Budget vs actual analysis is a key financial tool that compares project figures to real-world results. It helps businesses understand where plans align or diverge from reality. Tracking variances in revenue, expenses, or other metrics allows companies to gain insights into their performance and pinpoint areas that require attention.
This process informs smarter decision-making, promotes better forecasting, and improves financial accountability. An experienced CPA will help you leverage these insights and use them for effective resource management and sustainable growth.
What Does “Budget vs Actual” Mean?
Budget vs actual is a process that compares your company’s expected financial performance to its actual financial results over a chosen period. This comparison identifies the difference, or budget vs actual variance, between what was planned and what really occurred.
Variance is either favorable—denoting lower expenses or higher revenue than expected—or unfavorable, indicating overspending or missed revenue targets. Variance is expressed either as a number or a percentage.
Businesses’ budgets are calculated based on historical data, including income and expenses. However, this number doesn’t take into account unforeseen real-world factors like market shifts or significant global events that may cause actual results to deviate from the plan. Regularly comparing budgeted and actual performance helps companies stay on track as they factor in the constantly changing economic climate.
Many companies get help to prepare variance reports from experts in outsourced accounting services. Professional help is crucial to ensure assumptions about budgets and actual figures are correct. Financial managers then use the insights to compare the budget with actual costs to make informed decisions, adjust forecasts, and improve accountability across departments.
Common Causes of Budget vs Actual Variances
Many factors cause actual financial results to deviate from budgeted figures:
Expense Variances
Fluctuations in business costs are a common cause of variance. These include:
- Variable cost changes: Unexpected changes in material and labor costs, such as overtime.
- Fixed cost changes: For example, expenses incurred due to unforeseen repairs, maintenance, or rising overhead costs.
- Operational inefficiencies: Poor cost control, low employee productivity, or equipment downtime.
- Incorrect assumptions: Forecasting or budget projections based on false assumptions often lead to errors in budgeting.
Revenue Variances
Many factors influence how much revenue your business actually makes. These include:
- Sales volume: Customer demand may rise or drop due to competition or changing market conditions.
- Customer trends: Customers may start to purchase more lower-margin products or services.
- Timing: Changes in revenue recognition, for example, when revenue or expenses are recognized earlier or later than usual. This is more common in companies that use accrual accounting.
Possible Outcomes of a Budget vs Actual Variance Analysis
A budget vs actual variance analysis provides insights into how your business is going financially. The main outcomes and their takeaways are:
Favorable Variance
A favorable variance indicates one of two outcomes: that your company’s revenue was higher than expected, or that actual expenses were lower than expected. The takeaways from a favorable variance could be:
- Your company has performed better than expected financially.
- Cost savings or improved efficiency in your business are paying off.
- You’re outperforming on some key performance indicators like sales or revenue targets.
Unfavorable Variance
An unfavorable variance also indicates one of two outcomes: that a company’s actual revenue is lower than budgeted, or that actual expenses are higher than budgeted. An unfavorable variance could indicate:
- Poorer-than-expected financial performance: Factors such as overspending or cost overruns often tip the scales.
- Poor planning: Failure to anticipate factors that drive up costs or impact customer spending may lead to an unfavorable variance.
- Inefficiencies: Inefficient processes or operations impact margins in your business.
- Unexpected changes or events: Significant events like natural disasters or an economic downturn invariably impact businesses’ cash flow.
Mixed Results
Mixed results indicate that some areas came in under budget while others overspent (or underdelivered). Mixed results suggest better forecasting or more efficient operations are required in certain areas. It also offers a great opportunity to reallocate resources or reassess the budgeting strategy in specific areas of the business.
Why Is Budget vs Actual Analysis Important?
Conducting a budget vs actual variance analysis is important as it reveals insights into spending in your business that drive smarter, data-driven decisions. Knowing the difference between your estimated budget and what you end up spending allows you to:
Make Informed Decisions
Comparing budgeted and actual expenses helps you identify areas where changes are needed. Actual variance analysis is one factor that influences decisions like resource allocation, cost-cutting, or changes in operations.
Improve Forecasting Capabilities
Analyzing the trends from past variances will improve the future accuracy of your financial forecasting. Access to this amount of data isn’t available to startups. However, established businesses find past data useful to pinpoint where their assumptions were wrong and adjust future budgets accordingly.
Evaluate Performance
Comparing what was budgeted to what was actually spent is one way to track the performance of an individual, a team, a department, or even the entire company.
Variances from the projected budget can be interpreted both positively and negatively. For example, let’s imagine a company that budgeted $5,000 for marketing, but only spent $3,000. Some will interpret this variance as careful and efficient spending in the marketing department, while others will see a lack of initiative or even missed opportunities.
Improve Accountability and Control
Establishing a budget keeps teams and departments aligned and accountable to the same agreed-upon financial plan. This promotes financial discipline, transparency, and teamwork.
