When it comes to financial management, budgets are essential for both individuals and businesses. A budget is a financial plan that shows how much you expect to earn and spend over a given period. However, over time, actual financial results often deviate from the plan. This difference is called a financial variance. To make better financial decisions, you need to understand what these variances mean. Financial variances can tell us whether we are over or under budget and help us identify areas for improvement. Without proper variance analysis, you cannot determine whether you are meeting your financial goals or what problems exist.
Causes of Variances
Many factors can cause a budget to misalign with reality. Sometimes costs rise or revenues fall due to unexpected factors. For example, if the economy slows, people may spend less, meaning sales are lower than expected. The price of a product or service may increase unexpectedly, meaning costs rise more than planned. Budgeting errors, such as making incorrect assumptions or omitting key information, can also cause variances. It’s important to understand the reasons for variances so you can make adjustments in advance and better plan for the future.
Different Types of Financial Variances
Financial variances fall into two main categories: favourable variances and unfavourable variances. A favourable variance is when actual revenue is higher than budgeted or actual expenses are lower than budgeted. This is a good sign and can indicate that the company is doing well or that profitability is improving. On the other hand, an unfavourable variance is when actual revenue is lower than expected or actual expenses are higher than expected. An unfavourable variance indicates that something needs to be improved. Individuals and businesses can understand their financial situation and address problems by identifying the types of variances.
Get the Right Information
Before you can perform a useful variance analysis, you must have accurate and complete data. This includes the initial budget figures and actual revenue for the period in question. Supporting documents such as receipts, invoices, payrolls, and sales reports can help clarify the situation. Accurate data ensures that the analysis is based on facts rather than guesses. The more complete the data, the easier it is to determine where and why the variances occurred.
Finding the Root Cause
For analysis to work, you must understand the cause of each variance. Simply knowing that a variance exists isn’t enough. You must investigate the cause of each item that exceeded budget. Is the variance due to external factors such as market fluctuations or internal factors such as excessive spending or poor performance? Is it a one-time occurrence or a recurring problem? By answering these questions, you can better understand the factors affecting financial performance and take steps to correct or replicate those results.
Making Changes Based on Variance
The main goal of variance analysis is to help people make better decisions. Once you understand the cause of the variance, you can take appropriate action. If costs are consistently higher than planned, you may need to reduce them in certain areas or renegotiate contracts with suppliers. If sales results are poor, you may need to revise your marketing plan. The goal is to better align budgets and financial results and improve them over time. Budgeting shouldn’t be a fixed method; it should evolve to reflect how people actually spend their money.
Monitoring and Reviewing Budgets Regularly
Regular reviews are essential for effective variance analysis. If you wait until the end of the fiscal year to compare actuals to the budget, it may be too late to make significant adjustments. Instead, monthly or quarterly reviews can help you identify variances early and make improvements. Regular reviews can help you remember your financial goals and hold you more accountable. This transforms budgeting from a one-time exercise into a way to manage and improve your money long-term.
Involving the Right People
Financial variance analysis works better when the right people are involved. In business, this means department heads, financial analysts, and budget managers should all be involved. Each stakeholder has a different perspective that can help explain the root cause of the problem. In personal finance, for example, such an effort might involve talking to family or a financial advisor. When more people understand the budget and are concerned about its performance, it’s easier to implement changes and achieve financial goals.
Use Tools to Analyze Quickly
Technology can simplify variance analysis. Financial software and spreadsheets can help with comparisons and calculations. Some tools have built-in reporting capabilities that allow you to clearly see variances. You can monitor your budget in real time with dashboards, charts, and alerts. These tools save time, reduce errors, and increase learning. Using the right tools can make variance analysis easier and more accurate for both individuals and businesses.
Conclusion
Keeping track of financial variances is essential for effective financial management. Budgets create expectations, but comparing budgets to actual figures provides the best information. By understanding why variances occur, collecting reliable data, identifying the underlying causes, and taking action to address them, you can significantly improve your financial performance. Whether you manage your own money or run a business, variance analysis can help you achieve your financial goals and optimise your resources. This approach encourages learning, strengthens employee accountability, and helps employees achieve long-term financial success.
FAQs
1. Why is it important to perform variance analysis?
Variance analysis can reveal the difference between financial assumptions and actual results, enabling you to make better decisions and better plan future budgets.
2. What makes a variance undesirable?
Unexpected costs, lower-than-expected revenue, poor planning, or economic fluctuations can all lead to bad variances.
3. How often should you review changes in your financial situation?
It’s best to review variances monthly or quarterly so you can identify problems early and adjust your strategy as needed.
4. Can a positive variance be detrimental?
Yes, sometimes it can. A positive variance can indicate insufficient investment, resulting in missed opportunities or services not delivered as promised.
5. What tools can help you identify variances?
Spreadsheet programs like Excel or financial software like QuickBooks make it easier to compare and report data.
