Leveraging Forecasts To Create Insightful Budget vs Actual Variance Analysis

John Baule

In the final segment of this three-part series, our co-founder and CEO, and a former CFO, John Baule, explores variance analysis best practices and the importance of identifying risks and opportunities as part of your forecasts.

How Your Forecasting Approach Impacts Budget vs Actual Variance Analysis 

In the first installment of this series, we discussed annual budgets and how they differed in purpose from monthly forecasts. In the second installment of this series, we discussed our Integrated Accountability-Based Forecasting (ABF) approach. In this final installment, we will discuss the primary reason for budgets and forecasts in the first place - to generate a useful analysis of the variances between what we expected to occur and what actually happened.

Just as a well-defined scientific experiment generates better observations, a well-designed forecasting and budget process provides the raw material for a meaningful analysis of actual to forecast variances and points the way to the necessary mid-year corrections.  

There are three fundamental variance analyses that a Company should complete each month as follows:

  1. A comparison of the previous month’s actual results with the most recent forecast of the results for that month.  For example, if your last forecast was the 9+3 (Jan-Sept actual and Oct-Dec forecast for a calendar-year company) then the comparison would be of actual results for October compared with the predicted October results included in the 9+3 forecast.
  2. A comparison of the year-to-date (YTD) results compared with the year-to-date budget. For example, using our ABF approach of the 9+3, this would be a comparison of the October YTD results compared to the October YTD budget.
  3. A comparison of the updated full-year forecast  to the full-year budget. This is the culmination of the forecasting and analysis cycle.   You have completed items 1 and 2 above, and used them to inform an updated forecast which includes actual results for October, the 10+2. A comparison of the 10+2 full year outlook versus the full year budget tells management whether they are on track to achieve their annual goals.

There are obviously many additional analyses you can perform - comparisons of quarters, comparisons to prior forecasts, comparison of trailing twelve-months, etc., but these three are fundamental.

One type of variance analysis that I have never found particularly useful is the comparison between the month’s results and the original budget for that particular month. While banks often seem to like this, I find it cumbersome because so many of the variances are simply timing differences - we thought we would incur that expense in May, instead we incurred it in June. Explanations of this sort tend to obscure the real analysis of items that will impact the full-year results. If you are executing a monthly forecasting process you will have automatically adjusted for these timing differences in your latest forecast.

Evaluating Risks and Opportunities in Budget and Forecasts

Your forecast should represent your best projection of the full-year and includes those items that you think are likely to occur and that you can reasonably quantify. In accounting lingo, you can think of this as things that are “probable and estimable”.  However, as Einstein once wrote on a blackboard, 'Not everything that can be counted counts and not everything that counts can be counted.' (Einstein often gets credited for this quote, but it actually comes from a relatively obscure sociologist named William Cameron - demonstrating the value of a strong brand).

For example, suppose your business stages outdoor concerts in Florida. You may not have assumed the impact of a potential hurricane in your forecast because you don’t know if or when one will occur or how severe it will be, but you should have at least identified a hurricane as a potential risk to your current forecast. Conversely, if you elected to include the impact of a potential hurricane  in your forecast, say with some monthly expense line item, you have effectively created an opportunity in your current forecast in the event that your business is not impacted by a hurricane during the year.

Not all risks and opportunities are beyond the control of management like a hurricane.   When I was with Mead Johnson, a consumer products company, fourth quarter advertising was always assumed in the forecast but separately listed as an income opportunity until we committed to the agency in August or September. We assumed that we were going to advertise according to plan, but knew we had those extra dollars in our back pocket if we were short of our budget goal. The point is that no forecast or budget is complete without a thorough analysis of the embedded and excluded risks and opportunities.

How to Approach Your Forecasting Process 

Most of you understand that budgeting and forecasting are essential tools with distinct purposes, that doing each at a detailed level is critical, and that forecasting is best done monthly. But how should you develop a forecasting process?

According to a survey by APQC, 43% or respondents list improving planning and forecasting processes as their top priority. But where will finance executives find time and resources when the preparation of the budget alone consumes months of effort? The answer is to use the right tools and methods. 

Over the years, the tool of choice for Finance has been Excel. Although Excel is a great analytical tool, when it comes to building budgets and forecasts, it isn’t scalable. Here are the critical elements of an ideal forecasting process.

1. A consistent and well-defined monthly closing process.  

The monthly close is an unappreciated process. It’s a bit like electricity; disregarded when it is working, but top of mind when it is not. The monthly close is critical to establishing your company’s monthly cadence. Many CFOs focus on the speed of the monthly close; however, I think far more important is the regularity - that you close by the same day each month. Whether you close on business day 6 or day 10 is not as important as routinely closing the books by the target day. Also, by close, I mean pencils down the books are closed. There needs to be a definitive point where one month ends and the next begins.  