Possible Limitations of Budget Variance Analysis
A budget variance analysis offers an invaluable snapshot into the actual performance of your business. However, financial analysis must always be understood in context and with its limitations in mind. Possible limitations of budget variance analysis include:
- Failure to anticipate unexpected events: Events that cause economic crises, like the COVID-19 pandemic or natural disasters, make budgeting ineffective. The shockwaves they cause and their multi-year effects easily result in overinflated budgets, which in turn lead to fluctuations in expenditure, frequent rebudgeting, and cost-cutting measures.
- Can’t be used in isolation: Variance analysis only offers the numbers behind variance, not the reasons why. Further investigation is required when variances exceed a reasonable limit.
- Reliance on variance could impact business decisions: Managers too intent on meeting the budget may sidestep innovation or fail to make necessary investments that stimulate long-term growth.
- Budgets may be based on wrong assumptions: Budgets based on outdated data or flawed assumptions won’t yield reliable results. This is risky for your business, as bad budgets inevitably lead to bad decisions. Seek professional help with your budget to ensure you start on the right foot.
How to Perform a Budget vs Actual Analysis
Follow these steps to perform a budget vs actual variance analysis:
1. Gather Financial Data
Gather all relevant budgeted and actual data. Your budgeted data will include documents like planned revenues, expenses, and any other documents detailing your projections for the period you’re analyzing. Actual data includes real data from your financial statements, especially the income statement and cash flow statement.
Ensure you gather data from the same time period. The importance of accurate financial statements is also critical to guarantee that you base your budgets on reliable data.
2. Compare Budgeted and Actual Data
Use a spreadsheet to compare budgeted vs actual revenue, expenses, and net income. Variances can be calculated by dollar amount or by percentage. It may be useful to include both in your spreadsheet.
To calculate the dollar variance formula: Dollar Variance = Actual – Budgeted
To calculate the percentage variance formula: Percentage Variance = (Actual – Budgeted) / Budgeted x 100
Example
Let’s examine Cozy Café, a trendy coffee spot in a busy downtown area. They conduct a budget vs actual report for August:
| Category | Budgeted | Actual | Variance ($) | Variance (%) | Variance type |
| Revenue | $30,000 | $25,000 | -$5,000 | -18.2% | Unfavorable |
| Cost of Goods Sold (COGS) | $10,000 | $12,000 | +$2,000 | +20% | Unfavorable |
| Labor Costs | $15,000 | $12,000 | -$3,000 | -25% | Favorable |
| Marketing | $2,000 | $1,000 | -$1000 | -50% | Favorable |
| Net Profit | $7,500 | $6,000 | -$1,500 | -25% | Unfavorable |
3. Analyze Data
Analyzing the data you have and using it as a basis for your business decisions is the next critical step. Even this short table offers many insights into what might have gone wrong in August for Cozy Café. For example, the management will likely come to the following conclusions:
- Revenue was down $5,000. The café relies heavily on footfall from nearby offices for much of its revenue. This was impacted by many workers taking vacation time during the month.
- COGS was 20% higher than expected due to rising supplier prices.
- Labor costs were lower due to the implementation of a more efficient staff rota.
- The café saved a significant amount on marketing in August. However, decreased spending in this area could have contributed to the revenue shortfall.
- Net profit was 25% less than budgeted. This is a significant gap that will require action to address.
Possible Outcomes
Cozy Café’s management will use this analysis to make data-driven decisions for future months and years. Possible insights include:
- Investigating whether different suppliers offer more competitive prices
- Evaluating the impact of reduced marketing spending on revenue
- Adjusting the August revenue forecast to reflect the lower footfall from regular customers
Budget vs Actual Best Practices
A budget vs actual analysis offers invaluable financial insights, but only if you do it right. Your CPA is a crucial part of providing the numbers required to make the best decisions for your business.
Make Realistic Budgets
Budget vs actual is only useful if you base your budgets on real, historical data and market trends. This will help you make informed assumptions and avoid unrealistic projections.
Compare the Budget and Actual Variance Regularly
Budget vs actual is most useful for future financial planning when you review variances on a monthly or quarterly basis. This is especially important for startups that will benefit from catching problems early and avoiding costly beginner’s mistakes. Choose how often you compare budget and actual, and keep to this schedule to ensure valid comparisons and timely insights.
Investigate Significant Variances
Agree on a certain threshold for investigation (for example, 5% variance, or a set dollar amount) with your accountant. Significant revenue or expense variances must be explored to find out if they’re controllable, and if they represent one-off phenomena or are part of larger trends.
Introduce Rolling Forecasts
Budget vs actual is a useful tool, but one that is best utilized in conjunction with other tools. Using rolling forecasts, updated monthly or quarterly, alongside budget vs actual results, offers flexibility and a greater ability to adapt and improve accuracy over time.
Get Professional Help
Your CPA is the best person to help you conduct a budget vs actual analysis accurately and extract the most relevant data. As the business owner, you’ll then use these insights as a basis for making informed decisions.
Make Smarter Decisions With Accurate Financial Insights
Budget vs actual analysis is an essential practice for understanding financial performance, identifying inefficiencies, and making informed business decisions. Comparing your projections to real results allows you to adapt quickly, forecast accurately, and allocate resources more efficiently.
This process is a powerful tool when used alongside other financial data. Turn variances into opportunities for long-term growth with expert guidance from your CPA.
