Module 1 of 2 · 60 minutes
Building it, flexing it and explaining the variance
By the end of this module you will be able to
- Build a budget from underlying activity
- Classify costs as fixed, variable or stepped
- Flex a budget before comparing it to actuals
- Interpret a variance and identify the action it implies
Amara Most budgets are last year plus a percentage. What is wrong with it?
Nadia No line in it can be explained. Ask why the training figure is what it is and the honest answer is that it was that last year, and the year before, and nobody now in post knows the original reason.
Amara What replaces it?
Nadia Activity. Clients, shifts, units, cases. Costs then follow from the activity, so every line has a driver attached and can be defended against challenge.
Amara Which cost behaviour catches people out?
Nadia Stepped costs. One supervisor covers eight staff; the ninth requires a second supervisor, and that cost arrives whole rather than in eighths. A percentage built budget smooths straight over it and the jump lands as a surprise in month seven.
Amara Monthly review. The service is over budget.
Nadia First question is whether it did more than the budget assumed. A budget built for a hundred compared against actuals for a hundred and forty produces an arithmetic difference, not a variance. Flex it to actual activity, then compare.
Amara And if it remains over once flexed?
Nadia Then split price from volume. More units used, or each unit costing more. Those are different problems with different owners, one operational and one procurement. A total figure alone produces an argument rather than a decision.
Amara Forecasts in many organisations land back on the budget.
Nadia Then they are not forecasts. The budget is the plan. The forecast is the current honest expectation. Where they differ, that gap is the most valuable figure in the pack.
Amara And closing it on paper?
Nadia Removes the only early warning anybody had. The problem still arrives, later, and by then nobody can act on it.
The written material
Building from activity, not from history
A defensible budget starts with what the business will actually do: how many units, clients, shifts or cases. Costs then follow from that activity, and the budget can be explained line by line to somebody who challenges it.
Last year plus a percentage cannot be explained, because nobody remembers why last year's figure was what it was. It also embeds every past error permanently, since each year is built on the one before it.
Fixed, variable and stepped costs
Fixed costs do not move with activity in the short term: rent, insurance, salaried staff. Variable costs move directly with it: materials, agency hours, consumables.
Stepped costs are the ones that catch people out. They are flat until a threshold and then jump: one supervisor covers up to eight staff, and the ninth requires a second supervisor. A budget built by smooth percentages will miss that jump entirely, and it is usually the largest single surprise in the year.
Flexing, and variances that lead somewhere
Comparing a budget built for a hundred units against actuals for a hundred and forty is meaningless: of course the costs are higher. Flex the budget to actual activity first, then compare. What remains is a real variance rather than an arithmetic one.
A useful variance separates price from volume. Spending more because you did more is a different fact from spending more per unit, and they call for entirely different responses. A variance that stops at the total figure produces blame; one that separates price from volume produces a decision.
Knowledge check
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