A budget variance is the difference between an actual amount and a planned or budgeted amount in an accounting category. It can be positive variances (gains) — where expenses are lower than predicted or revenue is higher than budgeted.
A budget variance can also be negative variance (losses and shortfalls) — when revenue falls short of the budgeted amount or expenses are higher than predicted.
Budget variance occurs as forecasters are unable to predict the future costs and revenue with complete accuracy.
Budget variances can occur from:
- controlled factors — a poorly planned budget and labor costs.
- uncontrollable factors — usually external and arise from occurrences outside the company (natural disaster).
Variances can be considered ‘material’, although subjective and differs depending on the company and relative size of the variance. To determine the cause, a material variance will be investigated. Management will then be tasked to see if the situation can be remedied.
Management needs to evaluate its budgeting process if a material variance persists over an extended period of time.
Primary causes of budget variance
Errors
When the budget is being compiled by the creators of the budget — errors can occur. Faulty math, relying on stale/bad data, or wrong assumptions are some reasons for this.
Changing business conditions
Global trade and changes in the economy can cause budget variances. A new competitor could create pricing pressure or there could be a change in the cost of raw materials. Regulatory and political changes can be included in this category.
Unmet expectations
Budget variances also occur with underperformed or exceeded expectations.
Flexible budget versus Static budget
A flexible budget provides greater adaptability to changing circumstances. When assumptions used to devise the budget are altered, it allows for changes and updates. This should result in less budget variance, both positive and negative.
If production is cut, variable costs are also going to be lower. This is reflected under a flexible budget and results can be evaluated at this lower level of production.
The level of production stays the same and the resulting variance is not as revealing under a static budget. For this reason, most companies use a flexible budget.
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