Written by Marijn Overvest | Reviewed by Sjoerd Goedhart | Fact Checked by Ruud Emonds | Our editorial policy
Budget Variance — Everything You Need To Know
Key takeaways
- Budget variance shows the difference between the listed expense amount in comparison with the actual spending behavior of the company.
- Additionally, the variance is useful in informing the decision-making process, leading to better results.
- Controlling a company’s variance requires attention and managing potential expectations.
How do you know how well your business operations perform financially?
Although planning for budgets is a great help in identifying costs and anticipating losses or revenues, your actual financial performance may differ from what you expect. This is where the budget variance comes in.
Generally, a budget variance shows whether you are performing well financially. It’s an important concept to understand that helps businesses like yours assess their financial performance and make well-informed decisions.
In this article, we will dig into the intricacies of budget variance, understand its significance, and explore the factors that cause either a favorable or unfavorable type of budget variance, types, and how to calculate for it.
What is a Budget Variance?
A budget variance is the difference between the projected or budgeted financial performance and the actual financial performance of a business. Naturally, it provides insights into how well a company’s financial expectations align with real-world outcomes.
Significance of Budget Variance
Budget variance analysis offers several key benefits to businesses:
1. Performance Evaluation
Budget variance helps assess how well can you adhere to your financial plans. It evaluates whether you are overspending or underspending based on your allotted budget.
2. Early Problem Detection
Variance alerts signal potential issues early. Because you get to evaluate how you comply with your financial plans, you also get to identify arising issues to allow timely corrective actions.
3. Resource Allocation
Insights gained from budget variance analysis can guide you in doing effective allocation of resources. Moreover, it guides you in determining which areas you need to focus more on financially.
4. Decision Making
Understanding budget variance can also aid you in strategic decision-making and course correction. You can foresee what will happen to you and your company in the future and take necessary actions.
5. Goal Setting
Budget variance assists you in setting realistic future budget plans based on past data and patterns. In line with the previous point, you can foresee where you will go in the future with your current budget and cost choices.
Cause of Budget Variance
Many factors cause the root of budget variance including:
1. External Factors
Changes in market conditions, economic fluctuations, or unexpected events like natural disasters can exponentially impact budget projections and lead to variances. The rise of competitors may also pressure you to make pricing changes can cause variances.
2. Internal Mismanagement
Inaccurate forecasting, poor resource allocation, and inadequate project management can cause budget deviations. In addition, because of poor operation management, you may not be able to accurately perform well financially and impact the results of your budget deviation.
3.Price Fluctuation
Either increased or decreased costs of raw materials, labor, and services can result in budget discrepancies. Because the market constantly changes, this is inevitable. So, it’s important that you should be prepared and stay fluid when these changes apply.
4. Operational Inefficiencies
Inefficient processes like unexpected delays, and miscommunication can all contribute to budget variance consequences. Moreover, these can also influence and impact beyond financial results; these instabilities can greatly affect the entire business operation.
5. Unforeseen Expenses
Emergencies, unplanned repairs, and regulatory changes can lead to unexpected expenditures and cause negative variations in the allotted budget. Without a proper MRO process and regular evaluation of your business operations can lead to unmet financial expectations.
Types of Budget Variance
Let’s compare and contrast the six different types of budget variance:
1. Favorable & Unfavorable Variance
This type of budget variance is when actual results surpass budgeted figures. In simplest terms, if you have greater returns on investment you have favorable variance, you become more stress-free. Moreover, this can result from cost savings or revenue exceeding operations.
On the other hand, this type of budget variance refers to the actual results falling short of budgeted amounts. Several factors like higher costs for raw materials can greatly impact your budget variance.
2. Revenue Budget Variance
This type of variance compares the budgeted revenue with the actual revenue outcome. A positive revenue suggests higher-than-expected sales, while a negative one indicates revenue below projections. Positive is positive, and negative is negative.
3. Expense Budget Variance
Expense budget variance assesses the difference between budgeted expenses and actual expenses. A positive expense variance signifies cost savings, while a negative variance implies overspending.
4. Direct Material Budget Variance
If you own a manufacturing business, this type of variance is familiar to you. This budget variance compares the budgeted cost of materials with the actual cost incurred. It helps identify discrepancies in material consumption or prices.
