Unit 4 Budget Estimating and Variances

Overview

Adding to Unit 3, a leader’s use of budgets are potent tools to lead an organization. A simple budget can be powerful by itself, but with a little bit more effort, the budget can be transformed into being very powerful to aid in ONGOING cost controls within an organization. In fact, there may not be a more powerful tool to accomplish the necessary controls.

In context of this unit, we will add to last unit’s budget building, taking further steps to maximize the power of budgets.

Remembering that budgets are (just) ESTIMATES of what you plan to spend. But keep in mind that too many managers will act as if the budget is MORE than a collection of estimates. Leaders may find themselves not only digging to find the root causes of the variances, but they may also have to navigate conflict management, too.

Due to this fact, the methods used to estimate are critical to “holding to budgets.” Given this, we will investigate various estimating techniques, providing a guide to select the most appropriate estimation method(s).

Once the budget is live, the actual ‘spend’ (and/or revenue) will almost always deviate from the budgeted amounts. They will sometimes make many decisions driven by estimations. If the estimates are close to “reality,” then the decisions would accurately reflect the numbers.

As noted last week, many budget estimates are not accurate, or may even be complete guesses. This radically decreases the accuracy of organizational decisions based on those estimates. And to make these situations worse, managers will often ignore the fact of the poor quality of their estimates – and hold OTHERS accountable for the variances (budgeted numbers minus actual numbers).

Then, using the budget you have constructed, we will analyze your “variances,” - learning how to prioritize and interpret them. In the “real world,” you would discover the root cause of the variance and take appropriate action accordingly. (Sometimes there is no action that can be taken, but just the fact that you have discovered the root cause to KNOW there is no action that can be taken… this is important, too. Commonly, the variance research is what reveals that the estimates were dramatically off from “reality.”)

Proper estimating and variance control are the primary tools that leaders use when “working” their budgets. Budgets are NOT just assembled and forgotten - they are designed to be dynamic while constantly revealing guidance for building/estimating future budgets. There are powerful lessons to be learned in variance research, commonly holding the fate of the organization at stake.

Topics

This unit is divided into the following topics:

  1. Estimating
  2. Variance
  3. Variance Control

Learning Outcomes

When you have completed this unit, you should be able to:

  • Analyze the methods of a proper organizational budget estimating, being able to select the best method of estimating
  • Perform a Variance Analysis to investigate reasons why actual amounts vary from budgeted amounts
  • Recognize how actual amounts and variances can guide leaders to affect teams, organizations, and communities.
  • Demonstrate ways to use standard budgeting tools to guide an organization to make effective and pragmatic decisions.

Activity Checklist

Here is a checklist of learning activities you will benefit from in completing this unit. You may find it useful for planning your work.

Learning Activities

  • Complete the Estimating Budgets, and Revising as Necessary activity
  • Complete the Entering Actuals activity
  • Complete the Variance Analysis activity

Assessment

  • In this course you demonstrate your understanding of the course learning outcomes in different ways, including papers, projects, discussions and quizzes. Please see the Assessment section in Moodle for assignment details and due dates.
  • For this Unit, you will dropbox your budget from Unit 3, with the added details from Unit 4.

Resources

Here are the resources you will need to complete this unit.

  • Mullis, D. and Orloff, J.; (1998) The Accounting Game. Naperville, Ill: Sourcebooks.
    • 978-1-4022-1186-7
    • (TAG)
  • Kline, G. and Dabney, A.; (2013) The Cartoon Introduction to Statistics. New York: Hill and Wang
    • 978-0-8090-3359-1
    • (CIS)
  • Other online resources will be provided in the unit.

Planning Ahead

Before you examine the topics in this unit, take a moment to watch this video that has been provided by the instructor. This video will introduce each topic and help support your learning. You are encouraged to re-watch this video if you are struggling with any of the concepts you will be learning about in this section.

4.1 Estimating

We begin this unit by developing an understanding of the methods or techniques for budget estimating. In Unit 3 you were introduced to the idea of a budget, focusing on the overall shape and formatting of a proper budget. We now turn our focus to understanding the basic concepts of filling the budget with solid data that can be used… in other words, selecting the best estimating techniques to get each budget line item as accurate as possible.

Plus, we will add to our understanding of the basic concepts by filling the budget with solid data that can be used…in other words, selecting the best estimating techniques to get each budget line item as accurate as possible. There are certainly some tools to increase the accuracy of the estimation process, but the numbers are still estimated.

