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How to Read a Budget vs Actual Report

How to Read a Budget vs Actual Report

Every business needs a budget — but having a budget is just the start. In addition to making a budget every month, quarter, or year, you also need to compare that budget to what your company actually earns and spends.

Without a comparison between your forecasted income and expenses and your company’s actual income and expenses, you have no way of knowing whether you are on track, doing better than expected, or falling behind. A budget vs. actual statement lets you compare your projected expenses and income to reality. It is an essential tool for protecting your company’s financial health and for making plans for the future.

What is a Budget?

A budget acts as a roadmap for your company’s finances. When you make a budget for your business, you assign every dollar your company earns a task. For example, some of your dollars might have the task of paying rent while others are tasked with paying for advertising or utilities.

Though you should use previous income and expenses as a guideline when preparing a business budget, the figures you forecast when creating your budget might not reflect reality. You might earn more or less than expected one month or the cost of particular goods or services might increase or decrease.

Your budget is a forecast and a flexible plan. You might need to adapt or adjust it based on what actually happens. Along with creating the budget, it is important to periodically compare it to actual earnings and expenditures. You can then make adjustments as needed.

Generally, a business budget will contain several items:

  • Fixed expenses: Fixed expenses or costs stay the same month after month. They include costs such as your rent or mortgage, fees for services, bank fees, and insurance.
  • Variable expenses: Variable expenses or costs can fluctuate based on multiple factors, such as supply and demand. Often, variable expenses are connected to goods your company sells. For example, the cost of materials might spike one quarter and fall the next. If your team members earn a commission, those can fall under variable expenses, as well.
  • Irregular or one-time expenses: These expenses occur infrequently. They can include the cost of new equipment, moving expenses, or research.
  • Income/revenue: Your company’s revenue is how much money it brings in before you subtract anything from it. When creating your budget, you might look at the previous year’s revenue or industry averages to get a sense of what your revenue might be for the current year.
  • Cash flow: Your budget should also include cash flow or the money that comes into your business and out again. It could be the case that you have more cash coming in during certain months or a particular quarter of the year. Having an idea of when your company is most likely to be flush with cash can help you decide when to make one-time purchases or pay for irregular costs.
  • Profit: Your company’s revenue minus expenses is its profit. Ideally, your profit will grow from quarter to quarter or year to year. In cases when the expenses are more than the revenue, your business will have a loss, not a profit.
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How to Create a Budget

When you create a budget you typically need to look back so you can look forward. If your company is new or just getting started, you might have to rely on industry averages when putting your budget together. Otherwise, you can look at your previous year’s financial statements to get the numbers you need to put together a budget.

  1. Calculate revenue: The first step when making a budget is to forecast your revenue. Using your past year’s revenue as a guide will help you avoid over-projecting in this category. It is better to err on the side of forecasting less revenue than your business brings in rather than more revenue than it earns. If you have a breakdown of prior revenue by month or quarter, that can be even more useful as you put together a budget.
  2. List and add up expenses: Make a list of all of your company’s anticipated expenses, including variable, fixed, and one-time or irregular expenses. Then, calculate the cost of each and add them up.
  3. Determine your profit margin: Your profit margin is how much cash your business has after its expenses get subtracted from its revenue. Ideally, this will be a positive number.
  4. Forecast your cash flow: Cash comes into your business when customers pay for purchases or when clients pay their invoices. It flows out of your business when you pay bills and invoices. Having a balance of cash flow, meaning you have enough money from payments to cover your obligations, is ideal. If you know how much cash flow to expect, you can accurately allocate costs and expenses.

Depending on your situation, it might be beneficial to create multiple iterations of your budget. Having multiple budget versions gives you the opportunity to choose the one that best aligns with your company’s goals.

What Are Financial Statements?

Your budget is just one example of a financial plan you can use to keep tabs on your business’s financial health. Other types of financial statements give you a summary of how your company is faring.

Your company’s financial statements can let you know whether it is generating cash, and if so, where that cash originates. The statements can also give you an idea of whether your company can afford to repay its debts or afford to take on new debt. You can also use your financial statements to see if there are any areas of concern, such as a sudden drop-off in revenue or expenses that are higher than anticipated.

Each type of financial statement has its specific goals and purposes.

Balance Sheet

Your company’s balance sheet provides an at-a-glance summary of its financial status at a particular point. The balance sheet contains three pieces of information. It shows your business’s assets, liabilities, and net worth, also called shareholder’s equity.

Ideally, the balance sheet will show that your company’s assets, when added together, are worth as much or more than the total of the equity and liabilities.

  • Assets: Anything your company owns that has value is an asset. You can sell assets to generate cash or use them to provide services or make your products. Examples of assets include real estate, vehicles, inventory, and equipment. Assets can also be nontangible, such as a patent or trademark. Investments and cash also count as assets.
  • Liabilities: If your company has any debts, they fall under the liabilities category. Liabilities include debts, rent or mortgage, payroll owed, and taxes. If your company has a product in production and accepts preorders for it, those preorders also fall under the liability category.
  • Net worth: Your company’s net worth, or equity, is how much would remain if you sold the company’s assets and paid off its liabilities. Usually, the shareholders or company owners get to keep the equity.
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Cash Flow Statement

Your company’s cash flow statement shows how much cash is coming in and going out from your business. You need to have enough cash available to pay your bills and buy new assets. Keep in mind that cash flow is not the same as revenue. You can have revenue that exceeds your expenses one month or quarter but still not have enough cash to make ends meet.

