If you work in a finance related role, or are just starting to look into accounting, you may have come across the term “budget variance analysis”. So, what is it, and how does it work?
What is budget variance analysis?
Budget variance analysis is a process you go through at the end of your results cycle. It shows you the gap between the original budget and actual revenues and expenses, enabling you to see how accurate the original budget was.
The main reason behind this analysis is so that you can see where the variances occurred (whether good or bad), and address these so as to try to eliminate any variances in the future.
To work out your budget variance, you take your budgeted amount and your actual amount of revenues and expenses, and subtract the smallest from the largest. You can then work through your column of revenues and expenses to work out what had the greatest impact on any variances. It’s best to look at each by both amount and percentage, to give you an accurate idea of what made the most difference.
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How is it used?
Budgets are vital for any business, as they reflect how owners/directors see the business performing over a certain period of time, and underpin organisational strategy. The closer the budget is to actual figures, the better the business is at predicting its performance.
Budgets in the manufacturing industry can also help drive sales prices. A company will budget what it expects a product to cost to produce, and will reach a selling price from this. If the actual cost fluctuates too much from that of the budget, it could result in the company losing money on that particular product.
Conversely, if the budget for a product is too high, this could affect the selling price, and could mean that you price potential customers out of the market. This then will then have a detrimental effect on your turnover and profit.
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