budget variance analysis
Accounting

Budget Variance Analysis: Basics to Expert Insights

Nov 6, 2023 Stefan van Duyvendijk

In business, numbers don’t just tell stories; they reveal secrets. Like a sailor uses a compass to navigate the seas, companies employ tools like financial statements and budget variance analysis to pilot the tumultuous waves of comparing budget versus actual results and improve financial performance.

If you’ve ever heard the term “budget variance analysis” and wondered what it is and how it can help your financial planning and analysis (FP&A), this article serves as your guide. So, let’s dive into the concept of budget variance analysis to understand its significance and learn how to harness its power to drive your business toward financial success.

What Is Budget Variance Analysis?

Budget Variance Analysis is a systematic approach to understanding the difference between what you financially forecasted or budgeted and what was actually spent or earned. At its core, it’s a comparison of two sets of numbers: the budgeted amount and the actual amount.

Think of a budget as your financial roadmap. If you’ve ever planned a road trip, you know things don’t always go as planned. Maybe you took a few detours, stopped for longer lunches, or bought some souvenirs along the way. Looking back, you realize your budget didn’t account for those extra stops along the way.

A budget variance analysis is like a post-mortem on a road trip. In business, real-world events might lead to variances even with the most meticulously planned budget.

There are two main types of variances: favorable and unfavorable.

  • Favorable variance. A favorable variance occurs when actual results surpass budgeted expectations in a way that benefits the organization. For example, if you spend less than you budgeted for on employee overtime labor costs or your actual revenue exceeds budgeted goals, it’s a favorable variance.
  • Unfavorable variance. Conversely, an unfavorable variance happens when actual results fall short of budgeted expectations, potentially negatively impacting profitability. Examples include spending more than planned on marketing or when revenue falls short of the company’s goals.

Beyond deciding whether deviations are favorable or unfavorable, there are different types of variances you can calculate for different areas of your profit and loss statement:

  1. Revenue variances. Analyzing the differences between actual and budgeted revenue figures helps you understand your sales performance and market conditions.
  2. Expense variances. Examining expense variances allows you to identify areas where the company may need to focus on controlling overhead costs or optimizing spending.
  3. Profit variances. Profit, also known as net income, is one of the ultimate indicators of an organization’s financial health. When looking at profit, positive variances are usually good news, while negative ones may require corrective action.
  4. Volume vs. price variances. Break down revenue variances into volume (quantity sold) and price (average selling price) components to pinpoint drivers of change.

You’ll notice that all of these variances involve items from the profit and loss statement. While it’s possible to do a variance analysis on balance sheet accounts, it’s not as common.

What Is the Significance of Budget Variance Analysis for Your Business?

The sheer mention of a budget variance might seem like an issue, but in reality, comparing budgeted and actual results can provide a goldmine of insights. Here’s why a budget variance analysis is pivotal for any business:

  1. Course correction. Recognizing a negative variance early allows businesses to adjust and reallocate resources efficiently before it impacts long-term cash flow or profitability.
  2. Financial health. It offers a bird’s-eye view of a company’s health and operational efficiency.
  3. Forecasting and financial modeling. Businesses can make more accurate future projections by combining historical variances with knowledge of future events.
  4. Accountability. Pinpoints areas where performance might lag, holding departments or teams accountable for their financial decisions and initiatives.

How to Perform Budget to Actual Variance Analysis

Performing a budget variance analysis as part of your financial reporting might seem daunting, but with a structured approach, it becomes manageable.

Gather Relevant Data

Collect both your budgeted figures and the actual results for the period in question. It’s helpful to enter these figures into Excel spreadsheets with one column for budgeted values, one column for actual values, one column for calculated variances, and a final column to provide a written explanation of the reason(s) for the budget variances.

Identify Variances

Subtract the actual figures from the budgeted figures to calculate the variance for each line item.

Categorize the Variances

Label variances as either favorable (F) or unfavorable (U) based on whether they’re positive or negative in relation to your financial goals.

Analyze the Causes

Analyze variances to understand the underlying causes. Was a marketing campaign more expensive than planned? Did a supply chain disruption increase the cost of goods sold? Did you have too many direct labor hours without a corresponding increase in revenue? This kind of financial analysis can provide valuable insights.

Take Action

Based on your findings, adjust your strategies or allocate resources to bring your numbers back in line with your budget.

Budget Variance Analysis Example

Imagine ABC Ltd., a shoe manufacturer, budgeted $10,000 for marketing in January but ended up with actual expenses of $12,000. Here’s how the company’s financial team might perform a budget variance analysis.

  1. Identify the Variance: $12,000 (actual) – $10,000 (budgeted) = $2,000 (unfavorable variance)
  2. Analyze the Cause: After investigation, they found that an unplanned influencer collaboration led to the extra expense.
  3. Take Action: ABC Ltd. decided to cut back on some of the planned ads for February to compensate for the overspending.

Best Practices for Budget Variance Analysis

To truly make the most of this analytical tool:

  1. Set realistic, flexible budgets. Base your business budgeting process on sound assumptions and historical data. Even a startup can utilize a flexible budget that allows for tweaking numbers as you have more accurate data. Unrealistic expectations and a static budget can lead to constant unfavorable variances, causing frustration and uncertainty.
  2. Schedule regular budget variance analysis: Don’t treat variance analysis as an annual or quarterly exercise. Continuously monitoring your budget vs actual performance can help nip issues in the bud.
  3. Use tools and software: While most modern accounting software can automatically generate variance reports or leverage dashboards, making the process of comparing budgeted and actual results efficient, other tools can take your variance analysis several steps further. FloQast Variance Analysis automates the data collection process, notifies you when a variance is material, and assesses variances from past periods to get to the story behind the numbers. When you let automation handle a lot of the grunt work of comparing budgeted and actual figures instead of using a template, you free up time for your finance team to focus on analysis and strategy.
  4. Understand the root causes of budget variances. Identifying variances is a good start, but it’s just as important to dig deeper and understand why they occurred. Was it due to external factors, internal operation issues, or unexpected events? Understanding why unfavorable budget variances happen can help you take steps to prevent a recurrence while understanding what led to favorable variances might lead you to do more of that in the future.
  5. Train your team: Ensure everyone in the organization—from rank-and-file employees to the CFO—understands how to read and act upon variance reports. Variance analysis isn’t just a finance task; it’s a tool for informed decision-making across all departments.
  6. Stay flexible: The business environment is dynamic. Sometimes, variances can result from factors beyond control, like a sudden economic downturn. It’s essential to remain adaptable.

Budget variance analysis is about more than just pinpointing discrepancies. It’s about understanding those differences and their impact and ultimately steering your business ship through both calm and stormy financial waters.

If you’re ready to turn comparing budget vs actual costs into a strategic asset that empowers better financial decisions, schedule a demo of FloQast Variance Analysis. We’ll show you how digging into the numbers can help drive your organization’s financial performance.