How to Manage Your Internal Budgetary Controls
Managing internal budgetary controls involves comparing the budget plan to actual results, to measure growth and reveal potential issues. With a deeper understanding of operations, you can adjust budgets to maximize performance and manage risks.
In essence, budgetary control is the process of planning income and expenditure and monitoring actual results against these budgeted figures. In an effective budget control system, various types of budgets are created (which we’ll expand on later) and assigned to cost centers, departments, or individuals. This way, managers are able to use budget-to-actual comparison to accurately identify whether corrective action is required and within which area of operation.
What is the budgetary control process?
Budgetary control is a three-step process that uses budgets as a yardstick for actual results.
1. Prepare budgets
The starting point of budgetary control is a realistic budget. To create a budget, you need to factor in all relevant business costs and forecast how much you expect to earn.
Budgets typically use historical financial statements as a guide for creating assumptions and estimates. Your approved budget should use lessons learned from last year’s cycle and address changing market conditions.
The budgeting process also requires building and pitching plans, debating priorities, and allocating resources. Involving personnel in the budget process is crucial since departments may have unique opportunities or challenges to be considered.
2. Compare with actual performance
Your next step in budgeting control is to compare the plan to actual numbers, which is your variance analysis. For each period, look at deviations between the actual outcome and your targeted objective.
Variances could come from differences in price, cost, volume, and productivity. Investigate and explain both positive or negative variances.
For instance, a company may have missed a target because a deal fell through or competitive pressure made it necessary to bid for a lower contract price.
Conversely, numbers could exceed targets if the company secures a new corporate client or gains a competitive advantage, allowing it to increase prices without losing customers.
3. Revise budgets
As the year progresses, your budget loses accuracy and relevance. Throughout the year, you may have to redo forecasts after investigating variances. Remain focused on your original objectives, though how you achieve goals may change due to unexpected events like a lawsuit or losing a major customer.
Sudden changes are a breeding ground for fraud, especially for small businesses with limited internal controls. As a result, revising budgets becomes even more critical for SMBs to have a baseline for measuring performance and keeping internal controls in place.
Types of budget controls
Successful businesses manage multiple types of budgets, each serving a different purpose.
Since 61% of small businesses do not have an internal audit department, prioritizing these three types of budgets helps to focus budgeting controls and manage different aspects of a company’s financial performance.
Operational budgets project the company’s everyday activities, such as selling goods and services, buying inputs (materials, labor, and overhead), and SG&A costs.
Typically conducted annually, operational budgets serve as your company’s backbone for strategic management and help you plan for future revenues and expenses.
When comparing operational budgets to actual performance, your goal is to evaluate key performance indicators, including your net income, operating margin, and gross margin.
Many businesses compare operational plans to actual every month to create a trend line, which makes it easier to identify sudden changes in income or expenses levels.
Cash flow budget
A cash flow budget is a projection of all cash inflows and outflows expected to occur within a period. It reflects the expected sources of funds and how they will be allocated and spent.
Around the world, 64% of small businesses struggle with cash flows. Having a separate cash flow budget is particularly important for a business with receivables since accounting revenues do not translate into cash collections.
Monitoring money movements against a cash flow budget helps identify cash deficit periods well in advance, so managers can take action to navigate through tight cash periods. For example, they could adjust the timing of payments or temporarily increase bank loans.
A cash flow budget also ensures the business has sufficient working capital and can meet obligations as they fall due. Simultaneously, it provides a way to identify when the company has idle cash to fund new investments.
Capital expenditure budget
A capital budget estimates the timing and expenditure amounts of major asset purchases over the next year, such as new equipment, property, or facilities upgrades.
For growth-oriented companies, capital expenditure (CapEx) plans are crucial to pursuing investments that require substantial capital without hurting business operations. CapEx budgeting allows you to evaluate and measure investment options and plan for significant cash outflows.
Whether you’re investing in a building or new technology, developing products, or expanding to a new market, you need to forecast costs and project the return on investment.
Uses of budgetary control
Budgets help businesses plan for future events and avoid committing fatal mistakes. While the focus of most companies is to keep spending limited to specific thresholds, budgetary control plays a broader role.
Planning and resource allocation
With budgeting as a guide, you can identify available resources, assign them to departments, monitor the workload through the projects each team handles, and re-assign resources if necessary.
