Budget vs Actuals Variance Analysis and why it matters for businesses

Oftentimes, an unfavorable variance could be due to a combination of factors. The shortfall could be due, in part, to an increase in variable costs, such as a price increase in the cost of raw materials, which go into producing the product. The unfavorable variance could also be due, in part, to lower sales results versus the projected numbers. A variance is usually considered favorable if it improves net income and unfavorable if it decreases income. Therefore, when actual revenues exceed budgeted amounts, the resulting variance is favorable. When actual revenues fall short of budgeted amounts, the variance is unfavorable.

The methodology behind budget variance analysis is not to make you feel like you are doing something wrong. (Speaking from experience here!) Variance analysis not only provides insight into your operations but it also builds accountability. Understanding budget variances places helps you know whether it’s time to scale your company. In the example annual program reporting cycle dates below, we’ve used red for unfavorable variances and green for favorable ones. We’ve built in formulas that show all unfavorable variances as negative numbers in both revenue, COGS and expenses. If a company had budgeted its revenues to be $200,000 and the actual revenues end up being $208,000, the company will have a favorable variance of $8,000.

When revenue is higher than the budget or the actual expenses are less than the budget, this is considered a favorable variance. Unfavorable variances refer to instances when costs are higher than your budget estimated they would be. You will now have a picture of which items led to a favorable or unfavorable variance. Favorable variances are great if you aim to cut costs above all else. Regulation changes will introduce budget variances if your business reports to a regulatory panel or is subject to stringent laws. For example, enhanced compliance needs when handling customer data will increase your IT costs.

Failing to Account for Changes in Business Conditions

Variance caused by shifts in the business environment is mostly out of your control. But it can still inform your strategy by showing you which changes had the biggest impact on your business’s results. Firstly, you may decide to adjust your budget to ensure it remains realistic. You can also attempt to boost customer demand (perhaps by introducing new features to your product or overhauling your marketing strategy).

  • A budget variance refers to the difference between recorded and planned expenses in your budget.
  • Overperformance variance can be a sign of a competitive advantage that you can capitalize on, and underperformance tells you where you need to improve your operations.
  • By using budget variance analysis, you can monitor spending to identify where the actual results deviate in your business budget and analyze those deviations to reveal valuable insights.
  • For instance, assuming production is cut, variable costs are also going to be lower.

Instead, business owners and entrepreneurs have to make plans and decisions with ever-changing factors like market conditions and consumer preferences. For example, in the sample YTD budget vs. actual below, you can see that sales were overpredicted by 16%, and ultimately net income by 48%. That is a drastic difference and highlights exactly why it helps to monitor budget variance throughout the year to tighten up both the budget for next year and issues with sales.

A variance in your budget is often caused by improper budgeting where the baseline that has been set up has not been reasonably measured against the actual results. However, chronic underspending in developing business assets will lead to a sub-par product. The frequency of analyzing budget variance can depend on the organization’s size, nature, and the level of control required.

How to conduct a budget variance analysis

Unfavorable variance is an accounting term that describes instances where actual costs are greater than the standard or projected costs. An unfavorable variance can alert management that the company’s profit will be less than expected. The sooner an unfavorable variance is detected, the sooner attention can be directed towards fixing any problems. In an ideal world, you want to avoid unfavorable budget variances above your threshold. Unfavorable budget variances (also called negative variances) are indeed a cause for concern, as they have a negative impact on the company’s profitability, cash flow, competitive strength, etc.

Changes in the market or economy

You had budgeted for materials, labor and manufacturing supplies at the outset. A budget variance refers to the difference between recorded and planned expenses in your budget. For example, if your budgeted amount of marketing expenses was $10,000 last month but spent $20,000, you have a variance of $10,000.

Budget Variance

This might happen when an invoice has not been received or a payment was made earlier or later than expected. If an invoice is not entered during the correct time period, it can throw off your whole monthly budget and cause unexpected variances. Remember that every expense item must have a threshold percentage that accounts for the amount of money spent. However, if your projected spend is $200,000, that amount balloons to $2,000. Macroeconomic changes can wreck even the best financial management strategies.

Having an accurate budget is essential for smaller businesses that have less room for error. Whether you’re preparing a financial forecast or a flexible budget, the goal of budget preparation is to estimate revenue and expenses as accurately as possible. But no matter how well-prepared you are during the budgeting process, you’re going to have variances.

When analyzing budget variances, it’s crucial to identify both favorable and unfavorable variances and determine the cause behind them. Companies create sales budgets, which forecast how many new customers for new products and services are going to be sold by the sales staff in the coming months. From there, companies can determine the revenue that will be generated and the costs needed to bring in those sales and deliver those products and services. Eventually, the company can project its net income or profit after subtracting all of the fixed and variable costs from total revenue. If the net income is less than their forecasts, the company has an unfavorable variance.

How to Monitor and Understand Budget Variances

Changing customer needs aren’t usually as drastic as dealing with a pandemic. But it’s important to frequently reevaluate the products and services that you sell to be sure they’re still fitting the needs of your customers. Overperformance variance can be a sign of a competitive advantage that you can capitalize on, and underperformance tells you where you need to improve your operations. The analysis supports forecasting and long-term planning by providing a clear picture of past performance and highlighting areas that require attention. Next, add in any anticipated new clients and the additional income each month in a sort of waterfall effect.

Budget vs. actuals variance analysis can be automated using various tools and software such as financial planning and analysis (FP&A) software and enterprise resource planning (ERP) systems. This can help streamline the process, reduce manual errors, and provide real-time insights and reporting capabilities. While carrying out budget versus actuals variance analysis, a business may get a favorable or unfavorable variance. A variance should be indicated appropriately as “favorable” or “unfavorable.” A favorable variance is one where revenue comes in higher than budgeted, or when expenses are lower than predicted. Conversely, an unfavorable variance occurs when revenue falls short of the budgeted amount or expenses are higher than predicted. As a result of the variance, net income may be below what management originally expected.


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