Time For That Mid-Year Budget Tune-Up

If you were smart, you worked up an annual budget late last year. It’s now six months old, and what has that budget done for you lately? Not much, if it is stuck in a drawer, forgotten and unloved. But when put to proper use, your 2007 budget can tell you how your business is growing (or not) and guide you in making the spending decisions and trade-offs that will increase your chances for successful full-year results.

A budget is a reflection of how we think our business will run in an upcoming time period; it predicts how much revenue we will take in and how much we’ll incur in expenses. A budget may or may not have been put together based on an exacting review of past financial results. Either way, comparing your 2007 budget to actual current- year profit and loss results is a good opportunity to make sure that you are fully aware of the reality of your current operating environment and the profit implications to your business in 2007.

By July 1, there is no hiding from the current year’s actual results. For example, a business owner who is expecting to earn $900,000 profit in a year might dismiss a $20,000 monthly profit in the month of January as a slow post-holiday start on the year. But if the same business owner has posted only a $120,000 profit after the first six months of the year, it’s time to take a realistic view of whether the $900,000 is still an achievable goal, and if not, what to do about it. Unlike a single month’s actual results, six months’ results have some gravity; it is less likely that a single unexpected event such as a lost customer has caused a dramatic change.

Checking in after six months’ time makes it easy to do the math, too. Simply double the first six months’ revenue, and if the result is less than projected annual revenue, your sales are under pace. Likewise, double six months’ expenses, and if you are over the year’s expense budget, you are spending ahead of budget. In each case, you have the choice: Improve results in the second half or fall short of targeted profits on the year.

A midyear review isn’t just for dealing with bad news. Sure, it can help you decide to cut back on expenses if your sales are 10% below target. But what if a close examination of your budget reveals the happy news that sales are up 20% over your original estimate? You can decide to reinvest a little more in marketing or another area of the business, with the full confidence that the extra expenditures are both affordable and warranted.

Conduct a Detailed Review
A detailed comparison of actual versus budgeted results for revenue and for each spending area will lead to greater insights on spending items that may have been overlooked in the budgeting process. For example, a business owner who built his year’s marketing budget to cover advertising and direct mail would surely realize that he has neglected to cover trade show costs in his budget once he reviewed expenses for the first six months versus budget. But if the budget was done only for very broad categories such as Cost of Goods Sold and General & Administrative Expense, it might be possible to overlook the fact that these bills were never included in the year’s budget. Generally, more detail is better in a budget. (For instance, if profits are running below estimate, knowing that the cost of raw materials went up, while other costs held steady, helps pinpoint the cause of the profit decline.) If the year’s budget was created with a sufficient level of detail and appropriately documented, this review will be straightforward and efficient
There are two different ways to compare actual spending to budget:
1) Compare spending pace vs. the time passed, and
2) compare actual spending vs. budget on a month-to-month basis.

The first method is the simpler of the two, as you simply take the actual revenue and spending for each category and divide by the year’s budget to get a percentage, which is then compared to the percentage of the year that has passed. For example, after five out of 12 months, or 41.7% of the year, have gone by, spending over 41.7% of the year’s budget for any category is “ahead of space,” and may signal that spending is going to overshoot the year’s budget before the 12 months have passed.

A month-to-month comparison of actual spending vs. budget is possible only if you took the additional step of transforming your annual budget into a monthly budget. For business with seasonal sales, this can lead to an even more accurate analysis, especially if these seasonal factors were worked into the monthly budget.

Implications and Decisions
The real payoff from doing the kind of budget analysis described above is that it allows the business owner to make decisions and spending tradeoffs with a greater understanding of their implications to current-year budget results, and a greater level of intentionality of delivering hoped-for profit results.