Budget Variance: Definition, Causes, and Types A budget variance measures the difference between budgeted (planned) and actual figures for revenue, expenses, or other accounting categories. Variances help organizations and individuals assess performance, diagnose problems, and refine future budgets. Key takeaways
* Variance = Actual − Budgeted. Interpretation depends on the line item (revenue vs. expense).
* A favorable variance means better results than planned (e.g., higher revenue or lower expenses). An unfavorable variance means worse results (e.g., lower revenue or higher expenses).
* Variances arise from controllable factors (internal decisions, planning errors) and uncontrollable factors (economic shifts, disasters).
* Regular variance analysis and use of flexible budgets improve budgeting accuracy and responsiveness.
Types of budget variances
* Favorable vs. Unfavorable
* Favorable: actual revenue > budgeted revenue, or actual expenses < budgeted expenses.
* Unfavorable: actual revenue < budgeted revenue, or actual expenses > budgeted expenses.
* Controllable vs. Uncontrollable
* Controllable: caused by internal decisions or mismanagement (e.g., staffing, procurement choices).
* Uncontrollable: caused by external events beyond management’s reasonable control (e.g., supply shocks, regulatory changes).
* Static vs. Flexible budget variances
* Static budget: fixed at original assumptions. Variances against a static budget may reflect changes in activity levels and can be less informative.
* Flexible budget: adjusts for actual activity levels (e.g., production volume). Comparisons to a flexible budget typically isolate performance from activity changes and yield more actionable insights.
Primary causes of variance
1. Errors in the budget
2. Miscalculations, incorrect assumptions, stale or poor-quality data.
3. Changing business or economic conditions
4. Price changes for inputs, new competitors, shifts in demand, or regulatory changes.
5. Unmet or exceeded expectations
6. Operational performance diverges from forecasts—sales mix changes, productivity differences, or timing issues.
Interpreting and managing variances
* Determine materiality: set thresholds for when a variance warrants investigation.
* Diagnose the cause:
* Quantify the variance and categorize it by type (revenue vs. cost, fixed vs. variable).
* Perform root-cause analysis (e.g., sales mix review, cost-driver analysis).
* Take corrective action:
* Adjust operations (cost controls, pricing, promotional efforts).
* Revise forecasts and assumptions for future budgets.
* Use flexible budgets when appropriate to separate performance issues from activity-level changes.
* Monitor variances regularly (monthly or quarterly) to identify trends early.
Simple examples
* Revenue: Budgeted sales $250,000; actual sales $200,000. Variance = $200,000 − $250,000 = −$50,000 (unfavorable, −20%).
* Expenses: Budgeted expenses $200,000; actual expenses $250,000. Variance = $250,000 − $200,000 = $50,000 (unfavorable, +25%).
Best practices
* Use clear variance thresholds and reporting templates.
* Build flexible budgets for operations with variable activity levels.
* Improve data quality and document assumptions used in budgets.
* Integrate variance analysis into regular management reviews to drive timely corrective actions.
Regular, disciplined variance analysis helps organizations understand performance drivers, refine forecasting, and make better operational and strategic decisions. Explore More Resources