October 10th 2023

Budget Variance represents the contrast between planned and actual financial outcomes. It aids in assessing performance, financial control, and informed decision-making. Challenges include external factors and data accuracy. Impact-wise, it influences profitability and operational efficiency. Applications encompass financial reporting and performance reviews, illustrated by positive and negative variance scenarios.

For 2024 and '25 Kilimanjaro trips bo…
Saving Money Without Sacrificing Qual…
Master Your Gaming Skills with Luna C…
best projectors for home
Faith on Film - The Passion of the Ch…

Characteristics:

Performance Evaluation: Budget variance is primarily used to evaluate how well an organization adheres to its financial plans and forecasts.
Types of Budgets: Variances can apply to different types of budgets, including revenue budgets, expense budgets, and capital expenditure budgets. Each type of budget may have its unique variances to analyze.

Benefits:

Financial Control: Budget variances provide a tool for monitoring and controlling financial resources, ensuring that expenditures align with revenue and profit goals.
Decision Making: By identifying the causes of variances, organizations can make informed decisions to adjust budgets, reallocate resources, or modify strategies to meet financial targets.

Challenges:

External Factors: Sometimes, budget variances result from external factors beyond the control of the organization, such as changes in market conditions, economic fluctuations, or unforeseen events like natural disasters.
Data Accuracy: Accurate data collection, recording, and reporting are essential for meaningful budget variance analysis. Errors in data can lead to incorrect conclusions.

Impact:

Profitability: Budget variances have a direct impact on an organization’s profitability. Positive variances contribute to higher profits, while negative variances can reduce profitability.
Operational Efficiency: By analyzing budget variances, organizations can identify inefficiencies in resource allocation or operational processes, leading to improvements in efficiency.

Applications:

Financial Reporting: Budget variances are commonly included in financial statements and reports, allowing stakeholders to assess how closely the organization’s financial performance aligns with its plans.
Performance Reviews: Budget variance analysis is a crucial component of performance evaluations for departments, teams, and individuals. It helps identify areas that require attention or improvement.

Examples:

Positive Variance: A positive budget variance occurs when actual revenues exceed budgeted revenues, indicating that the organization is performing better financially than expected.
Negative Variance: Conversely, a negative budget variance happens when actual expenses surpass budgeted expenses. This can signal cost overruns or inefficiencies that need to be addressed.

Case Studies

Revenue Variance: A company projected $1 million in sales revenue for a quarter, but it actually generated $1.2 million. This positive revenue variance of $200,000 indicates better-than-expected sales performance.
Expense Variance: An organization budgeted $50,000 for marketing expenses but ended up spending $60,000. This negative expense variance of $10,000 signals overspending in the marketing department.
Favorable Variance: A manufacturing company budgeted $200,000 for raw material costs, but due to bulk discounts and cost-saving measures, it only spent $180,000. This favorable variance of $20,000 reflects cost efficiency.
Unfavorable Variance: A construction project was budgeted at $1 million, but it ended up costing $1.2 million due to unforeseen delays and cost overruns. This unfavorable variance of $200,000 indicates a budget shortfall.
Labor Cost Variance: A retail store budgeted $30,000 for employee salaries in a month, but actual payroll costs amounted to $28,000. This favorable labor cost variance of $2,000 shows efficient labor management.
Material Price Variance: A bakery budgeted $5 per kilogram for flour, but it had to purchase it at $6 per kilogram due to market price fluctuations. This adverse material price variance impacts profitability.
Sales Volume Variance: A software company projected sales of 1,000 licenses but only sold 800. The sales volume variance, in this case, is negative and indicates lower sales than expected.
Production Cost Variance: A car manufacturer budgeted $10,000 per vehicle in production costs but incurred $12,000 per vehicle due to increased material costs. This unfavorable production cost variance affects the product’s profitability.
Capital Expenditure Variance: A municipality planned to spend $2 million on a new public library construction project but ended up spending $2.5 million due to design changes. This unfavorable capital expenditure variance impacts the project’s budget.
Profit Variance: A restaurant budgeted a quarterly profit of $50,000 but achieved $60,000 in actual profit. This positive profit variance indicates improved financial performance.

Key Highlights

Performance Assessment: Budget variances are used to evaluate an organization’s financial performance by comparing budgeted figures to actual results. They provide insights into how well an entity has managed its resources.
Monitoring Tool: Budget variances serve as monitoring tools that help organizations track and control their financial activities. They enable timely identification of deviations from the budget.
Identification of Discrepancies: Variances highlight discrepancies between expected and actual outcomes, whether they are favorable (underspending or higher revenue) or unfavorable (overspending or lower revenue).
Management Tool: They are valuable management tools for decision-making. Understanding the reasons behind variances can lead to strategic adjustments and improvements in future budgets.
Cost Control: Negative variances, indicating overspending or cost overruns, prompt organizations to implement cost control measures and improve operational efficiency.
Revenue Enhancement: Positive variances, signaling higher revenue or cost savings, can guide businesses in identifying successful strategies and opportunities for revenue enhancement.
Continuous Improvement: By analyzing variances, organizations can adopt a culture of continuous improvement, striving to minimize unfavorable variances and maximize favorable ones.
Resource Allocation: Budget variances aid in the allocation of resources to various departments or projects based on their financial performance and contribution to overall objectives.
Communication Tool: They facilitate communication among departments and management by providing a common metric for assessing financial achievements and challenges.
Strategic Planning: Understanding variances helps organizations refine their strategic plans, ensuring that future budgets are more accurate and realistic.
External Reporting: Publicly traded companies may need to disclose significant budget variances in their financial reports to provide transparency to shareholders and investors.
Benchmarking: Variances can be used for benchmarking against industry standards or competitors, helping organizations assess their relative financial performance.

