancy" (Source: Dictionary.com, Random House Unabridged Dictionary). In budgetary terms, it means the difference between the amount of money in your budget and the amount of money you actually spent. Preparation for explaining variances begins as soon as you submit your budget for the next year. No matter how well you analyzed past purchases and anticipated future expenses, your budget will never be 100% accurate. No one can predict the future. If you don't believe me, watch the weather forecast tonight.


Most companies have annual budgets that are broken down by month. The monthly budget is either "flat" or "adjustable." A flat budget means that the annual amount is divided by 12 and distributed evenly across every month. For example, if you have a $600,000 postage budget, flat budgeting would allocate $50,000 to each month. An "adjustable budget" uses past experience to project the spending for each month. If you generally mail more during the first month of the quarter, then you would allocate more money for January, April, July and October. Table 1 illustrates the difference between flat and adjustable budget.


Department and Corporate Budgets

As a support services manager, you probably are responsible for two types of budgets your department's budget and the corporate budget for postage. In both cases, you will have to react to issues caused by actions outside your control.


Your department's budget is divided among direct and allocated expenses. Direct expenses will consist of payroll (including benefits), travel, education, supplies, maintenance, telephones and postage. Allocated expenses include rent, utilities, depreciation and internal service charges (e.g., human resources support).


While you do have certain control over the salaries of your employees, the health benefits and associated costs are managed by another department. Likewise, all allocated expenses are calculated by facilities management, human resources and corporate finance. Generally, you must accept the charges allocated to your department.


The corporate postage budget is handled differently by every company. Some companies allocate all charges to a separate account, while other companies charge back-postage directly to the department creating the mail. In either case, the mail center manager will be contacted to explain any variances.


If departments are able to bypass the mail center when sending out mail, explaining the budget becomes a real challenge. Mail centers cannot direct departments on volumes of mail, nor should they. But you do need to keep controls on measurements. All departments must be required to notify mail services whenever mailings are sent out, regardless of the source.


The 3 Cs Collect,

Calculate and Communicate

Each month, you will receive a report that compares that month's expenses to the budget, as well as the year-to-date (YTD) expenses to the budget. You will be asked to explain any significant variance. Often, the reports will look similar to Figures 1 and 2.


To explain the variances in each line, you will need to use the three Cs collect information, calculate impact, and communicate findings. Collecting information means finding out the assumptions used to create the budget, what the actual expenses were spent on and why there was a difference from the assumptions. It's important to keep your notes from the budgeting process and your monthly reports, as you'll be referring to them every time you go through this exercise. 

In Figures 1 and 2, we discovered the following information:


  •            The budget uses flat allocations for
                            every month.


  •            Temporary help was needed in January
                            for year-end.


  •            Raises for the staff won't go into effect
                            until April.


  •            This month, you attended the National
                            Postal Forum, increasing the education
                            and travel expenses.


  •            The postage budget was based on the
                            insurance company having 100,000
                            policies. There are now about 1
                            policies in effect.


    With this knowledge, we can calculate the impact these activities had on the budget. With a flat budget, some lines, like "Education," will be under budget in some months, on target in other months and over in others. As long as we don't have a major training expense planned for April, we can predict that we'll be under budget by the end of April.


    The number of policies directly impacts the number of bills, claims and certificates mailed. There are about 20% more policies, and postage is about 20% higher in the impacted departments. Having more policies than planned also means that the year-to-date variance will continue to grow each month.


    Prepare to communicate the variance explanations to your management and to any impacted departments. Schedule a meeting each month to review your report, and make sure everyone understands it. Establish a reporting template at the beginning of the year, and re-use it every month.


    Positive variances are still variances and must be explained. If you didn't explain the lack of expenses in travel and education for January and February, your manager might have reduced those line items. Similarly, you might use temporary employees only in the first month of each quarter.


    Do I Have to Explain

    Everything? The 10% Rule

    The budget examples used in the article have only a few lines and departments. If your
    budget is that small, congratulations! It should only take you a few minutes each month to create your variance report. Most companies, however, will have many expense lines. In that case, explaining every variance, no matter how small, would take hours of your time every month. Instead of attempting to explain everything, adopt the 10% rule.


    The 10% rule means that a variance is explained if it's more than 10% of that line's budget, and it's at least 10% of the overall budget variance. For example, in the corporate postage budget, the administration department is 15% under budget for the month. However, $600 is only five of the overall budget variance. On the other hand, Accounting is 20% over budget and represents 60% of the budget variance. That difference needs to be explained.


    Nothing Personal, It's Just Business

    Too often, managers get defensive when explaining budget variances. When questions are asked about differences between projected expenses and actual expenses, some people take that as a personal affront. Or the person asking the questions intentionally belittles the person responsible for the budget.


    Both approaches are wrong. Budgeting is an attempt to predict the future. And as we pointed out, no one can predict the future. At least not with 100% accuracy. And without 100% accuracy, there will always be variances. Accept that there will be variances and that you will be required to give reasons for them. It doesn't mean you don't know how to do your job or how to forecast your expenses. Explaining variances is part of good budgeting practices, and it is part of your job as a manager.


    Take time at the beginning of the budget cycle to draft your variance report template. Establish a methodology for collecting information, calculating the impact of changes to the budget and communicating your findings. Schedule time on your calendar to focus your efforts on completing your reports in a timely manner. And if done right, you won't have to explain variances again. At least, not until next month.


    Mark M. Fallon is President and CEO of the Berkshire Company. For more information, visit www.berkshirecompany.com.

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