Essentially, the cash flow statement takes information that is on other statements, such as the balance sheet, and rearranges it. The goal of the statement is to show whether there was an increase or reduction in cash during a particular period.

The cash flow statement usually has three parts, each of which looks at cash from a different type of activity:

  • Financing activities: Your company can raise cash flow from financing activities such as selling stocks or taking out a loan. If you make a payment on a debt or buy stocks, that would decrease your cash flow.
  • Investing activities: If your business buys equipment or property, or invests in the market, the investment activities section of the cash flow statement would show that as an outflow of cash. If you decide to sell equipment or property, the cash flow statement would show the money coming in from that sale as an inflow of cash.
  • Operating activity: The operating activity section of a cash flow statement shows how much cash is coming in from income or how much is going out due to expenses. It reconciles your business’s net income to the cash it used or received.

Income Statement

Your company’s income statement displays the amount of revenue the business earned during a particular period, such as a year or a quarter. The income statement also shows expenses and costs connected to revenue. The bottom line on the statement reveals how much your company earned or lost during the period.

Businesses also use the income statement to report earnings per share, which is the amount shareholders would get if the company distributed its net earnings.

Budget vs. Actual Statement

The budget vs. actual statement compares your company’s budget to its actual income and expenses during a designated period. The information on the budget vs. actual report comes from your company’s budget and its income statement and balance sheet.

While some variances between actual amounts spent and budgeted amounts should be expected, the budget vs. actual statement gives you an idea of whether your company is on-target with its financial goals or it has veered off-course.

How to Read a Budget vs. Actual Statement

It does not take much to analyze a budget vs. actual report, as the statement gives you a side-by-side comparison of your company’s budgeted income and expenses and its actual income and expenses.

For example, in the income section, the budget vs. actual statement will show you a breakdown of all of your company’s sources of income and revenue. In one column, it will show how much you expected to earn during a particular period, such as a quarter. In the other column, it will show you how much the company actually brought in.

During the first quarter of the year, you might have expected your company to bring in $10,000 from the sale of your signature product and $5,000 from the sale of extended warranties. Next to those amounts would be the actual income your business brought in — $12,000 from the product sale and $3,500 from warranty sales.

In another column, your budget vs. actual statement would show how much over or under budget your income was. In the case of product sales, your actual income exceeded your budgeted amount by $2,000. In the case of warranty sales, your actual income was $1,500 less, or -$1,500, than what you expected.

The budget vs. actual statement will also give you a percentage to help you see how much under or over budget you were. Your actual income for product sales was 120% of what you budgeted, while your actual income for warranty sales was 70% of what you budgeted.

The statement should also tally up the different sources of income, showing you how over or under budget your company was as a whole. In this example, your total anticipated income was $15,000, and you ended up bringing in $15,500. So, even though you were under budget in one category, you still earned more income overall than budgeted.

The process of reading and analyzing the budget vs. actual statement is similar for the expenses category and the profit category.

It does not take much to analyze a budget vs. actual report, as the statement gives you a side-by-side comparison of your company's budgeted income and expenses and its actual income and expenses. For example, in the income section, the budget vs. actual statement will show you a breakdown of all of your company's sources of income and revenue. In one column, it will show how much you expected to earn during a particular period, such as a quarter. In the other column, it will show you how much the company actually brought in. During the first quarter of the year, you might have expected your company to bring in $10,000 from the sale of your signature product and $5,000 from the sale of extended warranties. Next to those amounts would be the actual income your business brought in — $12,000 from the product sale and $3,500 from warranty sales. In another column, your budget vs. actual statement would show how much over or under budget your income was. In the case of product sales, your actual income exceeded your budgeted amount by $2,000. In the case of warranty sales, your actual income was $1,500 less, or -$1,500, than what you expected. The budget vs. actual statement will also give you a percentage to help you see how much under or over budget you were. Your actual income for product sales was 120% of what you budgeted, while your actual income for warranty sales was 70% of what you budgeted. The statement should also tally up the different sources of income, showing you how over or under budget your company was as a whole. In this example, your total anticipated income was $15,000, and you ended up bringing in $15,500. So, even though you were under budget in one category, you still earned more income overall than budgeted. The process of reading and analyzing the budget vs. actual statement is similar for the expenses category and the profit category.

The Benefits of a Budget vs. Actual Analysis

Analyzing a budget vs. actual statement gives you a big-picture look at your company’s financial situation. It also helps you zero in on potential problem areas. For example, in the case above, your company might be better off putting more energy into developing and marketing its products than promoting warranty sales. Alternatively, you might consider finding ways to better market the warranties so the actual income aligns with the budgeted amount.

The budget vs. actual report can help you identify factors that might have affected your budget. For example, if expenses end up being considerably higher than expected during one quarter, you can examine the reasons for that increase. There might have been supply chain issues or higher-than-usual fuel prices. It could be that the higher expenses will remain or were just a one-time fluke.

Regularly reviewing the budget vs. actual statement means you can detect issues and anomalies and fix them before they have a significant impact on your company’s financial well-being.

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Planning Maestro from Centage Corporation provides your company with year-round financial intelligence. Its features let you integrate budgeting, deep data analysis, and forecasting into a single, scalable Software as a Service (SaaS). To learn more about producing a budget vs. actual report with Planning Maestro, sign up for a video demo today.