While budgeting is critical to any business’s financial planning and management, it is not always a perfect science. There can often be differences between what was planned and what actually happened. Understanding these differences is critical to improving budgeting accuracy and performance. Regular budget variance analysis can assist with financial analysis and forecasting by providing a clear understanding of whether financial targets were met for a given period, such as a month, quarter, or year.
What is budget vs. actuals variance analysis?
Budget vs. actuals variance analysis is a process used to compare actual financial results with the budgeted amounts. This comparison provides insights into the accuracy of budget projections and helps to identify areas where actual results deviated from the budget. This analysis helps organizations to understand the reasons behind any variances and make necessary adjustments to improve the budgeting process.
Budget variance analysis allows companies to identify differences between budgeted and actual results, enables informed decision making and resource allocation, and provides a clear picture of financial performance. The analysis also helps determine the causes of variances and supports forecasting and long-term planning. There are different types of budget variances, including revenue variance, expense variance, volume variance, sales mix variance, and price variance.
- Revenue variance occurs when budgeted verses actual revenue numbers differ.
- Expense variance occurs when there is a difference between budgeted and actual expenses.
- Volume variance is the difference between budgeted and actual production volume.
- Sales mix variance occurs when the budgeted and actual sales mix differs.
- Price variance is the difference between budgeted and actual sales prices.
Companies can make better-informed decisions in key areas by using budget variance analysis to:
Adjust budgets. The analysis can help companies identify areas where they exceeded or fell short of their budgeted goals, enabling them to adjust their budgets to improve their financial performance.
Allocate resources effectively. By gaining a clear picture of their financial performance, businesses can allocate their resources more effectively to achieve their financial goals.
Improve operations. By determining the causes of variances, companies can identify areas of operational inefficiencies and make the necessary changes to improve their operations.
Measure initiative effectiveness. The analysis can measure the effectiveness of cost-saving initiatives, sales strategies, and other business initiatives, promoting accountability and continuous improvement.
Effectively forecast and plan. The analysis supports forecasting and long-term planning by providing a clear picture of past performance and highlighting areas that require attention.
Where does the variance come from?
Budget vs. actuals variance may arise due to various factors, including the following:
- Sales deviations: The differences in sales compared to budgeted figures due to changes in market conditions, competition, and product demand.
- Cost fluctuations: The variance in costs compared to budget due to price changes, production processes, or supplier pricing.
- Timing differences: Variances from differences in the timing of revenue recognition and expenses incurred.
- Inaccuracies: Variances due to inaccuracies in forecasting, budgeting, or data collection.
- External factors: Variances from external factors such as economic conditions, unforeseen events, or changes in laws and regulations.
The formula for budget versus actuals
Budget vs. actuals analysis can be calculated using either of these two formulas: percentage variance formula and dollar variance formula. Both calculations are straightforward mathematically.
Percentage variance formula
Percentage variance formula is calculated as (Actual sales or expenditures ÷ Budgeted sales or expenditures) –1.
The result of this calculation is a percentage. For instance, if a company’s budgeted sales amount is $120,000 and its actual revenues turn out to be $100,000, the variance will be -16.67%.
Dollar variance formula
Dollar variance formula is calculated as (Dollar value of actual sales or expenditures - budgeted amount) or simply (Actual sales or expenditures less budgeted value).
For instance, if the budgeted sales were $120,000 and the actual sales were $100,000, the dollar variance would be -$20,000.
Irrespective of which formula a business uses to calculate the budget variance analysis, it can get valuable insights into the financial performance of a period.
Understanding favorable and unfavorable variance
While carrying out budget versus actuals variance analysis, a business may get a favorable or unfavorable variance.
Favorable variances occur when actual results are better than expected, the variance is considered favorable. This could mean that the organization has received more revenue, spent less money, or has found other ways to improve performance.
Unfavorable variances occur when actual results are worse than expected, the variance is considered unfavorable. This could indicate that the organization has spent more money, received less revenue, or has encountered other challenges that have negatively impacted performance.
Budget variance analysis reports
There are several different types of reports that organizations can use to analyze budget versus actuals variances.
- Budget variance reports compares actual results to budgeted amounts and provides insights into the reasons behind any variances.
- Trend analysis reports look at the organization's historical performance and identifies trends and patterns.
- Cash flow reports show the movement of cash in and out of the organization.
Based on the results of budget vs. actuals variance analysis, organizations can develop strategies to improve the accuracy of budget projections and performance. Regular review is essential as it helps identify areas of over- or under-performance, track progress, and make necessary adjustments for financial stability and success. With these valuable insights into its financial health and performance, a business can identify areas for improvement.
Focusing on significant variances can help a company understand where additional resources or efforts may be needed and where cuts can be made. An organization can also detect potential financial problems early by identifying trends through variance analysis. For instance, if there's a consistent variance in marketing expenses, the marketing team can reevaluate existing strategies or shuffle resources. By using actuals versus variance reports as a tool for developing a business strategy, companies can better understand their financial performance and identify areas for improvement, ensuring long-term success and sustainability.
Communicating variances across the organization
It is vital to communicate budget vs. actuals variances across the organization so that each function is aware of the differences and their drivers. This can help improve collaboration among teams, and they can jointly work towards reducing variances. Effective finance leaders meet regularly with departments across the organization to help business partners understand key metrics for their teams. When reporting budget variances, it's important to use a consistent presentation for stating the variances, their drivers, the scale of variance, and how they impact the company's performance.
Tools that help the budget variance analysis process
Software and other tools can help to automate and streamline the budget versus actuals variance analysis process. These tools can help simplify data collection and analysis and provide real-time insights into performance and trends, helping organizations make data-driven decisions, improve budget accuracy, and achieve better financial results.
Software like Vareto helps simplify the process by automatically importing data from your ERP and updating the analysis at each month's end, ensuring that the analysis is always accurate and up-to-date so that your business can focus on essential insights instead of manual work.
How can budget to actuals variance be used to improve financial performance?
Budget to actuals variance can be used to identify areas where expenses are higher than expected and make changes to improve financial performance. For example, if the budget variance shows that certain expenses are consistently higher than budgeted, the company may be able to reduce those expenses or find more cost-effective solutions.
How often should budget versus actuals variance be calculated?
Budget versus actuals variance should be calculated regularly, ideally once a quarter or month. This can ensure a business stays on track with its financial goals. It also allows timely adjustments for improving business performance.
What actions can be taken to address significant variances between budget and actuals?
In case of significant variances between budget and actuals, a business can take various actions, including re-evaluating and adjusting the budget, implementing cost control measures, and focusing on the root cause.
How can budget versus actuals variance analysis be automated?
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.