Budget Variance

Budget Variance

Definition

Budget variance is the variation between planned and actual financial outcomes.

Description

On financial parameters, the difference between expenses or revenues and the actual amount incurred or earned during a given period is budget variance. 

It is a measure used in financial management to evaluate an organisation's or project's performance by comparing the planned financial targets with the actual outcomes. 

Positive variance= indicates that actual results exceeded the budgeted amounts 

Negative variance= suggests that actual results fell short of expectations. 

Analysing budget variances helps identify areas of overspending or underperformance, enabling managers to take corrective actions and make informed decisions to improve financial performance in the future.

Importance of Budget Variance Report

This is why budget variance report is important:

1. Performance Evaluation: Budget variance reports is a systematic approach to assess an organisation's or project's performance by comparing it with the actual financial results against the budgeted amounts.

Positive variances indicate areas of efficiency or favourable performance, while negative variances highlight potential issues or areas for improvement.

1. Financial Control and Accountability: By monitoring budget variances, organisations can adopt practices for better financial control. Companies can ensure accountability for resource allocation.
2. Decision-Making Support: Budget variance reports serve as valuable tools for decision-making, providing insights into where resources are being utilised effectively and where adjustments may be needed. Managers can use this information to plan resource reallocation, revise budget targets, or modify operational strategies to optimise financial performance and achieve organisational goals.
3. Forecasting and Planning: Analysing budget variances over time helps refine future budgeting and planning processes. By understanding historical variances and their underlying causes, organisations can make more accurate forecasts, set realistic budget targets, and allocate resources more effectively to meet future challenges and opportunities.

What are the steps for budget variance calculation?

These are the steps to calculate budget variance:

1. Determine the Budgeted Amount: Determine the anticipated or budgeted amount for the particular financial element (e.g., revenues, expenses) under consideration. Financial estimates or the organisation's budgeting procedure can provide this information
2. Obtain the Actual Amount: During the same period that the budget was set, collect the actual financial data for the same parameter. Financial statements, accounting records, and other pertinent sources may provide this information.
3. Calculate the Variance: To find the variance or difference, deduct the actual amount from the budgeted amount. A positive variance indicates that actual performance was better than anticipated when the amount surpasses the budgeted amount. On the other hand, a negative variance indicates that actual performance was below expectations if the actual amount is less than the budgeted amount.
4. Analyze the Variance: Examine the causes of the discrepancy between the planned and actual amounts after the budget variance has been computed. Identify the variables causing the variation, such as shifts in the economy, unforeseen costs, variations in revenue, or inefficiencies in operations.
5. Take Corrective Action (if necessary): Determine which areas require corrective action to bring actual performance in line with budgeted targets based on the analysis of the budget variation. Create plans to deal with large deviations, such as attempts to increase income, reduce costs, or better processes.
6. Monitor and Review: Determine which areas require corrective action to bring actual performance in line with budgeted targets based on the analysis of the budget variation. Create plans to deal with large deviations, such as attempts to increase income, reduce costs, or better processes.

Trends that can affect Budget Variance calculation

These are the trends that can affect budget variance:

1. Economic Conditions:  Economic downturns may result in lower-than-expected revenues or increased costs, leading to negative variances, while economic growth periods may result in favourable variances.
2. Market Competition: Intense competition may lead to pricing pressures, reduced profitability, or higher marketing expenses to maintain competitiveness, resulting in variances from budgeted targets.
3. Technological Advances: Investments in technology infrastructure, software systems, or automation tools may result in upfront costs but can lead to long-term cost savings and improved productivity, impacting budget variance.

Example

An example of budget variance from an Indian brand perspective could be a scenario involving a company like "Tata Motors." Suppose Tata Motors budgets ₹10 crore for research and development (R&D) expenses for a particular fiscal year. 

Due to unforeseen delays in project timelines and cost-saving measures, the actual R&D expenses incurred amount to ₹8.5 crore for the same period. In this case:

• Planned/Budgeted R&D Expenses: ₹10 crore
• Actual R&D Expenses: ₹8.5 crore
• Budget Variance: ₹1.5 crore (Positive)

This positive budget variance indicates that Tata Motors spent ₹1.5 crore less on R&D expenses than initially budgeted. The analysis of this variance could reveal areas of operational efficiency, potential underspending on innovation initiatives, or successful cost-saving measures the company implements.

FAQ

How is variance calculation performed in financial analysis?

Variance calculation in financial analysis involves subtracting the actual value of a financial parameter from its budgeted or planned value to determine the difference. 

What is the purpose of a budget variance report?

A budget variance report aims to evaluate performance, identify deviations from budgeted targets, analyse the reasons behind these variances, and take corrective actions to improve financial management and performance.

What are some common causes of budget variances in organisational financial management?

Common causes of budget variances in organisational financial management include changes in economic conditions, fluctuations in market demand or pricing, unexpected expenses or revenue shortfalls, inefficiencies in operations or resource utilisation, and errors in budgeting assumptions or forecasts. 

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