Most business owners have their own way of measuring their success. It could be cash in the bank, number of clients on the waiting list, how many holidays they’re able to take. Metrics like these are really important, as they’re often the reason the owner got into business in the first place. It can be hard to measure these in terms of performance so this article will describe a few standard ways of measuring progress that might apply to everyone in these situations.
Reporting on your business progress is really important. You can use Xero to create monthly reports that can be customised however you like; check out their article here which explains how to customise a report. Customising is useful because you can change the date range you report over, group expenses into categories, and report income against separate expenses in sections. You can also customise a report to report against your budget or prior period figures.
We recommend understanding what your Key Performance Indicators (KPIs) are before you begin. Your KPIs are those metrics which you track in detail and what you’ll be looking at in your report. Our article here explains how to figure out which ones matter for your business.
This is where your budget comes in. A monthly profit and loss report can show you how your business is performing, but a budget is the way you can compare how you did against how you were planning on doing. A straightforward way of looking at this would be preparing a monthly budget variance report. This would display in 3 columns:
- Your results for the month…
- Next to your budget/expectations for the month…
- With the third column showing if you were over or under budget for each item (the budget variance)
Budget variances can be slightly confusing, as negative can be good in some cases but bad in others. For example, if your actuals versus budget for sales show a negative number, that means that you’re under budget for your sales, which isn’t ideal. But if you see a negative number when looking at expenses actuals versus budget, then that means your expenses are tracking under, which could be a good thing (or also not – read on).
The absolute most important thing with budget variances is to understand why that variance has occurred. Just because your expenses are under budget doesn’t necessarily mean you’re doing as well as it looks, you could have budgeted for a large expense and not yet received the bill. So it is just a timing difference.
The simplest way of understanding budget variances is to figure out what you want to track:
- Decide your KPIs (article here) and then what financial metrics best represent these
- Decide your safe zone (materiality) – this is either the % variance or the dollar value variance that you are ok with. It could be you only look at variances more than $1,000, or that are 25% different than what you budgeted
- Investigate variances that relate to your KPIs or fall out of your safe zone until you understand how they occurred, and what impact they might have going forward
So long as you understand why a variance has occurred, and you’re confident it isn’t a material ongoing effect, then there is no need to update your budget. Your budget is the plan you made so reporting against it rather than manipulating it to match each month is where the value is.
When comparing your actuals to budget you need to think about what is actually useful for you to see, and how your business operates. For example for many charities we work with, a budgeted expense line is actually the maximum allowable spend for the year. So looking at how much is spent each month against what is budgeted isn’t very helpful. They want to know how much they have left to spend for the year for each expense item. This creates a very different report, a budget remaining report, which shows:
- Results for the year to date…
- Next to the budget/expectations for the whole year…
- With a column showing how much of each budget is left to spend/has been overspent
One note with this method – be careful to look at items line by line, as looking solely at totals can mask overruns in some areas. If your organisation has a policy of spending all budget, then any overruns should not be allowed to offset underspends unless this has been agreed. Otherwise you’ll reach the end of the year and have spent far more than you were planning.
A third option is to look at how far through your total budget you are for the year to date with a year-to-date budget variance report by:
- Results for the year to date…
- Next to the budget/expectations for the year to date…
- With a column showing if you were over or under budget for each of those items.
This is a good method for businesses that have operations that are really similar month to month.
As mentioned above, the point of a budget is to see how you perform against the plan you made. Therefore there isn’t much sense updating your budget every time you see a variance. However the following circumstances are indicators that it might be worth making a change
- A large increase in a monthly expense that is out of your control
- A change in your business such as adding a new product line
- Employing someone that you’d not budgeted for
Updating your budget for large, recurring changes will give you the opportunity to look ahead and make sure your business is still healthy, or if there are other downstream effects that mean there are other changes you’ll need to make too.
It can also be of use to review your performance against other businesses in your sector to see how you’re tracking. In the Wealth section of Beany if you have connected up your Xero account we can report your sector performance data. Sector performance usually incorporates a large range of business sizes so it is often most relevant to look at absolute (percentage) values rather than total dollar values (e.g. someone who is a web developer contractor would be in the same sector as a large web development firm, so look at total sales dollars as a performance metric wouldn’t give a particularly useful result). Speak to our Support team if you need any assistance setting up your Xero integration.
Reporting against your budget can suddenly create three times the amount of figures that you started with and seem overwhelming.
Your Beany accountant or our friendly Support team are here to answer your questions, plus we offer a full budgeting product which you can purchase through your Beany page.