5. Direct Labor Variance
This is quite similar to the previous type. However, the only difference is that this type of budget variance assesses the budgeted labor costs against the actual labor costs. Moreover, it uncovers discrepancies in labor efficiency and rates.
How to Calculate for Budget Variance
If you’re wondering how to calculate for budget variance then worry not, because we have you covered!Step 1: Determine Budgeted Amount
Start the process by identifying the budgeted amount for the particular line item, such as revenue or expenses. Whatever number comes up, it’s the amount that was initially projected for the period.Step 2: Calculate Actual Amount
Gather the actual financial data for the same line item during the same period. This involves actual revenue earned or actual expenses incurred.Step 3: Compute Variance
Calculate the variance by subtracting the actual amount from the budgeted amount. The formula is:Variance = Budgeted Amount – Actual Amount
Step 4: Analyze Variance
After you compute the variance, interpret it. If the result is positive, it’s a favorable variance which is good for you. If it comes out negative, it’s unfavorable. In this step, you should also analyze possible reasons behind the calculated variance, considering the causes mentioned earlier.Why Does Budget VS Actual Variance Matter?
Comparing your projected budget and actual variance matters because it helps you gauge how well your financial plans align with how you operate financially in reality.
Upon careful performance evaluation, a variance analysis lets you assess the effectiveness of your budget plans. Positive variances mean better performance than expected while negative numbers mean otherwise. With that, you’ll be able to find or pinpoint in which areas you need to improve financially.
In relation to that, understanding the results will help you make decisions in terms of readjustments and finding ways to increase revenue.
Moreover, variance assessments will allow you to highlight areas where you’re underutilizing resources which will help you to allocate your finances more efficiently.
Tips For Controlling Variance
Variance affects your business’ financial performance and its crucial to control it. To better control Variance, there’s 5 things to take note on. Here is 5 tips for controlling Variance.1. Constant Monitoring
Regularly keep a close eye on your finances. This includes constantly comparing your actual expenses and revenues against your planned budget plans. With that, you may also identify your variances early.2. Detailed Budgeting
Creating a specified and detailed budget plan that accurately reflects your income and expenses can make you understand your potential variances easier.3. Variance Analysis
You must break down your variances into categories (fixed costs, variable costs, and revenues) because it can provide you with insights into which areas need improvement.4. Adapt Flexibility
Adapt to your budget. Unexpected events can impact finances and you can’t do anything about it. So, having flexibility in your budget allows you to adjust without major disruptions.5. Communication
Communication is key, most especially in business operations. Your internal departments should share your variances even at the smallest numbers. This will allow you and your management teams to address issues collaboratively and innovatively.Conclusion
Calculating budget variance is critical for effective financial management that will enable you to better monitor your business performance. It will also assess how well you adapt to changes and make well-informed decisions financially.
Upon understanding the factors that cause a shift in your budget variance, its significance, the different types, and how to calculate it, you can navigate the complexities of financial planning and achieve greater control over your resources.
It is also important to remember that your goal is not to reduce variance or have a higher positive one. Rather, your goal is to leverage its insights for continuous improvement and sustainable growth.
Frequentlyasked questions
What is budget variance, and why is it important for businesses?
Budget variance is the difference between the planned or budgeted financial performance and the actual financial performance of a business. It’s important for businesses because it provides insights into how well their financial expectations align with real-world outcomes. Understanding budget variance is crucial for assessing financial performance and making well-informed decisions.
What are the main factors that cause budget variance in businesses?
Several factors can cause budget variance, including external factors like changes in market conditions, economic fluctuations, and unexpected events, as well as internal mismanagement, price fluctuations, operational inefficiencies, and unforeseen expenses. These factors can significantly impact budget projections and lead to variances.
How do you calculate budget variance, and why does it matter?
To calculate budget variance, you start by determining the budgeted amount for a specific line item, subtract the actual amount from it, and then analyze the result. The formula is Variance = Budgeted Amount – Actual Amount. Budget variance matters because it helps businesses gauge the effectiveness of their budget plans. Positive variances indicate better performance than expected, while negative variances signify areas that need improvement. Understanding these results can lead to better financial decisions and resource allocation.
About the author
My name is Marijn Overvest, I’m the founder of Procurement Tactics. I have a deep passion for procurement, and I’ve upskilled over 200 procurement teams from all over the world. When I’m not working, I love running and cycling.
