Budgeting and Variance
Business managers construct budgets to guide the future development of their companies. These budgets provide the guidelines for growth and describe how it should be accomplished and who'll be held accountable for the results. Variance reporting tells the managers whether or not they're meeting their budgets.
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Budgeting
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Management team members decide on strategic goals that explain where they want their businesses to go. They construct budgets that provide details on how to achieve these objectives. Budgets are also tools to evaluate the individuals responsible for achieving their portions of the strategic plan.
Business managers prepare budgets at the beginning of a reporting period for all segments of their businesses: profits, sales, overhead costs, marketing expenses, capital expenditures, manufacturing costs and labor productivity. Accountants break down the annual budgets into monthly or quarterly reports that allow the managers to monitor their progress on achieving the goals. Any deviations from the budgets are reported as variances.
Variances
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A variance is the difference between the results defined by a budget and the actual results. Variances may be either unfavorable or favorable. Examples of an unfavorable variance are lower-than-expected profits, lower-than-projected sales, higher materials costs, higher overhead expenses or lower labor productivity.
For even more detailed analysis to determine the cause of a variance, a macro variance might get broken down into subvariances. A labor cost variance, for example, might be further analyzed with a labor rate variance or a labor productivity variance. A material cost variance could be separated into a price or usage variance.
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Uses
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Business managers use variance analysis to spot favorable and unfavorable variances from their budgets. An unfavorable variance requires more analysis to establish the cause of the difference and to determine a suitable corrective action. Each variance must be analyzed on its own and how it relates to other parts of the budget to determine if the variance is good or bad.
For example, lower prices for materials could result in a favorable materials price variance. However, if the material were lower quality that required more labor hours, this would produce unfavorable variances for labor efficiency and labor cost.
Budgets and variances are often used to evaluate employee performance. Employees might receive bonuses or profit-sharing rewards for meeting budget objectives and staying within the variance allowances.
Personal Applications
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Although budgets and variances are normally used by businesses, they're also applicable to personal finances. Setting up a household budget that stays within your income helps to prevent overspending and incurring unnecessary debt. Tracking expenses and looking for variances from the budget will ensure that spending stays under control.
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References
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