How to address budget variance

Business owners and their finance teams who rely on static spreadsheets, often find themselves in a frenzy towards the end of the month or quarter. They scurry to gather vital data to compile the necessary reports for their divisions and head office. It's only at this juncture they can confront and address budget discrepancies head-on. Budget variances are a crucial aspect of financial management serving as a barometer for how well a company executes its plans.  Budget variances refer to the differences between planned or budgeted figures and actual results. These variations can occur in various aspects of business operations, including revenue, cost of goods, stock levels, expense variance such as marketing, and product performance. While some variances may be favorable, indicating better-than-expected outcomes, others may be unfavorable, signaling potential inefficiencies or unforeseen challenges.

Budget variance occurs when the planned expenditure deviates from the actual spending. For example, if you initially budgeted $350,000 for annual marketing but the actual expenses were $370,000, the variance amounts to $20,000. Differences, whether favorable or unfavorable budget variance, frequently indicate inaccuracies or assumptions in budgeting practices.

Budget variances are a crucial aspect of financial management, serving as a barometer for how well a company is executing its plans. However, effectively addressing budget variances requires more than just identifying discrepancies; it necessitates a strategic approach to analyzing and rectifying them.  

In this blog post, we'll delve into the intricacies of handling budget variances, exploring common challenges, and offering practical solutions for finance management and operational teams. CFOs and stakeholders may be surprised to discover that identifying and rectifying budget discrepancies can be more manageable than anticipated. Effectively resolving these budget differences necessitates a strategic pivot towards utilizing modern, companywide financial planning solutions such as Phocas for real-time budgeting and forecasting.

But first, let’s understand why static spreadsheets are so limited in addressing budget variances.

Limitations addressing budget variances with Excel  

For numerous finance teams and stakeholders, Excel is a double-edged sword. Its familiar interface and flexibility provide a sense of control, yet its constraints surface when analyzing budget discrepancies. Trying to manoeuvre through various financial statements in Excel is arduous, time-intensive and frequently unproductive.

Limited scalability  

Excel's finite capacity makes it challenging to manage large volumes of data efficiently. As businesses strive to do rigorous budget variance analysis across various dimensions such as revenue, cost, stock, and product, Excel's scalability constraints become increasingly apparent.

Manual data entry errors

The heavy reliance on manual data entry in Excel increases the risk of human error. Inaccuracies in data inputting can lead to unreliable budget variance analysis, hindering finance teams' ability to make informed decisions.

Lack of real-time updates

Using a combination of static budgets and financial statements exacerbate the challenge of managing budget variances. Locked into rigid structures, they provide a snapshot of financial health at a single point in time, failing to capture the dynamic nature of business operations. In a dynamic world where markets fluctuate and unexpected events occur, rigid budgets soon become obsolete artifacts of the past. This leaves finance teams in need of up-to-the-minute insights to steer their decisions and pinpoint areas of over or under budgeting.

Moreover, the reliance on static budgets stifles innovation and agility within organizations. When budgets are set in stone, there's little room for adaptation or course correction in response to changing market conditions or emerging opportunities. Finance teams find themselves shackled to outdated forecasts, forced to make critical decisions based on obsolete data.

Version control issues

Collaborative budgeting efforts in Excel often result in version control challenges. Multiple users working on different versions of the same spreadsheet can lead to confusion, errors, and inconsistencies in budget variance analysis, hampering the accuracy of financial insights. Excel's standalone nature means that spreadsheets are often disconnected from crucial datasets such as ERP, stock, operational, or sales data, resulting in a lack of real-time insights and a reliance on outdated information. This disconnect also means that there's no room for changes or updates to be easily incorporated into budgeting and budget variance analysis processes once the month or quarter has been closed off. As a result, finance teams are left grappling with fragmented insights, incomplete pictures, and an inability to provide timely and accurate guidance to decision-makers.  

Complex formulas and functions

Budget variance analysis in Excel often requires the use of complex formulas and functions. While these tools can provide powerful analysis capabilities, they also increase the risk of errors and may necessitate specialized expertise to implement correctly, posing challenges for finance teams.

