Budget variance analysis is a fundamental practice in corporate performance management and its application is an industry-standard. Because of its importance among corporate finance professionals, we have aggregated everything you need to know about budget variance analysis.
What is budget variance analysis?
Budget variance analysis is the practice of comparing actual results to the budget values for the same period and analyzing the variances. Since the budget is created to act as a guide for the business to accomplish its goals and objectives, it is important to periodically measure how well the business was able to stick to it.
While the process of comparing actual results to budgeted values is simple, the most important information is derived from the analysis of the variances. Analysis is typically performed whether results are favorable, meaning they exceeded expectations, or negative, meaning they were worse than expectations.
Why is budget variance analysis important to your business?
Budget variance analysis helps to reveal where your business exceeded expectations and where it came up short. Predictive budgeting can also help. The process of analyzing the variances reveals processes, initiatives, and other activities that created positive or negative results. Budget variance analysis helps business leaders to identify what is and what is not working.
Since the budget acts as a roadmap to carry out the objectives of the business variance analysis also helps business leaders to assess whether or not the targets will be achieved and what corrective actions should be taken to steer the ship back on course. Typically, variance analysis is always performed through the lens of understanding what, if any, corrective actions are required for the business to achieve the budget targets.
How do you calculate budget variance?
Calculating variance is mathematically simple. Simply compare the actual results to the budget and find the difference between the values (this is called budget vs actual variance analysis). While there might be other ways of producing variance analysis, this is perhaps the most common approach and simply involves placing the budgeted values in one column and placing actual results in an adjacent column followed by the variance in the third column.
The process involves comparing actual sales figures and actual costs figures to the budgeted value, and is sometimes referred to as the sales and cost vs budget approach. Each variance is typically accompanied by commentary that explains the deviations from the budget.
How to do budget variance analysis
FP&A analysts are usually tasked with creating and reporting budget variance analysis. Most corporate finance professionals utilize excel to perform variance analysis and as a result, it is easiest to perform variance analysis using some form of spreadsheet. We’ll walk you through the budget vs actual variance analysis formula in excel.
The typical process is made up of five basic steps.
Below are the five basic steps to performing variance analysis.
Step 1: Gather Data
Before beginning it is best to gather and aggregate all relevant data in one centralized location. Managing disparate excel files or data sets can produce challenges when trying to perform the analysis on variances. Furthermore, it streamlines the production of the report and helps to maintain version control over various versions of data that might be produced.
Ideally, data from multiple time periods will be gathered and stored together. This will be used to display a more broad level of detail and help to identify trends. It is important to note that the budget should be included in this package of data as this is what the actual results will be compared against.
Step 2: Calculate Variances
Once all of the relevant data is centralized, create the template for calculating variances in excel. In one column, place your budgeted values for each data point you would like to compare. For example, gross revenue, labor costs, cost of goods sold, and fixed costs might be presented in aggregate. Remember that you can be as granular as the data you aggregated in step 1 allows you to be.
In cases where there are multiple sources of revenue, it is important to identify the budgeted numbers and actual numbers for each source. The same applies with costs, as looking at aggregated values can be deceiving. For example, if you group all sales together, one product might be lagging behind the budget but others might be exceeding and making up for it. The overall impact is no variance, but individual variances exist.
Excel Formula For Calculating Variance
In excel you can simply take the difference between two values to identify the variance or you can use the “VAR” formula. The VAR formula returns the variance of a sample data set. This is particularly useful if you have sales over time that you want to compare to a fixed point in time in your budget.
VAR(number1, [number2], …)
The formula translates to:
= the simple average of the values
= sample size
Step 3: Analyze Variances
It is always a best practice to implement thresholds for materiality when performing variance analysis. Be sure that the time spent on investigating a variance is worthwhile and be sure to measure the cost and benefit of time spent during analysis. Once you have identified a materiality threshold, begin the process of analyzing each variance.
This is the most time-consuming part of the process and demands that FP&A analysts maintain diligence when investigating the root causes of variances. In the process analysts might work with various department leaders to understand what occurred to lead to a variance.
It is important to note that analysis is performed on both positive and negative variances.
Step 4: Compile Management Reports
Finally, compile all of the results into a singular report for management. The report should contain the identified variances and the root causes of each variance. It should also contain corrective actions and recommendations for management on what to do. Analysts take ample time to prepare for these presentations as management often asks questions that they need to be ready to answer.
Step 5: Adjust Forecasts
Once the actual values and emerging trends have been identified, it is important to update any forecast and additional financial models with the new information. Forecast should act as a compass that helps the business navigate towards its goals and provides a gauge to measure whether it is headed in the right direction.
Consequently, forecasts should be updated not only for the information gleaned from the variance analysis but also for the courses of action that management has elected to take.
This gives you everything you need to create a budget vs actual variance analysis template.
Using DataRails, a Budgeting and Forecasting Solution
DataRails replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal.
Every finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics.
Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.
DataRails is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.