Variances can be either:
* Positive/favourable (better than expected) or
* Adverse/unfavourable ( worse than expected)
A favourable variance might mean that:
* Costs were lower than expected in the budget, or
* Revenue/profits were higher than expected
By contrast, an adverse variance might arise because:
* Costs were higher than expected
* Revenue/profits were lower than expected
What causes budget variance?
There are four key reasons and it is important that good managers recognise the differences, because the action required is may be completely different in each case.
The four reasons are:
1. Faulty Arithmetic in the Budget Figures
2. Errors in the Arithmetic of the Actual Results
3. Reality is Wrong
4. Differences between Budget Assumptions and Actual Outcome 1. Faulty Arithmetic in the Budget Figures
It is perfectly possible to have an error in the budget. This includes errors of commission or duplication as well as pure arithmetic. One action is to make a note to ensure it does not happen again when the next budget is being done. Other action depends on the error. Assume the budget stated no overdraft would necessary and it now appears one is required because the sales forecast was used to predict cash inflows rather than the debtor payments. There are two options: Go to the bank and ask for an overdraft, or take some other action to improve cashflow to stay within the budget cash figure. The original budget numbers will need to be changed to reflect the new circumstances and future reporting should be against the revised budget (often called a reforecast or latest estimate.) Action is required but it may not be within the area where the error was made. 2. Errors in the Arithmetic of the Actual Results
It is perfectly possible for the actual results to be reported wrongly. This includes the use of the wrong category, omission of costs, double counting of income etc. One well known way of staying within...