If you are reading this article, the odds are you are either a business owner or you are employed in a key management role. Coupled with your responsibilities of running your business or managing an organisation, you are responsible for planning business budgets.For a wide variety of reasons, costs and revenue can come in higher or lower than calculated. To put this in another way, you are now looking at what is commonly termed as being a budget variance.
Be that as it may, you now need to analyse these budget variances. To help you understand budget variances in more detail, you are now looking for some information. This article is prepared to help you quickly and easily understand:
- What is a “Budget Variance”?
- What is “Budget Variance” Analysis?
- Price Variances vs. Quantity Variances.
- Reasons for “Budget Variances”?
- Analysing “Budget Variance
What is a Budget Variance?
After a period (i.e. month, quarter, year) is over, business owners and key managers will look at the actual amounts and compare them to what was budgeted. This process enables them to determine if there are any differences/discrepancies (also called budget variances).
What is Budget Variance Analysis?
Budget variance analysis is an analytical control tool, applied to financial and operational data that can be used to compare actual operations to budgeted estimates.
Budget variances analysis addresses any budget variances and helps you in:
- Identifying and determining the root cause of the budget variance; and
- Adjusting your budgeting procedures so as to avoid similar discrepancies occurring in the future.
Price Variances vs. Quantity Variances
There is often a tendency for some business owners and key managers to look at price variances and quantity variances. This will vary from business to business. For example:
- Price variances deal with measuring the difference between actual and budgeted revenues. For example, they will measure the difference between the actual and budgeted sales price per unit.
- Quantity variances deal with production levels. For example, they will compare the actual amount of units produced against the budgeted units estimated for the period.
Reasons for Budget Variances?
Budget variances can occur as a result of:
- Errors (e.g. this can be by way of using faulty calculations, or relying on stale or bad data);
- Inaccurate Budgeting (e.g. using wrong or bad assumptions at your expenses or income);
- Changing Business Conditions (e.g. changes in sales, changes in material cost, changes in labour cost, or the arrival of a new competitor);
- Unmet Expectations (e.g. when you exceed or underperform on your expectations).
Analysing Budget Variances
Analysing budget variances aids business owners and key management in:
- Identifying trends, problems, opportunities and threats;
- Understanding present costs and then control future costs;
- Making adjustments to the business’s or organisation’s goals, objectives or strategies;
- Understanding how well their business or organisation is performing;
- Determining if there is anything they need to do differently to help them in achieving better results; and
- Framing more accurate business budgets in the future.
When analysing budget variances, you should consider talking with your supervisors and employees to try to determine the root cause of the budget variance.
To illustrate the benefits. Let’s assume during one of your discussions, you find a labour variance has occurred because of product specification changes. This, in turn, has resulted in higher labour hour costs than what you originally budgeted for. The outcome of the variance analysis and your discussions has helped in determining if:
- The budget variance has occurred as a result of temporary issues; or
- The budget variance has reflected a more permanent change in the price and cost of the product.
Note: If the analysis reflects a more permanent change in the price and cost of the product. Consideration should be given to incorporating this information into the budget planning for the next accounting period as this will avoid similar variances (discrepancies) occurring in the future.
In summary, budget variance analysis enables you to:
- Compare different scenarios in order to make better decisions:
- Improve the overall performance and efficiencies of your business or organisation: and
- Attain the desired results of your business or organisation.