Budget Variance

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Understanding Budget Variance: Differences Between Projected and Actual Figures

Budget variance refers to the discrepancies between projected and actual performance in a business. This calculation is done for various aspects such as revenue, fixed costs, variable costs, and net profit.

Types of Budget Variance

There are two types of budget variance - favorable and unfavorable. A favorable variance occurs when the actual numbers surpass the projections, resulting in higher revenue or lower costs. In contrast, an unfavorable variance happens when the actual performance falls below expectations due to higher costs or lower revenue.

Determining the Causes of Budget Variance

To understand why there are differences between projected and actual figures, it is crucial to identify the causes of budget variance. Common reasons include miscalculations, changes in the business environment, and over- or underperformance.

Mistakes in Budgeting

While budgets are useful tools for predicting a business's future, they can also be prone to errors if the information used is of poor quality. Examples of these errors include miscalculations, incorrect assumptions, or outdated data. It is essential to regularly review the budgeting process and consider more accurate methods to forecast sales and expenses.

External Factors

External factors, such as changes in the economy or market, can also contribute to budget variances. For instance, if a competitor goes out of business, it may result in a favorable variance by gaining customers and increasing revenue. On the other hand, an economic recession or supply shortage may lead to an unfavorable variance due to declining revenue or increased costs. While these factors may be beyond the business's control, they can provide crucial insights for future strategic decisions.

Over- or Underperformance

Budget variances can also occur when a business performs better or worse than expected. Overperformance, such as increased efficiency or improved lead generation, can result in a favorable variance. In contrast, underperformance, such as inefficiencies or low retention rates, may lead to an unfavorable variance. Analyzing these variances can help identify the business's strengths and weaknesses, allowing for better decision-making and leveraging competitive advantages.

Calculating Budget Variance

There are two formulas for calculating budget variance:

  • Variance = Actual Value - Projected Value
  • Variance = Projected Value - Actual Value

The magnitude of the discrepancies is more critical than whether the amount is positive or negative. The specific line item will determine whether a variance is favorable or unfavorable.

Budget variance can also be calculated as a percentage using the formula Variance % = ([Actual Value - Projected Value] / Projected Value) x 100. Again, the focus should be on the percentage difference, rather than the positive or negative value.

Example Analysis of Budget Variance

Let's use an example to demonstrate how to analyze budget variance. Consider the following numbers:

  • Total revenue: Actual - $2m, Projected - $1.5m
  • Total costs: Actual - $4m, Projected - $2.8m
  • Net profit: Actual - $1m, Projected - $1.7m

The first step is to calculate the variance for each line item using the formula Variance = Actual Value - Projected Value.

Next, determine if the variances are favorable or unfavorable:

  • Total revenue: $2m - $1.5m = $0.5m (favorable variance)
  • Total costs: $4m - $2.8m = $1.2m (unfavorable variance)
  • Net profit: $1m - $1.7m = -$0.7m (unfavorable variance)

In this example, the business had a favorable budget variance in total revenue but unfavorable variances in total costs and net profit. This analysis can provide valuable insights for the business's performance and inform future strategies.

Managing Budget Variance for Business Success

One essential aspect of running a business is tracking and comparing actual revenue and expenses to your projected budget. This process, known as budget variance analysis, allows you to identify areas for improvement and ensure financial stability. To effectively manage budget variance, it is important to understand its impact and how to control it.

The key to managing budget variance is understanding the acceptable threshold. In this example, we will use a threshold of 10% to determine if your variances are within a normal range. If your total revenue variance falls within 10%, it is considered acceptable. However, exceeding this threshold for cost and net-profit variances requires further investigation and action.

Investigating Budget Variances

To gain insights into budget variance, prepare a detailed report explaining the reasons for any significant variances. Look for common root causes such as inaccurate budget numbers, changes in the business environment, or unexpected performance. This report will help you understand the issue and take necessary steps to address it.

Effective Tips to Control Budget Variance

To avoid unfavorable budget variances, implement these tried and tested tips for successful budget management:

  • Double-check your calculations: Human error is one of the main causes of budget variances. Simple mistakes like data entry errors or miscalculations can skew your projections. Make it a habit to double-check all calculations and eliminate any data errors.
  • Stay consistent with projections: Accurate budget projections are only effective if you stick to them. While it may be tempting to make changes or adjustments as you go, this can result in unpredictable variances. Instead, regularly review and adjust your budget projections to reflect the current business environment, and stick to them.

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