Budget Variance

What is 'Budget Variance'

A budget variance is a periodic measure used by governments, corporations or individuals to quantify the difference between budgeted and actual figures for a particular accounting category. A favorable budget variance refers to positive variances or gains; an unfavorable budget variance describes negative variance, meaning losses and shortfalls. Budget variances occur because forecasters are unable to predict the future with complete accuracy.

BREAKING DOWN 'Budget Variance'

Budget variances can occur from controlled or uncontrollable factors. For instance, a poorly planned budget and labor costs are controllable factors. Uncontrollable factors are often external and arise from occurrences outside of the company such as a natural disaster.

Causes of Budget Variances

There are three primary causes of budget variance: errors, changing business conditions and unmet expectations. Errors by the budget creators can occur when the budget is being compiled. There are a number of reasons for this, including faulty math, using the wrong assumptions and relying on stale or bad data. Changing business conditions, including changes in the overall economy, can cause budget variances. There could be a change in the cost of raw materials or a new competitor could have cropped up to create pricing pressure. Political and regulatory changes that were not accurately forecast are also included. Budget variances also occur when management exceeds or underperforms expectations.

A variance should be indicated as favorable or unfavorable. A favorable variance is one where revenue comes in higher than budgeted or expenses are lower than predicted. The result could be greater income than originally forecast. Conversely, an unfavorable variance occurs when revenue falls short of the budgeted amount or expenses are higher than predicted. Hence, net income may be below what management originally expected.

If the variances are considered material, they will be investigated to determine the cause. Then, management will be tasked to see if it can remedy the situation. The definition of material is subjective and different depending on the company and relative size of the variance. However, if a material variance persists over an extended period of time, management likely needs to evaluate its budgeting process.

Flexible vs. Static Budget

A flexible budget allows for changes when assumptions used to devise the budget are altered. A static budget remains the same, even if the assumptions change. The flexible budget allows for greater adaptability to changing circumstances. For instance, assuming production is cut, variable costs are also going to be lower. Under a flexible budget, this is reflected, and results can be evaluated at this lower level of production. Under a static budget, the original level of production stays the same, and the resulting variance is not as revealing.

RELATED TERMS
  1. Variance

    The spread between numbers in a data set, measuring Variance ...
  2. Mean-Variance Analysis

    The process of weighing risk against expected return. Mean variance ...
  3. Unfavorable Variance

    An accounting term that describes instances where actual costs ...
  4. Static Budget

    A type of budget that incorporates anticipated values about inputs ...
  5. Production Volume Variance

    The amount of fixed overhead costs that are not allocated to ...
  6. Cost Control

    The practice of managing and/or reducing business expenses. Cost ...
Related Articles
  1. Personal Finance

    How Budgeting Works For Companies

    Learn how to break down and understand a corporate budget.
  2. Markets

    Explaining Variance

    Variance is a measurement of the spread between numbers in a data set.
  3. Managing Wealth

    Calculating Portfolio Variance

    Portfolio variance is a measure of a portfolio’s volatility, and is a function of two variables.
  4. Investing

    Explaining the Cash Budget

    A cash budget is a plan for the inflows and outflows of cash for a business or an individual.
  5. Investing

    Exploring The Exponentially Weighted Moving Average

    Learn how to calculate a metric that improves on simple variance.
  6. Investing

    Using Historical Volatility To Gauge Future Risk

    Use these calculations to uncover the risk involved in your investments.
  7. Personal Finance

    Budgeting Basics - Conclusion

    By Amy FontinelleBudgeting is an important component of financial success and one that's not difficult to implement. Let's recap what we've learned in this tutorial: Budgeting isn't just ...
  8. Personal Finance

    5 Reasons Why You Can't Stick To Your Budget

    You want to stay on track with your finances, but these fatal budgeting flaws may be holding you back.
  9. Personal Finance

    Budgeting Your Small Business

    Budgeting helps small businesses determine if they have enough money to fund operations, expand and generate income.
  10. Retirement

    This Is the Year to Start Budgeting

    Whether your issue is credit card debt, student loans (or the fact that Social Security isn't rising next year), it's time to learn how to build a budget.
RELATED FAQS
  1. How is an unfavorable variance discovered?

    Learn how unfavorable variance is discovered through defining budget numbers, such as standard rates for labor and materials, ... Read Answer >>
  2. What does an unfavorable variance indicate to management?

    Learn what an unfavorable variance indicates to management, such as problems with meeting expense and revenue targets or ... Read Answer >>
  3. What is price variance in cost accounting?

    Understand what price variance is in relation to cost accounting. Learn the most common way price variance arises and how ... Read Answer >>
  4. What is the difference between standard deviation and variance?

    Understand the difference between standard deviation and variance; learn how each is calculated and how these concepts are ... Read Answer >>
  5. How can I measure portfolio variance?

    Find out more about portfolio variance, the formula to calculate portfolio variance and how to calculate the variance of ... Read Answer >>
  6. What is the difference between expected return and variance?

    Learn about expected return and variance, the difference between the two measures and how to calculate the expected return ... Read Answer >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center