Page 4: Using budgets
Typical budget statements are given for the Textiles budget/UK Midland region of Davis Service Group. The budget for the year (£81m) is based on the historic year data and the assumptions for the year. The two forecast outcomes use two different sets of assumptions resulting in lower or higher levels of sales.
In the example, sales for the first three months of the year were budgeted at £19.8m. Actual sales were £20.3m 2.5% above budget. If this level of increase were to continue, sales would reach £83m.
Variances may be favourable (better than expected) or adverse (worse than expected). Small variances are inevitable and usually not significant. A key task of managers is to watch for variances that are unexpected, either in their size or timing, and take action accordingly.
Managers generally focus their energy on these 'exceptions'. For example, the weather can cause an unexpected variance for Davis Service Group's business. June and July 2008 were warm, sunny months in the UK; the hotel and restaurant industry was busy and therefore the laundries and their staff were busy. This was followed by a wet August. The number of people going on holiday fell and resulted in reduced linen services. The knock-on effect of reduced traffic in the hotel and restaurant industry was less linen processed at Davis Service Group.
Adverse variances prompt investigation into what has gone wrong. They may suggest:
- unrealistic budgeting; budget data may need to be revised or flexed
- a failure with part of the process (e.g. missed targets by sales force); this needs immediate management attention
- a change in the external environment (e.g. a new competitor); this might require a counter-attack with an increased marketing budget.
Favourable variances represent good news but should not be ignored. Instead they may carry an opportunity perhaps a new market is emerging or a competitor has withdrawn? Either way, managers are responsible for their budget variances and would need to report on outcomes and propose action to their own manager.
Budgets use resources so they are closely linked with key performance indicators (KPIs). KPIs help to evaluate the overall performance of the business. Davis Service Group's KPIs include measurement of:
- organic revenue growth (i.e. sales growth excluding acquisitions)
- operational throughput (e.g. tonnage of linen processed)
- management retention rate (i.e. keeping experienced staff in the company)
- health and safety records (e.g. major incident injury rate)
- environmental performance (e.g. water and energy consumption).
As with the budget, action is prompted through variance from the KPI. For example, if a plant's environmental performance has worsened, does it require additional investment in equipment? If health and safety incidents have increased, do employees need more training?