What is Budgetary Variance? A Comprehensive Guide

Budgetary variance is a powerful tool that helps businesses stay on track with their financial goals. It allows companies to spot when things are off course quickly and highlights the areas that need attention. In this guide, we’ll dive into budgetary variance, how to calculate it, how to analyse it effectively, and why it’s essential for maintaining control over your finances and ensuring your business is positioned for success.

What is Budgetary Variance?

Budgetary variance is the difference between the budgeted or forecasted financial figures and the actual financial outcomes. This variance is a key indicator for businesses to assess whether their economic performance is aligned with their expectations. By analysing budgetary variance, companies can understand the reasons behind discrepancies, allowing them to take corrective actions and refine future budgets.

Budgetary variance plays a significant role in financial planning because it highlights areas where the business is overspending or underperforming, helping to make more informed decisions in the future.

Types of Budgetary Variance: Favourable vs. Unfavourable

Understanding the nature of budgetary variance is critical for businesses to act appropriately. There are two primary types of variance:

Favourable Variance

A favourable variance occurs when the actual financial performance exceeds the budgeted figures. For example, if a company had budgeted £10,000 in sales but achieved £12,000, the £2,000 excess is a favourable variance. This suggests that the business is performing better than expected and might have higher profitability or revenue than anticipated.

Unfavourable Variance

An unfavourable variance occurs when actual results fall short of the budgeted figures. For example, if a company’s budgeted expenses were £5,000, but the actual costs reached £6,000, the £1,000 difference is an unfavourable variance. This could indicate inefficiency, unexpected costs, or poor financial planning.

How to Calculate Budgetary Variance

The calculation for budgetary variance is straightforward. It involves comparing the budgeted value to the actual value:

Budget Variance Equation

Budget Variance = Budget Value – Actual Value

• If the result is positive: It’s a favourable variance (better than budgeted).
• If the result is negative: It’s an unfavourable variance (worse than budgeted).
  

By calculating the variance for each item in the budget, such as sales, expenses, or profit margins, businesses can assess where they stand financially.

How to Analyse Budgetary Variance (with Example)

Once you’ve calculated the budgetary variance, it’s important to analyse the reasons behind the variance. Here’s how to conduct the analysis:

Step 1: Compare Actual Results to Budgeted Figures

Begin by comparing the actual results against the budgeted figures. This is the foundation of variance analysis and highlights areas where actual performance deviates from expectations. For example, if a business budgeted £500,000 in revenue for the quarter but only achieved £450,000, there’s a £50,000 unfavourable variance in revenue.

Step 2: Calculate Variance Percentages

To better understand the magnitude of the variance, calculate the percentage difference. This can be done using the formula:

Variance Percentage = (Budget Value – Actual Value) / Budget Value × 100

Using the example above, let’s calculate the variance percentage for revenue:

Variance Percentage = (£500,000 - £450,000) / £500,000 × 100 = 10%

This percentage helps in understanding the proportion of variance relative to the overall budget. In this case, the revenue is 10% below what was expected.

Step 3: Identify Key Drivers of Variance

Once variances are calculated, investigate the root causes. Are costs higher due to unexpected expenses? Was revenue lower due to market conditions? Identifying key drivers allows businesses to understand the reasons behind variances and make more informed decisions.

For example, the 10% revenue shortfall could be due to a drop in demand, a delayed product launch, or an increase in competition. Similarly, if expenses are higher than expected, it might be due to rising material costs or unexpected repairs.

Step 4: Report Findings and Take Action

Finally, document the findings and communicate them to relevant stakeholders. Based on the analysis, take corrective actions, such as cutting costs or adjusting strategies, to stay on track with the financial goals.

For example, if the variance was caused by lower-than-expected revenue, the business might decide to increase marketing efforts, reduce costs in other areas, or adjust sales targets. Reporting and adjusting will help the company regain its financial footing and stay aligned with its goals.

Common Causes of Budgetary Variance

Several factors can lead to budgetary variance, including:

• Inaccurate budgeting assumptions: Unrealistic expectations or poor forecasting can lead to variances.
• Manual processes: Human error, such as data entry mistakes or miscalculations, can cause discrepancies between actual and budgeted amounts. The Post Office scandal is a prime example of how errors in manual processes can snowball, leading to inaccurate financial reporting and significant operational challenges. 
• Lack of training: Without proper knowledge of budgeting and variance analysis, employees may overlook or misinterpret key figures.
• Unexpected market changes: Economic downturns, inflation, or supply chain disruptions can affect both revenue and expenses, leading to budget variances.
  

Best Practices for Managing Budgetary Variance

To manage budgetary variance effectively, consider implementing these best practices:

• Regularly monitor and review budgets: Conducting monthly or quarterly budget reviews helps businesses identify variances early and make adjustments before the end of the financial year.
• Rolling forecasts: Use rolling forecasts to adjust budgets dynamically as new information becomes available, ensuring they remain relevant and accurate.
• Implement variance analysis tools: Using automated tools to track budgetary variance can simplify the process and reduce errors, making it easier to analyse and manage variances in real time.
  

Software Solutions for Managing Budgetary Variance

Managing budgetary variance can be complex, especially for large businesses with multiple departments or products. Aurum Solutions’ Journal Entry Automation simplifies the process of managing and reconciling financial data, providing businesses with a precise, real-time view of their financial position. Key benefits include:

• Automated Data Import: Seamlessly import and reconcile financial data across different systems, reducing manual effort and ensuring accuracy.
• Comprehensive Fee Analysis: Analyse the financial impact of variances, helping businesses better understand cost fluctuations and take corrective action.
• Enhanced Reporting Capabilities: Generate detailed, customisable reports that highlight budgetary variance trends and provide actionable insights.
• Broad Integration: Integrates with existing financial systems, allowing businesses to monitor their budgetary performance without disrupting current workflows.
  

To see how Aurum can help improve your financial processes, book a demo today.

Conclusion

Budgetary variance is an essential concept in financial management that helps businesses stay on track with their financial goals. By understanding budgetary variance, how to calculate it, and its causes, companies can identify areas for improvement and take timely action to avoid unfavourable results. Adopting best practices such as regular reviews, rolling forecasts, and variance analysis tools can help businesses manage their budgets more effectively. Aurum Solutions offers automated tools to streamline budgetary variance analysis and reconciliation, ensuring financial accuracy and efficiency.

Get in touch today to book a demo and discover how Aurum’s Journal Entry Automation can help you effectively manage budgetary variance and improve your financial reporting.

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Disclaimer:

At Aurum Solutions, we are committed to upholding fiscal responsibility in all our financial endeavours. We prioritise prudent financial management, transparency, and accountability to ensure the effective allocation and utilisation of resources. Our commitment to fiscal responsibility extends to our stakeholders, fostering trust and sustainability in our financial practices.