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Budgeting in project management, or any other field, involves planning and controlling the available resources for a future period. Organizations prepare budgets and allocate resources on the items based on the expected activity level. However, preparing a budget is not the ultimate objective of any organization; a firm should be well positioned to compare the budget to the actual performance to identify any variations between the expected and the actual results. Variance analysis is useful to managers and other users who use available information to deduce the cause for the variation, and make the necessary changes to correct it.
1.Preparation and comparison of the budget with 'actual'
This is the first stage of budget distribution and monitoring. A budget is a planning tool for managing future revenues and costs. Organizations prepare a budget and actual statement to facilitate the comparison of the two; a process known as variance analysis commonly used for decision-making purposes. Sometimes, a difference occurs between the two, which is called a budget variance (McCarthy, 2004). A budget variance can be desirable or undesirable depending on the type of budget. In a cost budget, an actual figure that is lower than the standard cost in the budget is desirable whereas, a lower actual figure that what was budgeted for would be undesirable.
Budget variations may arise from arithmetic errors in the budget or actual results, unexpected occurrences, and variations between the actual results and the budget allocation (Label, 2010). It so happens that, in many organizations, managers strive to eliminate budget variances rather than understand the cause.
Budget variance analysis includes; flexing the budget to factor changes in the level of activity, variance analysis, establishing the cause for variation, and implementing the action (Bragg, 2002). There are five types of variances in project management, namely; start, finish, cost, duration, and work variances (Happy, 2010).
Even though variance analysis is a useful tool for comparing the budget costs against the actual cost, it has a downside too. It has been argued that obtaining the actual costs is time consuming thus, slowing down the monitoring process such that it might even be too late to take any remedial actions (Bragg, 2002). This is undesirable because projects usually work on a budget and a time limit; hence, the essence of costs and time.
2.Monitoring the income and expenditure regularly
Actual activity ought to be monitored and compared to the budget regularly to mitigate unfavorable budget variances. This stage involves identifying a budget variance and explaining the cause for variation. It could help if the people preparing the information would explain the causes for variation to increase reliability and accuracy level. Small variances are not significant thus; they can be overlooked, and weight is usually given to larger ones. Monitoring the actual results enables users to identify problematic areas such as lower than expected income, higher than expected expenditure, or a general change in expected income and expenditure estimates.
Reporting the variance analysis results comes after monitoring the actual results, which is then compared against the budget. Reporting involves thorough analysis to establish the cause for variation and these results should be reported to the manager. Budget variances can be caused by internal or external factors (Gruen & Howarth, 2005). Some of the causes of budget variation include; misuse of resources, higher than expected prices of supplies, delays in processing invoices after items have been received, changes in the level of demand, prepayment and recording of products that are yet to be received, improper budget preparation, lack of consistency in timing, etcetera.
Upon monitoring and identifying possible variance, taking corrective action might be necessary. Management should use the report prepared after monitoring to take remedial actions, which may include, adjusting expenditures, or activity levels.
In this stage, the management chooses whether to take action to correct the budgetary variance. Some of the actions that it could take include making no adjustments if the variance is only temporary or trifling, and it is expected to correct itself in the following period and making predictions about future trends for the whole period. Furthermore, the management could reverse to the figures in the budget, communicate the importance of sticking to the budget while suggesting how this can be achieved, and evaluate of the actions taken.
Taking corrective action is crucial because it reverses the deviations from the budget, thus checking the actual activity. Failure to take remedial actions could result in higher than allocated for costs, and lower than expected income; these may lead to poor performance with respect to other players (Shim & Siegel, 2007). It would be prudent to evaluate the effectiveness of the corrective actions taken to avert potential problems.
Variance analysis is the process of comparing the budget to the actual results. More often than not, a budget variance will exist, but one of less than 5% is usually ignored. It is necessary to conduct thorough variance analysis to detect any deviations through monitoring the actual results, which are compared to the actual budget. However, a variance is said to be desirable if the actual cost is lower than the budgeted cost. The analysts who are responsible for the variance analysis process should indicate the cause for variations, should they find any. The management makes use of the findings to take action to correct the deviation. In essence, managers strive to keep the budget variance as minimal as possible.