What Is Budget Variance — And How To Calculate It

Budgeting is an essential process that businesses use to project their estimated earnings and expenses over a specific period of time.

This process helps guarantee that resources are available to execute business initiatives and meet objectives.

Budget variance is a measurement of how closely revenue and expenses match up against an organization’s budget. It helps assess how well the plan was constructed, allowing businesses to adjust their plans if necessary.

What is Budget Variance?

Budget variance is the difference between actual sales and costs and those planned in your company’s budget. It serves as a valuable tool for financial managers to assess their organization’s performance and identify areas for improvement.

Budgeting for one project or the entire company can lead to unexpected discrepancies over time. These deviations could be due to various causes, such as price changes and unanticipated expenses.

The good news is that most budget variances can be managed. Utilize this data to make changes to your business’ budget or even set new objectives based on what you’ve learned from a budget variance analysis.

Once a month, review your budget variance to identify trends and make necessary course corrections. For instance, if customers are leaving faster than anticipated, assess how well your customer acquisition strategy is working. Or if profit per customer isn’t enough to cover expenses, evaluate ways to enhance marketing and product development tactics.

Another purpose of checking budget variance is to decide if it’s time for any major adjustments in your business. For instance, if labor expenses turn out higher than anticipated for your project costs, you might want to assess whether investing in improving efficiency or raising prices makes sense.

If your payroll expenses appear to be increasing over time, it could be a sign that you should evaluate how much is spent on hiring new employees. Comparing actual expenditures with amounts in your budget allows for quick identification of what needs changing and can help determine where money is being spent incorrectly.

How Do I Calculate Budget Variance?

Calculating budget variance begins by collecting all relevant data. This could include actual sales and costs as well as budgeted values for each line item. Afterward, create a spreadsheet where you can compare those figures and identify any discrepancies.

Variance analysis is an indispensable tool for businesses that want to understand how their financial performance has changed over time. Additionally, it can help make forecasting more precise.

A variance analysis report is more insightful than a standard budget, as it allows for tracking trends over time and making necessary adjustments to improve business operations. It can also assist in discovering new value creation opportunities through process optimization and strategic spending.

Budget variances come in two forms: favorable and unfavorable. Favorable variances indicate a positive impact on the business, such as higher than anticipated sales or lower-than-planned expenses or costs.

Unfavorable variances are those which indicate a negative impact on the business. Causes could range from inefficient processes to complex issues like employee turnover.

A variance report can assist FP&A and finance professionals in pinpointing areas for improvement. It’s also an effective means of communicating with other departments and stakeholders about how the company’s financial performance is evolving over time.

When creating your variance report, utilize chart diagrams to make it simpler for people to comprehend the outcomes. For instance, a waterfall chart diagram organizes results by breaking up expense items into distinct categories.

It’s essential that your formulas for calculating budget variance are straightforward and intuitive to follow. Doing so will reduce human error, which could result in costly budgeting miscalculations.

Tracking variances throughout a project’s lifespan is essential for staying on budget. That’s why selecting project management software that can keep your budget data accurate in real-time is so critical.

ProjectManager can make this task effortless and help you avoid cost overruns. It’s a powerful, cloud-based solution that keeps all of your budget data updated in real time, helping you manage projects more effectively. Take the free trial now!

What is Favorable Variance?

When comparing your company’s budgeted revenue and expenses with actual results, you may notice some discrepancies. This is known as a variance, and it’s essential to comprehend its significance so you can make better financial decisions in the future.

Favorable Variance is when your company achieves more sales or reduces costs than anticipated. This can be an encouraging sign for the business, showing that everything is going as planned and you’re making the right decisions.

Unfavorable variance, on the other hand, occurs when your business generates less sales or incurs more costs than anticipated. While this can be detrimental to your operations, it’s not always a major concern.

It is essential to recognize that favorable and unfavorable variances can occur for a variety of reasons, such as changes in business conditions (e.g., supplier pricing changes), management negligence or the absence of an organized budget.

Consider this scenario: you’re creating custom blankets from a luxurious acrylic and polyester blend. Although this material was difficult to locate when you began the company, its availability has proven more expensive than anticipated.

This cost has an unfavorable variance of $3,000, which is the difference between what you spent on materials and what you actually earned. Although this might not seem like much, it’s actually quite telling.

When measuring variances for an area of your business, it’s always best to start with the budgeted figure for that area and then use the same formula to calculate any actual changes. This approach provides you with a complete picture of your company’s progress over time.

The next step is to analyze the differences between each item you’re comparing. This could include anything from how long a project takes to employee efficiency levels.

The good news is that this concept can be applied to nearly any aspect of your business and made even stronger by applying it accordingly. Once you grasp its meaning, use it to make your enterprise stronger and more efficient.

What is Negative Variance?

Budget variance is the difference between a company’s anticipated spending and actual expenses. It plays an essential role in budget management, helping to identify areas where money is being wasted inefficiently.

When a company over- or under-performs its budget, it can have detrimental effects on its profits. To prevent this from occurring, management must thoroughly examine the variance and identify what caused it.

Budget variances typically arise due to external factors that management has no control over. Changes in the economy or global trade patterns, for instance, can cause costs to change unexpectedly. Other potential causes could include a new competitor entering the market with pricing pressure or changes to industry regulations which were not anticipated.

These variables can cause negative variance and should be addressed promptly to minimize their effect on financials. Furthermore, companies should monitor trends from month to month in order to detect any recurring patterns contributing to budget variances.

A positive budget variance, on the other hand, indicates that a company is on track and within its original expectations. This could indicate that they have exceeded revenue goals or reduced costs significantly – both of which can be advantageous to their operations.

