When you prepare a budget or decide on an investment, you can be certain of one thing: The numbers will not be exactly as you predicted. That's why you need to monitor your results. If they differ significantly from your projections, you can take corrective action. If they are more or less on track, you can be confident that you are in control of the situation.
PERFORMANCE OF AN INVESTMENT
When you evaluate a new investment, you're planning for the long term- typically a year or more. But if you track your projections monthly, you'll spot variations early.
Consider Amalgamated' s new Coatrack Division. The senior team ended up using Theodore Bullmoose's optimistic cash flow projection of $75,000 a year (or $6,250 a month) as the basis for its investment. "Amalgamated Hat Rack, Coatrack Division, January 2022 results," shows the state of affairs early in the first quarter. (For simplicity's sake, we'll assume here that operating profit is equivalent to the cash flow projections used for NPV calculations.)
The division is doing reasonably well on revenue and cost of goods sold. Its most significant negative variance is in the marketing expense line. It's difficult to be certain on the basis of figures from just the first month: Is this simply a onetime or seasonal variation? Or will Amalgamated have to spend more on marketing than anticipated?
If your ROI varies from what you expected- and the pattern of unexpectedly high costs ( or unexpectedly low revenue) seems likely to hold- it may be necessary to correct course. Amalgamated might decide to reduce its marketing outlay. Or it might decide to keep spending at that level, recalculate the expected cash flow, and see whether the investment still makes sense. Since Bullmoose's projection was highly optimistic, the company has some wiggle room before it must conclude that it has made a bad investment.
PERFORMANCE OF AN EXISTING UNIT
Tracking the budget for an established unit involves many of the same procedures. You monitor results so that you can make spending or operating adjustments as quickly as possible. When a line item contains a surprise, ask first whether the reason is related to timing. In other words, are you looking at a monthly aberration or a long-term problem?
If you suspect an aberration, don't be too concerned; the situation should straighten itself out. Just keep a close eye on that line item in subsequent months. If the variance is not an aberration, however, you need to determine why i's occurring. Maybe expenses are higher than budgeted because sales have increased sharply, in which case expense overruns would be good news rather than bad. Alternatively, maybe you made a poor projection and must find some way to make up the loss. Can you decrease spending on other line items to compensate for those that are over budget?
TIP: ENLIST HELP WITH ABERRATIONS
Involve team members in addressing variances. They're likely to have some good ideas about what's going on and what to do about it.
FORECASTS
In addition to comparing your actual results to the budget, you'll sit down and update your projections with new information to create forecasts. But don't throw out the old estimates in the process. When budget time rolls around next year, you'll want to assess how accurate your original assumptions were. That will help you improve your estimates the next time around.
If you are well off budget partway into the year- and if your forecasts don't show a correction- let senior management know. Explain the reasons for the variances and how you propose to make up for them. That way, the senior team can adjust the overall company forecast and perhaps provide direction on whether and how to address the shortfalls.
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