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Budget Variance Analysis is a systematic approach to understanding the difference between the budget you set aside for your business operations and the actual amount you spend or earn.
What is Budget Variance Analysis?
Budget variance analysis compares two sets of numbers: the budgeted amount and the actual amount, which you may spend while conducting different business operations, like procuring raw materials, manufacturing, marketing, other supply chain activities, etc. The actual amount could also pertain to the revenue you earn (it might be higher or lower than what you expected).
There are many hiccups or unplanned spending on the way when you decide on a budget, and you may end up shelling out more. So, budget variance analysis is like a financial GPS that navigates you through your actual expenses.
What are the Types of Variances?
There are mainly two types of variances:
Favorable variance
When the actual results exceed budgeted expectations and benefit the organization, you call it a favorable variance. For example, if your company earns more revenue than you expected or you end up spending less than your budget for overtime labor costs, it's a favorable variance.
Unfavorable variance
On the contrary, when the actual amount falls short of the budgeted expectations, adversely affecting your profitability, it becomes an unfavorable variance. For instance, you may have to spend more on marketing than you initially planned as per your budget, or you may not make enough revenue to meet your goals.
The above-mentioned are the types in which you can categorize your variances. Besides these, there are other kinds of variances that you can use for various aspects of your profit & loss statement:
- Expense variances: You can use expense variances to figure out areas of your business that need control on overhead costs or require optimized spending.
- Revenue variances: If you want to know your firm's sales performance and understand market conditions, analyzing the variance between actual and budgeted revenue is the way to do it.
- Profit variances: Your profit or net income is an indicator of your company's financial health. So, favorable variances are a positive sign when it comes to profit, while the unfavorable ones may need some corrective action.
- Volume vs. price variances: Sales price variance shows you the distinction between the standard and actual per-unit selling prices of your product/service. Sales volume variance is the gap between actual sales volume and the budgeted quantity you sell at a specific price. Break revenue variances into volume and price variances to highlight the drivers of change.
How To Do A Budget Variance Analysis?
This is how you can perform budget variance analysis for your business:
Collect relevant information
Gather all the data relating to your budget and the actual amount for the period for which you want to calculate variances. You may use Excel sheets to assemble this information into separate columns of budgeted and actual values. Add another column stating the reason(s) for the budget variances.
Identify and calculate variances
After centralizing the data, create a variance calculation template in Excel. Allocate a separate column for each budgeted value concerning the data point you need to compare. For instance, labor costs, gross sales, fixed costs, and COGS can be shown in aggregate.
Now, figure out the budgeted and actual numbers for every source that has multiple revenue sources. The same applies to costs, as aggregated values can be deceptive.
Let's say we group all sales data, but one product lags behind the budget, and others exceed it. Then, the overall impact is no variance; however, individual variances exist.
Calculating budget variances with Excel formula:
Simply take the difference between budgeted and actual values or apply the VAR formula. This is specifically helpful if you want to compare sales over time to a fixed period in your budget.
The VAR formula in Excel helps you find out how spread out numbers are in a sample dataset. It measures how much the values differ from the average (mean) of the dataset.
Formula:
=VAR (number1, [number2], ...)
* number1 and number2 are the numbers or cell references from your data that you want to use.
Here,
- Variance: Shows how much the numbers in your data differ from the mean. A high variance means the numbers are more spread out, while a low variance indicates they're closer together.
- Sample Data: VAR calculates variance for a sample, not the entire data. For the whole set, use VAR.P.
Example:
For data points 5,7,9,12,15, use: =VAR (5,7,9,12,15)
This will return the variance, showing how much these numbers differ from their average.
Label the variances correctly
Mark variances as favorable (F) or unfavorable (U) depending on whether they affect your financial goals.
Observe and analyze the causes
Analyze variances to determine the underlying causes of their occurrence. For instance, your marketing expenses may have exceeded the planned budget, or there may have been a disruption in your supply chain that spiked the cost of goods sold. Such financial analysis will give you valuable insights.
Adjust strategies and allocate resources
Use your findings to adjust or revamp your strategies or allocate resources to rectify the numbers to align with your budget.
A Budget Variance Analysis Example
Let's say a shoe company planned to spend ₹8,00,000 on marketing in January but spent ₹9,60,000. Here's how they might handle this:
- Spot the Difference: They spent ₹9,60,000 instead of the ₹8,00,000 they planned, so they exceeded the budget by ₹1,60,000.
- Figure Out Why: They found that the extra cost came from an unexpected influencer collaboration.
- Adjust the Plan: To make up for the extra spending, this company decided to reduce some of its planned ads for February.
Mistakes To Avoid In Budget Variance Analysis
Here are some common mistakes that companies or accountants make while calculating variances:
- Focusing on small differences: Spending too much time on minor variances can distract you from bigger and more important ones.
- Not updating changes: Variance analysis can miss the mark if it doesn't doesn't keep up with changes in the business environment.
- Overlooking timing issues: Variances can be misleading if there are timing gaps between when costs happen and when they're recorded.
- Mixing up cause and effect: Just because two things happen at the same time doesn't mean one has caused the other. You must look for the real reasons behind these variances.
Conclusion
Budget variance analysis is more than just highlighting discrepancies. It's about getting the hang of those differences, understanding their impact, and finally taking corrective measures to balance your finances. Automation streamlines budget variance analysis by instantly comparing actual spending with budgeted figures, flagging discrepancies, and providing real-time insights, saving time and reducing errors.
Bluecopa’s automated workflows make this process seamless, empowering finance teams to take control of their budgets effortlessly.
FAQs
1. How can I avoid budget variances?
Creating a careful and well-researched budget can help you stay on track, but sometimes unexpected changes in the market can still cause your expenses to vary.
2. How often should a business perform budget variance analysis?
Businesses should check their budget regularly to keep track of their finances. It's usually best to do this every month, but some companies might prefer to review it quarterly or even weekly, depending on their specific needs. Regular checks help catch any financial problems early on and keep things on track.
3. What causes differences in a budget?
Budget differences usually happen because of three main reasons: mistakes, changes in business conditions, and when expectations aren't met.
4. What are the downsides of budget variance analysis?
Using flexible budgets for variance analysis has some drawbacks, like being complex and taking a lot of time to prepare and update. It can also be challenging to set the right standards or rates for adjusting the budgeted amounts.
5. What is the difference between budget vs. actual variance analysis?
Budget vs. actual variance analysis differs on the front that the first takes into account the budgeted amounts planned for your business operations while the latter helps you calculate the actual amount spent.
6. What is a budget variance analysis report?
The budget variance analysis report is a financial document that outlines the difference between the budgeted and actual figures for various business operations. It helps you categorize variances as either favorable or unfavorable and provides detailed insights into these discrepancies.
