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23.5 Explain How Budgets Are Used to Evaluate Goals

Performance Evaluation​

Budgets provide benchmarks for evaluating performance:

  • Budget vs. Actual: Compare actual results to budgeted targets
  • Variance Analysis: Analyze differences (variances) between actual and budget
  • Management by Exception: Focus on significant variances

Variance Types​

  • Favorable Variance: Actual results better than budget
  • Unfavorable Variance: Actual results worse than budget

Examples:

  • Actual sales > budgeted sales = favorable sales variance
  • Actual expenses > budgeted expenses = unfavorable expense variance

Variance Analysis Process​

  1. Compute variance (actual - budget)
  2. Determine whether variance is favorable or unfavorable
  3. Investigate significant variances
  4. Determine causes
  5. Take corrective action if needed
  6. Update future budgets if necessary

Quantitative and Qualitative Factors​

Budget evaluation should consider qualitative factors:

  • Market conditions
  • Regulatory changes
  • Currency fluctuations
  • Staffing issues
  • Operational disruptions (e.g., supply chain, pandemics)

Behavioral Considerations​

  • Avoid punishing managers for variances beyond their control
  • Recognize achievements
  • Use budgets for continuous improvement, not blame

Key Performance Indicators (KPIs)​

Budgets often include KPIs:

  • Revenue growth
  • Gross margin
  • Operating margin
  • Cash conversion cycle
  • Return on investment

Balanced Scorecard​

Budgets can integrate non-financial goals (customer satisfaction, process improvements, learning and growth).

Luxembourg Compliance Note​

In Luxembourg, budget variance analysis helps SMEs respond to economic changes (e.g., cross-border worker regulations, energy costs). Banks may request variance explanations for covenants.

Think It Through​

Should favorable variances always be celebrated? What might an unexpectedly high favorable variance indicate?