Budgets are necessary to answer two questions:
- How are we doing relative to what we planned to do?
- Do we have enough cash to do what we planned to do?
We answer the first question by preparing a monthly financial report after the end of each month. An example is shown below
The report tells us a lot, but it is not as complicated as it looks. The first column lists the sources of income and, in this case, expenses by department.
How Did We Do This Month?
The next three columns are concerned with just one accounting period, usually a month. The first of these shows the monthly budget. This is the intended income and the amount we planned to spend for that month. The next column, Actuals, shows what we actually recorded for income and expense in that month. The number all the way at the bottom shows us the Net Income (profit or loss) for the month. In this case, it shows a loss for the month of $1,328 because they spent more than they took in.
For organizations that do not have a calendarized budget, this column is all they know. Most would quickly assume that a loss in a given month is bad. But the real question is “How are we doing relative to what we planned to do?” The Actuals column tells us nothing about that question.
The next column is the answer. It shows if the Actuals were Better or (Worse) than planned. Note: It does NOT say “Higher” or “Lower.” Income higher than budget is Better, Income lower than Budget is (Worse), The reverse is true for Expenses. Actual Expenses higher than Budget is (Worse) and Expenses lower than Budget are Better. Remember that the Budget is the “feasible, acceptable, baseline.” and is the standard we use for comparison.
We do this to make it easy for non-financial managers and board members. If a number in this column is red, It’s bad. If it is black, It’s good. No math required.
In this case, we did $479 better than planned for income, primarily in Other Income. However, we spent $1,515 more than planned for the month. Adding the two together, we are $1,036 worse than we planned (budgeted) to be for that month.
Note that we had planned to have a loss of $292 for the month, but we did worse than that financially. To answer the question, “No, we did not do well that month, primarily because one department overspent their plan, but this was offset in part by additional Other Income.
But monthly numbers move around a lot. It is not uncommon to see wide variances. The Year-To-Date (YTD) numbers provide a better view.
How Have We Done So Far This Year?
Next three columns answer this question. The three columns are the same Budget-Actuals-Better/(Worse) sequence as in the current month columns.
However, the result is different in this view. We have a Net Profit of $9,868 (bottom line, second column from the right). However, we had planned to be $1,813 in the hole at this point in the year. That means were are $11,681 better than we planned (budgeted) to be at this point.
We can see that $9,226 of this good news came from Other Income. We can also see that the Departments have spent $2,455 less than planned until now. Adding these two variances together gives us the same $11,681 good news.
Many boards also like to see an additional column explaining why the Year-To-Date variance exists. It is recommended, but optional.
Summary
We’ve answered the “How are we doing?” question, but we still don’t know if we are doing well enough. The next post will talk about Full Year Projections, often called the Forecast. Then we will put those together to answer the second big question, “Do we have enough cash to do what we planned to do?”