Question

Describe the budgeting control process and explain how significant variances are determined.

minimum of 300 words.

Answer 1

Budgetary control is financial jargon for managing income and expenditure. In practice it means regularly comparing actual income or expenditure to planned income or expenditure to identify whether or not corrective action is required.

For example most University departments are given annual chest budgets for general equipment. By regularly comparing actual expenditure on this budget to planned expenditure a department will be aware of whether a particular item can be afforded. If the account is in deficit a department will need to identify an alternative source of funds (e.g. departmental reserves or charging to a research grant or contract). This process of monitoring expenditure and taking appropriate action is known as budgetary control

Variance Analysis

After the year gets going and the actual results start coming, the management starts comparing the actuals with the budgets. At this time variances from the budget are identified, and the management has to dig deep to find out the reasons for such variances. This analysis is used for maintaining a control over the business. For instance, if the budget for sales is INR 1,00,000 and the actual sales are INR 80,000, variance analysis produces a difference of INR 20,000. This analysis is effective when the management reviews the variance on a trend line. Sudden changes in a month to month (MoM) variance are clearly visible. This analysis also requires investigation of these variances which helps the management to interpret as to why such variance or differences occurred.

Application of Variance Analysis

a. Comparing Budget with Actual: Variance analysis helps in managing the annual budgets by monitoring the budgeted figures and comparing it with the actual revenue/cost. In case of companies which are project or program driven, the financial data are evaluated at key intervals such as month close, quarter end, ect. For example, the month end reports can just provide quantitative data with respect to revenue and expenses or inventory levels. However, variance analysis would help to understand the reasons behind the variances between planned and actual revenue/cost which could lead to adjustments in the business strategies and end objectives.

b. Identifying Relationships: Relationship between a pair of variables/elements/items could also be identified with the help of variance analysis. Correlations (both positive and negative) are critical in business planning. For instance, variance analysis could reveal that when the sale for Product A rises there’s a correlated rise in the sales for Product B. Thereby, revealing a positive correlation between 2 products.

c. Forecasting: Forecasting uses patterns of the past data for developing a theory about the future business performance. Variances are placed into the context which helps analysts in identifying factors. For example, seasonal change holidays could be a major cause of positive/negative variances.