Budget variance analysis is a fundamental practice in corporate performance management. Most businesses perform regular budget variance analysis monthly, quarterly, or yearly.
Consistent analysis offers you the insights you need to:
- Identify trends in business performance
- Increase budgetary accuracy
- Track financial performance
- Manage costs
- Make data-driven decisions
Because budget variance analysis is incredibly valuable to corporate finance professionals, we have compiled everything you need to know about this practice in this article.
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. The budget is created to guide the business in accomplishing its goals and objectives.
With this goal in mind, periodically measure how well the company adheres to it.
While comparing budgeted and actual figures is straightforward, the most important insights come from analyzing its variances.
Businesses usually use analysis to determine whether results are a favorable variance (exceeding expectations) or an unfavorable variance (falling short of expectations).
Gathering insights is one thing, but applying them is another.
Why Is Budget Variance Analysis Critical To Your Business?
Budget variance analysis reveals where your business exceeded expectations and came up short.
Predictive budgeting can also help. This type of budget forecasting involves using historical data and AI to pinpoint recurring trends and patterns in data.
Analyzing the variances reveals processes, initiatives, and other activities that create positive or negative results.
Ultimately, budget variance analysis helps business leaders identify what is and is not working.
The budget acts as a roadmap to achieving the business objectives.
Variance analysis also helps business leaders assess whether they will achieve targets and what corrective actions they should take to get back on course.
Typically, you perform variance analysis to understand which corrective actions will help your business achieve its budget targets.
Curious about the best business budgeting software in 2024? See a list of the top 10 options here.
How Do You Calculate Budget Variance?
Calculating variance is mathematically simple: 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 the most common approach.
It simply involves:
- Placing the budgeted values in one column
- Placing actual results in an adjacent column
- Adding the variance in the third column
The equation looks like this: Budget variance = Budget value – Actual value
The process involves comparing actual sales figures and actual cost figures to the budgeted value, sometimes referred to as the sales and cost vs. budget approach. Commentary explaining the budget deviations usually accompanies each variance.
How To Do Budget Variance Analysis
FP&A analysts are usually tasked with creating and reporting budget variance analyses. Most corporate finance professionals utilize Excel to perform variance analysis, and it is easiest to perform variance analysis using some form of spreadsheet.
Next, we’ll walk you through the budget vs. actual variance analysis formula in Excel.
The typical process comprises these five basic steps for performing variance analysis.
Step 1: Gather Data
Before beginning, gather and aggregate all relevant data in one centralized location.
Managing disparate Excel files or data sets can present challenges when performing variance analysis. Furthermore, a centralized location streamlines the report’s production and helps maintain version control over the various versions of the data it produces.
Ideally, data from multiple time periods will be gathered and stored together. This displays a more broad level of detail and helps identify trends.
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 the relevant data is centralized, create the template for calculating variances in Excel. Each budgeted value gets its own column for the data point you want to compare.
For example, gross sales, labor costs, cost of goods sold, and fixed costs might be presented in aggregate. Remember, you can be as granular as the data you aggregated in Step 1 allows you to be.
Identify the budgeted and actual numbers for each source in cases where multiple revenue sources exist. The same applies to costs, as looking at aggregated values can be deceiving.
For example, if you group all sales together, one product might lag behind the budget while others exceed and make up for it. The overall impact is no variance, but individual variances exist.
Excel Formula For Calculating Variance
You can simply take the difference between two values to identify the variance in Excel or 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 you want to compare to a fixed point in time in your budget.
VAR(number1, [number2], …)
The formula translates to:
Where:
= the simple average of the values
= sample size
You can learn more about Datarails formulas here.
Step 3: Analyze Variances
It is always a best practice to implement thresholds for materiality when performing variance analysis.
These financial thresholds consist of predefined limits to determine the impact of budget variances and if they warrant further investigation.
With these thresholds, you can prioritize which deviations to focus on and use resources more efficiently.
Measuring the cost and benefit of the time spent on the analysis is important so you know the time spent investigating a variance is worthwhile.
You can base these thresholds on percentage variances, absolute dollar amounts, or a combination.
Once you identify a materiality threshold, begin analyzing each variance.
This is the most time-consuming part of the process. It 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 caused a variance.
Both positive and negative variances are analyzed.
Step 4: Compile Management Reports
Finally, the results will be compiled into a single 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 they need to be ready to answer.
Step 5: Adjust Forecasts
Once you identify the actual values and emerging trends, update any forecast and additional financial models with the new information.
The forecast should act as a compass that helps the business move toward its goals. It provides a gauge to measure whether it is headed in the right direction.
Consequently, you should update your forecasts based on the information you glean from the variance analysis, and the courses of action management elects 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 lets you work comfortably in Excel while having a much more sophisticated data management system available.
Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash more straightforward and efficient. It also shifts the focus to cash analytics.
