An annual budget will allow a business to get financial planning for the coming year. It will assist the management team in planning their revenues, expenditures, workforce, investment needs, and cash flow needs. However, an annual budget must not be made and left untouched until the end of the year because the business situation may change very quickly.
Virtual CFO services can be helpful to a business in creating a budget and sustaining it throughout the year. The virtual CFO will be able to analyze the company's financial history, set realistic assumptions, compare the planned performance to the actual one, and give suggestions to the management on how to respond to any deviations.
How Virtual CFO Services Build an Annual Budget From the Ground Up
An annual budget requires an understanding of where the company is financially. A virtual CFO takes a look at the past financial data on revenue, expenses, payroll, cash flow, financing cost, and other financials.
Then, together with the management, the CFO understands what kind of objectives the company has for the next year. Expansion, staffing, higher sales, introduction of products, increasing profit or creating new capacities may be among them.
Typically, the budgeting process is the following:
- Historical review of financial performance
- Creating a projection of revenue
- Forecast of operating expenses
- Staffing and payroll planning
- Planning of investments
- Cash needs
- Alignment of financial objectives with the business objectives
Revenue forecast is especially important because the forecasted revenue determines many decisions regarding expenditure. A CFO can take into account historical performance, current sales, customer demand, changes in pricing policies, and objectives of management while creating revenue forecast assumptions.
All the expenses are planned depending on the needed resources to achieve these objectives.
It is not necessary to make a complicated spreadsheet, but a financial plan that can be used by management during the whole year.
Top-Down vs. Bottom-Up Budgeting Explained
Two common approaches are top-down budgeting and bottom-up budgeting.
Top-down budgeting involves financial targets formulated at a higher level by management, which are translated into budgets of particular departments or functions. Top-down budgeting may help maintain alignment of expenditures with corporate strategy.
Targets formulated without any involvement of operations may sometimes not correspond to actual needs of the organization.
Bottom-up budgeting involves individual departments or teams. Each department makes its estimates regarding revenue, labor force, expenses and other parameters which then make up an organization-wide budget.
This method may be helpful in terms of providing more practical information since people responsible for day-to-day operations understand better their cost requirements.
Virtual CFO services may allow combining both budgeting methods. Strategy is set by management, and information about required expenditure and activity comes from operations.
How Virtual CFO Services Track Budget vs. Actual Performance
Creating a budget is only the beginning. Businesses also need to determine whether actual results are matching the original plan.
Thebudget vs actual analysis involves comparing the expectations of what will take place at a particular time and what actually took place.
For instance, a company may budget a particular income level for a month; however, it can earn either more or less than what was expected. The CFO then analyzes why this happened.
This is also applicable in expenditure cases. Expenditure can exceed budget expectations due to additional hiring, higher cost from suppliers, or unforeseen operations needs. Expenditure can also be less than budgeted due to a postponed plan.
All variances do not necessarily indicate that there is something wrong.
The virtual CFO determines whether the difference is temporary, sustained, favorable, unfavorable, or requires any action.
Reviewing regularly helps the management spot problems early enough. When a particular cost category exceeds budget expectation in one month, it may just be a timing issue. However, when it exceeds the budget expectations in several consecutive months, it means that the assumption has to be revisited.
Budget analysis makes everyone accountable. The departmental managers get to see their budget versus actual, and the management finds out whether resources are used according to business priorities.
When and How Budgets Get Revised Mid-Year
An annual budget helps with planning, but it should not stop an organization from responding to changes that really matter.
Some circumstances that might require an adjustment in a budget include significant revenue changes, unexpected costs, changes in staffing, new investments, a shift in strategy or any other material event.
Reasons for mid-year budget adjustment may include:
- Significant revenue changes
- Unexpected operating expenses
- Significant staffing changes
- New investments
- Expansion to new markets
- Financing changes
Not all variances may require a budget revision. Constant adjustments to a budget may make the initial budget too hard to use as a benchmark.
Virtual CFO services will help management to determine whether some change is normal and how important that change might be.
For instance, some minor revenue timing issues may not necessarily require the modification of the annual budget. But losing a significant client or expanding to new markets might require material adjustments in the initial assumptions used to prepare the budget.
In such a situation, the CFO can revise the budget forecast while keeping the initial budget as a benchmark.
In this way, the management will have two different views: the initial budget which shows what management expected at the beginning of the year, while the updated forecast reflects what management expects based on current information.
Turning Budget Variances Into Action
Identification of a budget variance is valuable only when the management is aware of the reason behind it and makes a decision on the necessity of taking action.
The virtual CFO services provide an opportunity for making financial differences work.
The variance analysis could start with questions like:
- What causes the variance?
- Is it a one-time or permanent situation?
- Will it have an influence on the future periods?
- Is there any impact on the cash flows?
- Have business circumstances changed?
- Is it necessary to revise the forecast?
In case when revenues regularly fall below expectations, then it may be the time to reconsider assumptions about sales or general business strategy.
If expenses regularly exceed expectations, the management can consider whether the extra cost incurred is really necessary, temporary or part of the regular business structure.
However, the increased spending doesn't always reflect poor financial management. The company could decide to invest additional money into marketing, recruitment, and technologies to ensure further development.
Therefore, the variance analysis performed by the CFO takes into consideration specific circumstances.
But in case of regular deviations of actual results from assumptions, management may use these findings for developing more realistic forecasts during next planning processes.
Thus, it creates a continuous process:
Plan → Measure → Analyze → Adjust → Reforecast
The result is a budget that remains useful as the business evolves.
The yearly budget should be used for managing purposes, not just prepared for its sake. It is important to conduct periodic reviews, which will help to determine if the financial performance is still consistent with expectations and goals set.
Services of virtual CFOs that are provided by The Fino Partners could help in each and every step in the process starting from creation of the budget, through analysis of the budget vs. actual and forecasting, till variance analysis.
It would be even more effective if both top-down budgeting and bottom-up budgeting were used. Leaders determine the strategy and finance teams provide the relevant data.
If companies conduct financial performance reviews and take actions accordingly, they can develop a more flexible budget. Thus, managers will be able to make decisions on the basis of current information instead of working under previous assumptions only.
