Interpretation of Variances

Last updated Mar 13, 2023 Edit

• Business

• The difference between a budget and the actual result is described as a variance. They can be favourable (in favour of the business) or adverse (not in favour of the business).
• Variance Analysis is the process of calculating and interpreting these variances.
• Notes on variances exist in Budget Research

• Expenditure higher than budget
• Income lower than budget
• Profit lower than budget

• Expenditure lower than budget
• Income higher than budget
• Profit higher than budget

• Once a variance has been identified it is important to:

  • Identify the cause of the variance
  • Consider the effect of the variance
  • If appropriate look for a solution

• Possible causes of variances

  • Actions of competitors
  • Internal inefficiency
  • Action of suppliers
  • Changes in the economy
  • Internal decision making

• Having identified variances managers now need to respond:

  • Change budgets
  • Staff training
  • Reward Staff
  • etc

A budget is a financial plan for the future concerning the revenues and costs of a business.

Budgets for sales/revenues and expenditure are prepared in advance and then compared with the actual performance to establish any variances.

Managers are responsible for controllable costs within their budgets and are required to take remedial action if favourable or adverse variances arise, and they are considered excessive.

There are many management uses for budgets. For example, budgets are used to:

• Control income and expenditure (the traditional use)
• Establish priorities and set targets in numerical terms
• Provide direction and co-ordination, so that business objectives can be turned into practical reality.
• Assign responsibilities to budget holders (managers) and allocate resources.
• Communicate targets from management to employees.
• Monitor performance.

1. Variance Analysis
2. Sales Revenue Budget
3. Financial Forecast
4. Adverse Variances

1. False
2. True
3. True

Sales discrepancy: £50,000 Expenditure discrepancy: -£11,000 Profit budget: £255,000 Actual profit: £294,000 Profit discrepancy: -£39,000£255,000 Actual profit: £294,000 Profit discrepancy: £39,000

Why might a sales revenue budget be higher than forecast?

A sales revenue budget might be higher than expected if the demand in the market is very changeable. If the market is for a product such as masks, then planners before the covid pandemic would not have been able to predict the sharp increase.

A sales budget is also based on extrapolated data, so changes in the real world may differ greatly from assumptions made by a budget planner.

Business