Good morning everyone. Today we’re going to talk about budgets and variances, a key part of financial control in business. Now, we all know that businesses make budgets to plan how much they expect to spend and earn. But once the budget period ends, the business needs to check if things actually went according to plan. That’s where variance analysis comes in.
A variance is simply the difference between what was budgeted and what actually happened. It helps the business see if it spent more or less than expected, or if it earned more or less than planned. In other words, it shows how close reality is to the plan.
We use a simple formula for this:
Variance = Actual Value – Budgeted Value.
If the actual figure is better than expected, we call it a favourable variance. But if it’s worse than expected, it’s an adverse variance.
Let’s look at what these mean in practice. A favourable variance means the business performed better than planned. For example, suppose your school tuck shop expected to earn twenty thousand dollars in sales but actually earned twenty-five thousand. That’s a five thousand dollar favourable variance because the revenue was higher than expected. Or if the tuck shop expected to spend ten thousand on supplies but only spent eight thousand, that’s another two thousand favourable variance. It means the business saved money or earned more than expected, which is always a good thing.
On the other hand, an adverse variance means performance was worse than planned. For example, if a business expected to spend twelve thousand dollars on labour but ended up spending fifteen thousand, that’s a three thousand dollar adverse variance. Or if it expected revenue of thirty thousand but only made twenty-five thousand, that’s a five thousand adverse variance. This tells managers that costs were higher or income was lower than planned, and they might need to investigate why.
Now, when businesses calculate variances, they compare budgeted and actual figures across all income and expense categories. Each variance is labelled as favourable or adverse. For example, imagine a small clothing store that budgeted fifty thousand dollars in sales but actually earned fifty-two thousand. That’s a two thousand favourable variance. But its raw material costs went from fifteen thousand to eighteen thousand, which is a three thousand adverse variance. Labour costs were budgeted at ten thousand but came to nine thousand five hundred, a five hundred favourable variance.
Looking at these figures, we can interpret that overall, the store earned more than expected, which is great. However, its material costs were higher, which might be due to rising fabric prices or supplier issues. Labour costs were slightly under budget, showing some efficiency there.
Variance analysis is very useful for businesses. It helps them monitor performance, showing which departments are doing well and which ones need attention. It supports decision-making, as managers can take corrective action when something goes wrong. It also helps improve future planning, because understanding why variances occurred can make future budgets more accurate. And finally, it encourages motivation and accountability, since people become responsible for managing their budgets effectively.
But like most tools, variance analysis isn’t perfect. There are some limitations. First, it often takes time to collect and review the data, so by the time variances are found, it may be too late to fix the issue. Second, sometimes adverse variances happen due to external factors outside the business’s control, such as inflation or economic downturns. And lastly, if managers focus too much on cutting costs to stay within budget, it could hurt product quality or staff morale.
So, to sum up, variance analysis helps a business stay on track financially. By comparing actual results with the budget, managers can see where things went right or wrong. Favourable variances show good performance, while adverse variances signal problems that need attention.
By the end of today’s lesson, you should be able to explain what a variance is, identify favourable and adverse variances, calculate them using the simple formula, and describe how businesses use this ana