There are certainly some tools to increase the accuracy of the estimation process, but the numbers are still estimated. The following videos help to explain:

Watch: How to Estimate Project Costs: A Method for Cost Estimation

Watch: 7505NSC Lecture 7 - Cost Estimation and Budgeting

Watch: Spotlight on the Difference between Budgeting and Forecasting

In addition, the following video will help reinforce the content of the previous video. If your budget takes place over time (e.g., annual) then you have to spread out your data into their respective time ‘buckets’. In other words, if you have an annual budget with income throughout, you CANNOT have all of your expenditures in January, as you will run out of CASH until the income eventually offsets the expenditures.

It will help you in comprehending the components of a Cash Flow Statement.

Watch: 27. How to read a cash flow statement

4.2 Variance

We now turn our attention to developing an understanding of discovering and “chasing” variances. To do this, our budget must contain the columns of Actuals and Variance.

By using this style of budget, the “power” of budgets will be illustrated and you will see how a budget can be a dynamic document instead of one that is archived after being initially built and “totaled.”

Business leaders use budgets to monitor (progress) and control (make informed decisions).

The videos below help to explain:

Watch: Budgeting: Calculating Budget Variances

Watch: Build a Dynamic Budget vs Actuals Dashboard on Excel (Variance Analysis)

4.3 Variance Control

In Unit 3, we began to develop an understanding of what a budget is. Now, we turn our attention to understanding how to calculate budget variances.

It is imperative that we appreciate that the true power of a dynamic budget is the power to display, and prioritize, variances in a manner that will bring the worst offenders to light (both positive/under-budget and negative/over-budget) and permit leaders to investigate and take applicable corrective action.

To better understand why this is important, and what requires consideration, watch the following video:

Watch: Budgeting: Calculating Budget Variances

A properly built budget will allow it to be used dynamically - instead of being a “snapshot” that is built and never referred to again. A “working” budget is important because it allows for the insertion of “Actual”* expenses AND calculates Variances.

Activity: Estimating Budgets, and Revising as Necessary

For this activity, you will use your budget from Unit 3’s activity

Ensure you have the following column headers:

Description Budget Amount Actual Amount Variance Estimation Rationale

Be sure to include column “Totals” on the bottom of each:

Reconsider EVERY estimation and add a REVISED comment in the Estimation Rationale column (each row should have an entry) if you made any adjustments.

Next, consider how variance control can happen after the vacation is over.

Be prepared to defend your conclusions and share your thoughts with other members of the class.

Activity: Entering Actuals

The idea of a “working” (or Dynamic) budget is to have it usable beyond just initially creating it. In this exercise, we will use the results of the previous Activity to take the next steps toward Variance reporting and investigation.

The objective of this next step, is to develop some semblance of variance analysis skills. You will accomplish this by prioritizing variances and trying to determine the root cause of the largest variances - both negative and positive.

Because this is a fictitious activity based on a scenario, you will be required to enter FABRICATED Actual amounts. Some amounts will be exact (e.g., airfare), while others will be completely variable (e.g., souvenirs and daily food). Your task, for this activity, is to experiment by adding various Actuals (in the appropriate fields that would be variable) to see how it impacts the budget. Also consider revising numerous fabricated Actuals just to see their impact on the whole budget. Your final budget would include a combination of variable Actuals and non-variable Actuals.

Activity: Variance Analysis

After you have inserted these Actual costs, follow the steps below:

  1. Copy your entire budget onto a new tab (on MS Excel)
  2. Highlight the data
  3. Sort the data by the “Variances”
    1. There are a couple ways to do this.
    2. Consider this tutorial if you need help: https://www.youtube.com/watch?v=Bm_uWOUiUFI
  4. You will want to select Ascending or Descending to give you the Largest NEGATIVE variances at the top
    1. NEGATIVE variances are OVER budget
    2. POSITIVE Variances are UNDER budget
  5. Variances near the center of the list should be at (or near) ZERO
  6. Largest POSITIVE variances should be at the bottom
  7. Add a new column to this file as *Variance Investigation*.

After performing this analysis, take some time to determine the root cause of your five WORST (Most extreme, whether negative or positive) variances (ignoring the fact that some may be negative/adverse).

Assessment

Refer to the course schedule for graded assignments you are responsible for submitting. All graded assignments, and their due dates, can be found on the “Assessment” tab.

For this unit, you will upload your budget that includes the above Activities in this unit (carrying over your standard budget from Unit 3 and adding more content).

Checking your Learning

Before you move on to the next unit, you may want to check to make sure that you are able to:

  • Analyze the methods of a proper organizational budget estimating, being able to select the best method of estimating

  • Perform a Variance Analysis to investigate reasons why actual amounts vary from budgeted amounts

  • Recognize how actual amounts and variances can guide leaders to affect teams, organizations, and communities.

  • Demonstrate ways to use standard budgeting tools to guide an organization to make effective and pragmatic decisions.