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Budgets help you set financial goals. They also provide a way to review actual performance against these goals. Because a budget is an estimate of future numbers based on information already known, your business’s actual performance should be similar to the budgeted amounts. Actual performance, however, will never be exactly the same as the budget. It will come close, fall short, or exceed the budget. Your job is to monitor the budget to answer the following questions:
- How close did the business come to the budgeted figures?
- What adjustments, if any, should be made to the current year’s budget?
- What adjustments, if any, should be made to budgets in future years?
- What changes, if any, should be implemented to improve performance?
The budget should be monitored on a regular basis throughout the year: quarterly, monthly, or even weekly. Consistently reviewing the budget will help you identify problems before they cost the business too much time or money. How often you review the budget depends upon your confidence in the figures and the risk associated with not meeting the budget. For example, if you must meet a certain budget in order to meet your loan obligations, the risk of falling short is high. You should review the budget often in order to assure that the business is on track.
You might also consider adjusting the current year’s budget at various intervals throughout the year. Many businesses will re-evaluate their budgets halfway through the year. This way they can assess the actual results for the first half of the year and adjust the budget for the second half of the year so that the budget more accurately represents real expectations.
Stop and Think
Carol Frank, founder of Avian Adventures in Dallas, Texas, a company that creates a premium quality line of bird cages, and author of the book Do As I Say Not As I Did!: Gaining Wisdom in Business Through the Mistakes of Highly Successful People, hosts a quarterly retreat for all her management team members. At this function, the team reviews budget variances between estimated amounts and the actual quarterly figures. Based on this analysis, together the team reviews and adjusts the budget for the rest of the year, making it a useful budget.
Falling Short of Budgeted Figures
When your business is not able to meet budgeted figures, start by reviewing the business strategy that formed the basis for the budget. Some aspect of implementing your business strategy did not happen as expected. Did you misunderstand the market? Did you have too little information? What do you know now that will change the budget in the future? Can you still plan for profitable performance based on this business strategy?
You also need to take a hard look at the budget figures, paying close attention to the major components of profitability—Sales, Cost of Goods Sold, and Operating Expenses. Maybe you met your Sales goals and understood the Cost of Goods Sold, but misjudged Operating Expenses. Evaluate the changes you must make to future budgets to include this new knowledge.
Exceeding Budgeted Figures
Entrepreneurs would much prefer to exceed the budget rather than fall short. A considerable variation between forecasted amounts and actual amounts, however, places some doubt in the budgeting process, even when it is in your favor. Exceeding the budget by a great deal implies that the budget was either too easy or inaccurate. In either case, you will want to review each of the major components of profitability to determine where the variations occurred. When you discover the reasons for your discrepancies, form a more accurate future budget that will be more helpful in guiding your financial plans.