Negative budget variances can be caused by inaccurate predictions of future spending or by unexpected changes in the financial environment, such as an unexpected rise in interest rates or an increase in inflation.

As a small business owner, it is essential to monitor your company’s spending closely and be aware of budget variances so they can be addressed promptly. Doing this will guarantee your finances remain accurate and cash flow remains healthy.

Understanding budget variances and why they occur can give you a better insight into your financial situation and enable you to create strategies that improve it over time. Furthermore, being aware of any necessary adjustments for your company to stay on track and maintain healthy finances will enable it to make adjustments as needed.

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Favorable vs. unfavorable budget variance

There are two types of budget variance: favorable and unfavorable. A favorable budget variance happens when your actual figures are better than expected. Higher revenue or lower costs both count as favorable variances.

Unfavorable variance, on the other hand, occurs when your real performance is worse than you anticipated. If you have higher actual costs or lower revenue than expected, then you have unfavorable variance.

Budget variance explanations

Understanding the causes of budget variance can help you figure out why your performance numbers differ from your projections and what those differences mean for your business.

The most common causes of budget variance include inaccuracies in your budget, changes in the business environment, and over- or underperformance.

Budgeting errors

Budgets are forward-looking tools that use financial modeling to predict your business’s future. These projections are based on research, historical data, and assumptions.

Poor-quality information can lead to budgeting errors that result in variance from actual performance. Inaccurate budget figures can come from calculation errors, incorrect assumptions, or outdated data.

Variance from budgeting errors can be a sign to review your budgeting process to remove errors and look for more accurate methods to forecast sales and expenses.

Changes in the market or economy

External factors, such as changes in economic conditions, can also account for budget variances. If one of your main competitors goes out of business, that may lead to favorable variance where you gain customers and have higher revenue than expected.

In contrast, an economic recession or supply shortage may lead to unfavorable variance where revenue declines or costs increase.

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.

Overperformance and underperformance

Variance can occur because your business performed better or worse than expected. Overperformance — such as more efficient operations, better customer conversion rates, or improved lead generation — can contribute to favorable budget variance.

Alternatively, underperformance, such as operational inefficiencies or low talent retention, may lead to unfavorable variance.

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.

Why does budget vs. actual variance matter?

According to accountant Antonette El Baz, “Analyzing budget variance helps businesses control spending, maximize profitability, and make more informed decisions about long-term growth.”

Budgets are valuable decision-making tools for any business. If you have a high budget variance, that means you’re using less accurate information to make strategic choices.

For instance, drastically overestimating your income may lead to overspending, which can drain your cash reserves. This can be especially damaging to startups and small businesses with limited resources.

How much variance is too much?

Ultimately, your budget is made up of guesses about what will happen in the future. That means there’s bound to be some difference between your budget and actual performance.

But when does variance switch from normal to too high?

In accounting, a budget variance of 10% or less is usually considered tolerable.

For instance, if you budget $20k for a project, and it ends up costing $22k, most financial planning professionals wouldn’t consider that a significant problem.

But if your project ends up costing $28k (40% higher than expected), then you may want to dig deeper and figure out what caused the difference.

While 10% represents the industry standard, that doesn’t mean you have to use that threshold. If you don’t have a lot of cash reserves, you may choose to stay on the safe side and aim to keep your variances under 5%.

Either way, establishing a threshold for your budget variance helps with analysis. You can spend more time investigating and addressing the variances that were higher than you wanted.

Budget variance formula

To calculate budget variance, you can use one of two formulas.

Variance = Actual Value – Projected Value

or

Variance = Projected Value – Actual Value

The size of the budget discrepancies is the most important factor here. Whether the amount you calculate is positive or negative doesn’t matter as much, since favorability depends on the line item.

In addition to measuring the actual amount, you can calculate budget variance as a percentage using this formula:

Variance % = ([Actual Value – Projected Value] / Projected Value) x 100

Once again, the goal is to focus on the size of the percentage difference. Positive percentages aren’t automatically favorable, and negative percentages aren’t automatically unfavorable.

Budget variance analysis example

Say you have the following numbers and you want to analyze budget variance.

The first step is to calculate the variance for each line item.

In this example, use the first formula: Variance = Actual Value – Projected Value.

Next, interpret the variance of each line item to see if it’s favorable or unfavorable.

  • Total revenue: Your actual revenue was $0.5m higher than your expected value, which is a favorable variance.
  • Total costs: Your actual expenses were $1.2m higher than the budgeted amount, which makes this an unfavorable variance.
  • Net profit: You have a negative variance of -$0.7m, and your actual profit was lower than expected, making this an unfavorable variance.

Now that you’ve interpreted each line item, it’s time to calculate the budget variance percentages to flag any significant variances for further investigation.

For this example, use a threshold of 10%.

Your total revenue variance is in the normal range of 10%. However, your cost and net-profit variances are higher than your threshold of 10%.

At this point, you should prepare a detailed variance report explaining why your costs were much higher, and your profits were much lower. You can look at common root causes: inaccurate budget numbers, changes in the business environment, or unexpected performance.

Tips for controlling budget variance

In an ideal world, you want to avoid unfavorable budget variances above your threshold. Below are some tips to consider.

First, you can improve the quality of your projections by double-checking your math and removing data errors. And once you are able to make better projections, make sure you stick to them.

Frederick Lansky, owner of travel consultancy Points Panda, recommends continually “monitoring your spending so you can identify trouble spots early on and make adjustments.” By doing so, you can catch variances when they’re small and take action to prevent them from becoming significant.

Then, if you’re using a static budget, consider switching to a flexible budget that lets you adapt your projections based on external factors and actual performance. Adjusting your budget based on new information can lead to more accurate projections and less variance at the end of the year.

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