Since there are so many variables that go into estimating costs and due to uncertainty, you should compare your estimates to your actual costs.  Why? Well, first of all the auditors most likely will and you want to be prepared to respond to any questions.  However, it is sound business practice and will only benefit your company in the short and long run.  Trust me, when you least expect it, you will be glad you did.

 

Actuals provide a sound and verifiable starting point for your estimates.  The difference, or variance, between your estimates and actuals becomes your focus of analysis and explanation.  This one number, the variance, tells you how much and why the change.  The change in cost from actuals may be up, down, eliminated completely, or newly added.

 

As I always strive to do, let’s keep this concept and process simple.  Here are 10 basic steps: 

  1. Look at the difference, or variance, between your actual and projected cost for “Each Line Item Account” on your Income and Expense (I&E) Statement.
  2. Determine why that accounts costs is changing
  3. Briefly document, or at least be prepared to explain the cause
  4. Determine the importance of the change to the company’s goals and the contracts effectiveness and rate the change Low, Medium or High.  This will provide you with “Options” if you must come back and change your estimates for competitive reasons or due to funding limitations of your customer.
  5. Identify all general assumptions used in your estimates.  For instance: Cost of Living Adjustments (COLA), Location Inflation Adjustment, Health Cost Adjustments (its good to isolate this due to its significant costs escalation compared to other costs)
  6. Formalize the above in an easy to read and follow manner.
  7. Indicate the “Date of Estimates and Assumptions” on all documents above
  8. Prepare an “Estimates” main hanging folder (or similar to your preference)
  9. Title a regular folder with the date and/or contract that the projections apply
  10. File everything in the folder

 

You are now as prepared as one can be IF you are ever called on to substantiate your estimates.

 

Remember, these are estimates for your “Company’s Overall Business” over a “Stated Point in Time”.  For small businesses, the time period acceptable is generally your fiscal year.  This is your company’s normal operating period each year. 

 

Although this is considered your Budget for each New Year and should be a part of every company’s' annual process, I am also talking about estimates that are required due to Proposals, Bids, Adjustments, etc.  These can occur at various times during the year.

 

If you are preparing estimates, for example mid-year, then you should prepare your estimates to reflect your “Entire Fiscal Year”.  This requires you to Start With Your Actuals year-to-date (there we go again with the actuals).  Then make your estimates for the remaining of the current fiscal year.  Again, in making your estimates you should be prepared to explain variances.  The result is that your current fiscal year will be a combination of “Actuals Y-T-D and Estimates For The Balance Of The Year”.  You next Full Fiscal Year will be estimated from that point, based on your current year numbers estimated.

 

Please remember that Risk and Materiality are important.  Don’t be too concerned about small dollar expense accounts.  You can make some general assumptions on these items with little impact on the results.  Focus on the larger expense accounts that could have significant impact on your business profit and competitive position.

 

So, is it important to compare Estimated to Actual costs even if there appears no correlation to what happened in the past to what might happen in the future?  In my opinion, the answer is Yes!

 

Paul Sr.