Read Next: Porter’s Five Forces, PESTEL Analysis, SWOT, Porter’s Diamond Model, Ansoff, Technology Adoption Curve, TOWS, SOAR, Balanced Scorecard, OKR, Agile Methodology, Value Proposition, VTDF Framework.

Connected Strategy Frameworks

ADKAR Model

The ADKAR model is a management tool designed to assist employees and businesses in transitioning through organizational change. To maximize the chances of employees embracing change, the ADKAR model was developed by author and engineer Jeff Hiatt in 2003. The model seeks to guide people through the change process and importantly, ensure that people do not revert to habitual ways of operating after some time has passed.

Ansoff Matrix

You can use the Ansoff Matrix as a strategic framework to understand what growth strategy is more suited based on the market context. Developed by mathematician and business manager Igor Ansoff, it assumes a growth strategy can be derived from whether the market is new or existing, and whether the product is new or existing.

Business Model Canvas

The business model canvas is a framework proposed by Alexander Osterwalder and Yves Pigneur in Busines Model Generation enabling the design of business models through nine building blocks comprising: key partners, key activities, value propositions, customer relationships, customer segments, critical resources, channels, cost structure, and revenue streams.

Lean Startup Canvas

The lean startup canvas is an adaptation by Ash Maurya of the business model canvas by Alexander Osterwalder, which adds a layer that focuses on problems, solutions, key metrics, unfair advantage based, and a unique value proposition. Thus, starting from mastering the problem rather than the solution.

Blitzscaling Canvas

The Blitzscaling business model canvas is a model based on the concept of Blitzscaling, which is a particular process of massive growth under uncertainty, and that prioritizes speed over efficiency and focuses on market domination to create a first-scaler advantage in a scenario of uncertainty.

Blue Ocean Strategy

A blue ocean is a strategy where the boundaries of existing markets are redefined, and new uncontested markets are created. At its core, there is value innovation, for which uncontested markets are created, where competition is made irrelevant. And the cost-value trade-off is broken. Thus, companies following a blue ocean strategy offer much more value at a lower cost for the end customers.

Business Analysis Framework

Business analysis is a research discipline that helps driving change within an organization by identifying the key elements and processes that drive value. Business analysis can also be used in Identifying new business opportunities or how to take advantage of existing business opportunities to grow your business in the marketplace.

BCG Matrix

In the 1970s, Bruce D. Henderson, founder of the Boston Consulting Group, came up with The Product Portfolio (aka BCG Matrix, or Growth-share Matrix), which would look at a successful business product portfolio based on potential growth and market shares. It divided products into four main categories: cash cows, pets (dogs), question marks, and stars.

Balanced Scorecard

First proposed by accounting academic Robert Kaplan, the balanced scorecard is a management system that allows an organization to focus on big-picture strategic goals. The four perspectives of the balanced scorecard include financial, customer, business process, and organizational capacity. From there, according to the balanced scorecard, it’s possible to have a holistic view of the business.

Blue Ocean Strategy

GAP Analysis

A gap analysis helps an organization assess its alignment with strategic objectives to determine whether the current execution is in line with the company’s mission and long-term vision. Gap analyses then help reach a target performance by assisting organizations to use their resources better. A good gap analysis is a powerful tool to improve execution.

GE McKinsey Model

The GE McKinsey Matrix was developed in the 1970s after General Electric asked its consultant McKinsey to develop a portfolio management model. This matrix is a strategy tool that provides guidance on how a corporation should prioritize its investments among its business units, leading to three possible scenarios: invest, protect, harvest, and divest.

McKinsey 7-S Model

The McKinsey 7-S Model was developed in the late 1970s by Robert Waterman and Thomas Peters, who were consultants at McKinsey & Company. Waterman and Peters created seven key internal elements that inform a business of how well positioned it is to achieve its goals, based on three hard elements and four soft elements.

McKinsey’s Seven Degrees

McKinsey’s Seven Degrees of Freedom for Growth is a strategy tool. Developed by partners at McKinsey and Company, the tool helps businesses understand which opportunities will contribute to expansion, and therefore it helps to prioritize those initiatives.

McKinsey Horizon Model

The McKinsey Horizon Model helps a business focus on innovation and growth. The model is a strategy framework divided into three broad categories, otherwise known as horizons. Thus, the framework is sometimes referred to as McKinsey’s Three Horizons of Growth.

Porter’s Five Forces

Porter’s Five Forces is a model that helps organizations to gain a better understanding of their industries and competition. Published for the first time by Professor Michael Porter in his book “Competitive Strategy” in the 1980s. The model breaks down industries and markets by analyzing them through five forces.

Porter’s Generic Strategies

This post first appeared on FourWeekMBA, please read the originial post: here