Budgeting controls help limit under and over-utilization of resources to hit organizational, departmental, operational, and individual goals.
Responsibility and accountability
Budgets instill a sense of responsibility and accountability in both managers and employees. Managers are responsible for delivering expected results and approving transactions that are within the allocated amount. While managers can approve costs over budget, they have to justify their actions.
Budgets also provide a benchmark to target. Comparing budgeted to actual performance kickstarts the budgeting process of identifying variances, taking corrective action, or adjusting the budget forecast if needed.
Since budgets serve as a shared goal, budgeting allows company owners to convey expectations to managers and employees regarding profit and cost savings.
Budgeting controls make departments aware of what they should deliver and the resources available to them.
As a tool for evaluating performance, variance analysis reveals a manager's ability to deliver profit and control costs. Involving employees in budget planning improves motivation because they can internalize budget goals as their own. Having a sense of ownership over the process drives goal targeting, as do bonuses tied to specific budgets.
Using actual results in your budget control process
Budgetary controls rely on two items—your budget (which should be as realistic as possible) and actual business performance.
Comparison to actual results is key in budgetary control
On a monthly or at least a quarterly basis, a business should perform variance analysis. Comparing your budget to actual performance helps you validate transactions.
Reviewing variances regularly also allows you to identify and investigate discrepancies and take corrective action if needed. An effective comparison between budget and actual data should be reliable and timely.
This means that companies should make an effort to churn out reports as soon as the month or quarter-end. Delays in reporting and creating a variance report could mean missed opportunities to take corrective action.
Data from multiple sources pose challenges
Budgeting control requires distinct inputs—the company budget and financial statements based on actual performance. While the data collected is typically accessible to finance departments, the information needed for variance analysis comes in varying forms from different systems. Data sources may include legacy systems, spreadsheets, HR systems, and other department-specific applications, cloud-based applications, marketing automation tools, etc.
Dealing with multiple data sources and maintaining consistent data is a struggle for about 60% of organizations. In fact, workers spend about 36 hours a week on data gathering, preparation, and analytics.
To make matters worse, manual compilation is prone to human error. You could spend valuable time investigating several differences resulting from these errors and completely miss the bigger picture.
Benefits of automation
Managers have to move fast in a competitive market, and waiting around for variance reports isn’t always an option.
If you don’t have access to real-time information, variance analysis becomes a less effective tool for decision-making. In fact, stale data is one of the major drawbacks of using variance analysis.
When traditional budgeting makes it challenging for your business to respond to a rapidly changing market, automation can provide significant improvements. Software makes collaboration easier across teams and locations and ensures stronger version integrity than using spreadsheets.
How to calculate and control budget variances
Whether your company uses spreadsheets or software for budgeting, budgeting control reports plan to actual variances. Variances could be in dollar amount or a percentage, but it’s better to display both positive and negative differences in both formats.
Positive or favorable variances happen when you exceed your target income or cost savings. Unfavorable variances occur when the reverse happens—if actual revenues fall short or when actual expenses are higher than your budget.
Understanding how your company’s financial health stacks up against budget allows you to take immediate action to recover lost revenues.
Your next steps may involve forecasting the budget again, reviewing your pricing, shifting the allocations, or adjusting business processes to improve efficiency. Understanding the business better allows you to take advantage of opportunities to improve profitability, efficiency, productivity, and competitive advantage.
Improve budget controls with automation
Implementing internal budgetary control helps you grow your business with more certainty and confidence. While traditional patchwork spreadsheets could work, your business needs a more reliable and efficient way to implement budgeting controls, especially as revenue increases and operations become more complex.
When this happens, your finance department may spend unnecessary time preparing manual budgets and variance reports. You do have a choice—make budgetary control as painless as possible with a software solution like Lola.com.
Lola’s spend management tool allows you to ditch manual reports, track spending in real-time, and implement more robust risk management by controlling spend before it happens. Modernizing budgetary controls improves information accuracy by creating a central data repository, reducing reporting delays, and supporting real-time budget revisions.
Spend management systems eliminate a process that isn’t working and turns budgeting controls into an ongoing undertaking. Lola makes it possible to capture information, update and implement the budget using control limits, and provide variance reports in real-time.