Too often, the variance itself becomes the bad news. So instead of fixing what the budget reveals, we find ourselves covering up, writing acceptable explanations, or blaming outside influences. The only real consequences of this is to neutralize the budget and bypass its intended control features.

What Variances Are Significant?
In deciding to track down both positive and negative variances and analyze their causes, you must address another question: Will you explain every variance,  or only those that are significant? It doesn’t make sense to explain every account, when some will show variances of only a few dollars. Only the “significant” variance needs explanation. Too much unimportant detail is time consuming in preparation and review, and distracts from the value of a variance report.

How do you make the distinction? You need to set a policy (or, more precisely, ask top management to decide upon a policy and then impose it on each department) concerning the definition of a significant variance. This definition should apply to positive and negative variances, and should involve both the amount and the percentage of variance. For example, you could decide that a “signifi¬cant” variance is one that varies 10 percent or more from the budget, when the amount is $1,000 or more.

The amount and percentage should be modified up or down based on the volume of income, costs, and expenses, and on the outcome of the variance report. You should be able to spot a truly significant variance by simply looking at the amounts and percent¬ages as they fall.

But as unreasonable as it is to ask others and ourselves to waste time, often that’s what budgeting is all about. We stay late every night for weeks and place similar demands on subordinates. We rush to meet deadlines, only to discover that the whole thing is being revised. We make up numbers without any logical reason, and they are accepted without question.

These are the reasons budgeting causes such dread. Everyone knows the budget is a useless waste of time when it is prepared under the usual method. You can change this, however, by suggesting to your management that the budgeting philosophy be changed-that it can be used as a profit center rather than as a waste of time. Your company is constantly looking out for new ways to improve the bottom line. Yet few people realize that the budgeting process itself can be used as a profit center.

The usual process looks like this: weeks of discussion, filling out forms, more discussion, more forms, and, way beyond deadline, a “final” budget. Of course, that final version is changed yet again, so it’s nearly the end of the first quarter before the budget is accepted. In some companies, the budget for the new year is barely finalized when six-month revision work starts.

There is little if any follow-up on the budget. Once the budget is done, there are no meetings to discuss variances and their causes. Or maybe causes are discussed, but no one takes any steps to fix the problem. So it goes on, until the next revision deadline or year-end.

What is wrong with this description? It is not budgeting! It’s only filling out forms and passively finding and acknowledging problems. Lacking are the controls and actions that bring budgets to life, the follow-up, the investigation, and the reversal of discovered negative trends. Without these steps, the budgeting process has only gone a fraction of the way toward achieving its intended purpose.

A big problem with monthly reporting is that previous, unresolved variances fall between the cracks-unless there is some fol¬low-up procedure to investigate and correct a problem. Anyone who has been involved with budgets already knows how difficult it is to add this amount of bureaucracy to an already paper-intensive procedure. The important thing is to know why a variance exists and to take corrective action, if possible.

By the time you come to the end of a budget period, having to summarize a large number of variances belonging to past months may be quite irritating. But remember that the purpose of the budget is to set a measurable standard, and not to guess the future precisely. The problem of outstanding and uncorrected variances only emphasizes the point that no one can really predict the future. A best guess is acceptable; an informed best guess is extraordinary.

Remember this key point: The purpose of developing assumptions is not to specifically guess at future expense levels, but to arrive at a reasonable standard against which the level of future expense can be judged.

Some expenses can be budgeted from an assumption base dictated by contract, such as rent or equipment leases. For these types of expense, budgets are incredibly easy. Since there is no varying level to watch for, there is no need for control, nor is there an opportunity to reduce expenses through monitoring and correction. One exception: when market expansion could dictate additional facility or equipment leasing. In that instance, careful planning, control, and pre-approval should be part of the plan and budget.

Other expenses are entirely unpredictable, and present a much more complicated budget challenge. For example, building or equipment maintenance cannot be predicted by amount or by timing. The only fair way to budget is to set up a reserve in the budget, and allow expenses to fall against that reserve. The reserve amount can be established based on historical maintenance patterns, the age of equipment on hand, or plans to replace equipment during the year.