Common Pitfalls in Budget Actuals Analysis and How to Avoid Them

Budgeting is powerful. Joe Biden remarked, “Don't tell me what you value. Show me your budget, and I'll tell you what you value.”

However, just creating the budget is only half of this activity's true significance.

The second part – unfortunately getting less attention–compares the budget to what actually happened, also known as budget actuals analysis. This process helps business leaders check the original assumptions underpinning their budget calculations, draw learnings, identify and drill down into variances, monitor the business's financial health, enable better strategic decision-making, and make the next budget cycle more accurate.

However, several common pitfalls can distort this analysis, resulting in misleading conclusions and poor financial decisions.

We’ll explore five common budget actuals analysis mistakes and practical advice on how to avoid them.

1. Not accounting for timing differences

Mistake: Businesses often fail to account for the timing differences between when expenses are expected to occur according to the budget and when they happen.

For example, say a business budgets for a significant increase in advertising spend for November and December, anticipating that it will drive higher sales during those months. With this increase in sales, the business also budgets for certain capital expenditures in December. The budgeted advertising expenses are $50,000 for each month, with expected sales increases of 20% compared to the previous months. In reality, however, the impact of the spending is only felt slightly later than expected in December and January.

This has several implications:

• Short-term financial misinterpretation: When analyzing November's budget vs. actuals, it appears that the business overspent on advertising without achieving the anticipated increase in sales. This is inaccurate because the impact was felt, with only the timing not being as expected.
• Inaccurate assessment of strategy success: Conversely, December might show a significant increase in sales that isn't directly attributed to the November advertising spend, leading to confusion about what drove the performance.
• Cash flow issues: The mismatch in timing can also affect cash flow management. The business might find itself short on cash in November, having spent heavily on advertising without the expected return in sales.
• Impact on other projects: Any planned capital expenditure must be re-evaluated.

Advice: Absorb lessons learned in previous years to build timing differences into your budget. This might mean looking back several years to find a similar budget event (such as an advertising campaign) to estimate the expected timing of costs and revenue.

2. Failing to adjust for variable costs

Mistake: Variable costs can fluctuate significantly from the budgeted amounts due to changes in production levels, sales volumes, or market prices.

Consider a manufacturer of computer monitors. Halfway through the fiscal year, the prices of key components unexpectedly increased due to global supply chain disruptions. Despite this, the company fails to adjust its budget to reflect these higher variable costs.

Whether it’s company policy to adjust budgets or not, real damage can be done to the business by not taking this into account. For example, due to these variances, management might erroneously conclude that the manufacturing process has become less efficient or that there is wasteful spending in production, leading to unnecessary cost-cutting measures that might harm product quality or employee morale. Pricing strategy is another area that could be adversely affected.

Advice: If a flexible budget (one that adjusts costs based on actual activity levels) is not an option, then consider a contingency fund. Most importantly, drill down to understand what is driving variances, and ensure this is communicated effectively across the organization.

3. Overlooking committed spend

Mistake: Committed spend refers to funds that have been earmarked and approved for expenditure but have not yet been paid out. Ignoring these commitments can make the actuals appear more favorable than they truly are.

A recent case illustrates this: a technology company that is in the process of upgrading its data center infrastructure. The company has formally committed to purchasing this new equipment. However, the actual cash outlay for these commitments will not occur until the equipment is delivered next quarter.

The company prepares its quarterly financial report and budgets without including the costs associated with these committed – but not yet realized – expenses, showing a healthier financial position than is accurate (showing surplus cash and underreported liabilities).

Advice: Include committed spend in your actuals analysis to provide a clearer picture of your financial position. While challenging, this involves tracking all commitments in a financial system and considering them as if they were actual expenses, even if the cash has not yet been disbursed. In most cases, only a purpose-built solution will enable you to capture spend before it happens.

4. Neglecting non-financial metrics

Mistake: By definition, analyzing the budget and spending only surfaces insights around financial decisions. However, solely focusing on financial metrics without considering the operational or strategic metrics that drive those financial outcomes can lead to a narrow understanding of the business’s performance.

Take a fast-growing online retailer. Management tracks metrics like monthly sales growth and profit margins but might not pay as much attention to metrics like customer satisfaction levels or Net Promoter Scores (NPS). While encouraging success in the short-term, this can have long-term implications for the business that may not be reflected in the budget actuals analysis.

Advice: Integrate non-financial metrics such as customer satisfaction, employee turnover rates, and production efficiency into the budget vs. actual analysis. This broader perspective can uncover insights that purely financial metrics might miss.

5. Inadequate use of technology and tools

Mistake: Many businesses still rely on manual processes or outdated software for budget actuals analysis, increasing the risk of errors and limiting the depth of analysis.

Advice: Leverage modern payment software that offers automation, real-time data integration, and advanced analytics capabilities.

PayEm is the leader in this field, offering a powerful, user-friendly budget control solution. With PayEm you can:

With PayEm, you can:

• Gain real-time visibility for effective budget management, accessing a comprehensive view of all spend data, including off-platform expenses, to stay on top of in-process requests and make informed decisions.
• Transition from Excel and traditional tools, moving beyond the limitations of ERP modules by embracing PayEm's dedicated budget planning tool for enhanced efficiency and collaboration.
• Achieve unprecedented visibility with immediate insight into actual versus budgeted spend, including in-process payments, which aids in informed decision-making.
• Enhance budget owner accountability as they can access all relevant information, reducing their reliance on the finance team.
• Benefit from automatic Budget Variance Analysis (BVA) calculation, where PayEm calculates the variance between planned budgets and reconciled payments, including committed Purchase Orders (POs) and bills, thus promoting a culture of accountability.
• Ensure constant synchronization between your ERP and PayEm, reflecting any budget modifications in the ERP on the platform within a 15-minute window, enhancing operational efficiency.
• Utilize a dedicated interface for quick access to budget details and instantaneous updates, allowing budget owners to track their performance against the budget conveniently.
• Facilitate proactive decision-making and timely actions with real-time visibility and contextualized data, enabling budget owners to implement strategies to minimize divergences and foster fiscal responsibility across the organization.

You can see PayEm in action for yourself or get in touch with a product expert here.