2. A well-defined organizational responsibility matrix.  

There should be a clear understanding of the expenses and their department-specific attributions. Additionally, all labor and non-labor expenses should be budgeted and tracked against the department responsible for optimizing the return on the expense.  It is also important that the accounting department records the expenses in the same manner so that actual results can easily be compared to the latest forecast.   

3. A transactional-level  integration  connecting your general ledger and FP&A platform.

Many companies spend days each month extracting or downloading their data from their G/L system once the books are closed and then developing complex Excel workbooks to reconfigure the data and generate monthly reports.  Not only is this inefficient , but you are almost certain to have version control issues when the Controller books an additional journal entry and the FP&A team is already two-days into the preparation of the Excel report. Relying on a directly integrated FP&A Platform eliminates these version control issues. When the final journal entry is processed and all debits equal credits, you must be able to generate standard monthly reports automatically, as well as comparing the results for the month to the latest forecast and the YTD results to the budget. 

4. A well-defined process analyzing variances and updating forecasts.  

This process should include regular conversations with department or functional heads to discuss the budget vs actual variance analysis results and their impact on the full-year forecast. 

5. An appropriate finance technology infrastructure

You must utilize technologies that allow you to collect department-level updates and to quickly consolidate them into full-company views of the budget or forecast, while providing transparency to all stakeholders. If you occasionally do a few weekend home repairs, you may be able to suffice with the toolkit you received 30 years ago as a wedding present but a professional craftsman knows that half the battle is using the right tool for a job. If you are a finance professional in the business of forecasting and analysis, you need the proper tools. Trying to rely solely on Excel is the equivalent of bringing a knife to a gunfight.

The Need For Finance to Develop a Well-Defined Scoreboard

If you are in a financial management role at a Company, the odds are that you produce nothing physical. You do not hammer any nails, twist any screws or insert bolts into sheet metal.  At the end of your day, there is likely nothing physical other than reports, which become obsolete shortly after creation.

Many characterize finance practitioners as “numbers” people, which I suppose is true, in as much as Shakespeare was an “alphabet” person.  No one, however, would judge Shakespeare on his skillful use of specific letters, they judge him on the word interplay and the stories he created with them. Similarly, a finance leader uses numbers and accounting as a vehicle to create the context for meaningful company conversations.

Comparing Mature Finance Functions to Lackluster Ones

To better understand how mature finance functions operate, consider a trio of coaches huddled together during a time-out in the closing seconds of a game discussing the best play to run in the situation. The information on the big stadium scoreboard is never explicitly discussed and yet it informs every aspect of the coaches’ conversation. The information and the metrics that are reflected on the scoreboard are so well-defined and their meaning so well-understood, that they become an invisible and frictionless part of the coaches’ decision-making process. This is indicative of finance’s role in a company.

In companies that struggle with the challenges of monthly reporting and expend significant effort just to compile an annual budget, and where multiple departments maintain their own versions of metrics; finance is all about the numbers.   In these companies, management meetings quickly go off-track; finance and sales don’t agree on the value of bookings in a month; human resources have different headcount numbers than everyone else, etc. These companies never get past the numbers and their lack of an analytical framework hinders their ability to have the “right” impactful strategic conversations.

In companies that struggle with financial processes, finance is all about the numbers. In companies with well-honed finance processes, it is all about the conversation."

Contrast this with companies which have mature financial processes, a regular reporting and forecasting cadence, and well-defined, universally accepted metrics —these companies rarely discuss the mechanics of finance. Similar to the scoreboard, financial understanding is embedded in the organizational DNA, informing every discussion. Typically, these companies have higher-quality conversations, make more informed decisions and likely generate superior outcomes.  

Do's and Don'ts of Successful Finance Leaders - FutureView Systems free white paper

Partnering With The Optimal Finance Solution Provider

The bottom line is that companies are largely defined by their internal conversations, and thus, it stands to reason that those having the highest-quality conversations are likely to win in the long-run. These conversations are made possible by a high-performing finance team using well-honed processes. 

If our discussion on budgeting and forecasting has resonated with you and you would like to build a world-class integrated budgeting and forecasting process that is scalable and efficient, I would encourage you to take a look at FutureView Systems. Our platform not only includes robust technology, but it incorporates tried and true methodologies developed through years of real-world finance experience.  

Ready to create a high-impact finance function and transform your Company? We would love to speak with you. Request a demo or contact us to learn more.



Schedule a Personalized Demo

FutureView Systems yellow line break

Let us know what interests you most, and your availability. We look forward to introducing you to the FutureView Systems platform, and demonstrating how it can transform your finance processes.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.