Budgeting: Calculating Budget Variances

What is a budget?

• A financial plan for the future concerning the revenues and costs of a business

What is budgeting?

• A process by which financial control is exercised in a business

• Budgets for revenues and costs are prepared in advance and then compared with actual performance to establish any variances

• Managers are responsible for controllable costs within their budgets

Variances:

• A variance arises when there is a difference between actual and budget figures

• Variances can be:

  • Positive/Favourable (better than expected)

  • Adverse/Unfavourable (Worse than expected)

Favourable variances:

• Actual figures are better than the budgeted figure

• E.g. costs lower than expected

• E.g. revenue/profits higher than expected

Adverse variances:

• The actual figure is worse than the budget figure

• E.g. costs higher than expected

• E.g. revenue/profits lower than expected

Possible causes of favourable variances:

• Stronger demand than expected=higher actual revenue

• Selling prices increased higher than the budget

• Cautious sales and cost assumptions (e.g. cost contingencies)

• Better than expected productivity or efficiency

Possible causes of adverse variances:

• Unexpected events lead to unbudgeted costs

• Over-spends by budget holders

• Sales forecasts prove over-optimistic

• Market conditions (e.g. competitor actions) mean demand is lower than budget