Limited visualization options

Excel's visualization capabilities are limited compared to dedicated business planning and analytics tools. Analyzing budget variances solely through Excel may restrict finance teams' ability to gain comprehensive insights from data visualization, hindering their decision-making process.

The dangers of static budgets  

Recognizing these challenges, organizations must explore alternative solutions, such as cloud-based dynamic budgeting tools like Phocas. By leveraging advanced analytics and visualization capabilities, Phocas empowers finance teams to overcome the limitations of Excel and address budget variances effectively across various dimensions and over time.

Next, we will explore the various budget variances to understand their root causes.

Causes of budget variances

Budget variance analysis is crucial for accurate financial reporting, dependable cash flow, and trustworthy short- and long-term planning and spending strategies. Variances arise due to various factors which we outline below.

Whether it is caused by external factors like natural disasters or supply chain delays, or internal challenges such as underperforming sales and customer support departments.

• Human error could be caused by several factors, including unoptimized budgeting processes outdated tools such as legacy systems or standalone Excel or lack of training.
• Increased competition often in tandem with changes to economic conditions and with direct impact on how effectively you attract and retain customers—and important revenue concerns such as sales volume.
• Supplier pricing changes, such as a supplier announcing new pricing after your budget has already been finalized.
• Employee fraud is a frequent and regrettable source of unfavorable budget variances.
• Process Improvement, which can create more favorable budget variances through increased efficiency and lower costs.

Types of variance  

In addition to the reasons that budget variance occurs let's now discuss what types of variance can occur.  Below we will outline sales, direct material, direct labour, labour variance and overhead variance.

Sales variance

Sales variance denotes the contrast between anticipated or projected sales and the actual sales achieved. Analyzing sales variance facilitates the assessment of sales performance, comprehension of market conditions, and evaluation of business outcomes. There are two primary forms of sales variance. Sales price variance occurs when sales are made at prices either higher or lower than anticipated, while sales volume variance reflects the variance between projected and actual sales volumes.

Direct material variance

Direct material variance is the difference between anticipated and actual costs and quantities of inventory materials utilized in production. This variance typically stems from two primary factors. Purchase Price Variance and Material Yield Variance. Purchase price variance is the disparity between the projected and actual prices paid for materials. Material yield variance is the difference between the anticipated quantity of materials required for the standard units produced and the actual quantity used.

Direct labor variance

Direct labor variance characterizes the gap between the standard or projected labor cost for production and the actual incurred cost. It comprises two key components:

Labor rate variance

Signifies the disparity between the expected cost and the actual cost expended for the labor hours.

Labor efficiency variance

This represents the difference between the anticipated number of units to be produced in a standard hour of labor and the actual units produced.

Overhead variance

Every business incurs ongoing operational expenses or overheads, which may be fixed or variable. Overhead variance manifests when the day-to-day expenses of business operations deviate from the budgeted amount. This variance can arise with both fixed and variable overheads.

Key strategies for addressing budget variances

Establish clear budget targets

Before delving into variance analysis, it's crucial to establish clear and realistic budget targets. These targets should be aligned with the company's strategic objectives and take into account market conditions, industry trends, and internal capabilities.

Monitor variances regularly in the budget

Effective variance analysis requires ongoing monitoring of financial and operational performance. Rather than waiting until the end of the fiscal period to review variances, adopt a proactive approach by regularly tracking key metrics and identifying deviations from the budget.

Identify root causes

When variances occur, it's essential to dig deeper to uncover the underlying causes. This may involve conducting detailed analyses, such as trend analysis, variance decomposition, or benchmarking against industry standards. By identifying the root causes of variances, organizations can implement targeted corrective actions to address them effectively.

Collaborate across departments

Determining the causes of budget variances often transcend departmental boundaries, requiring collaboration across finance, operations, sales, and other functions. Establishing cross-functional teams to analyze variances and develop action plans can lead to more holistic solutions and better outcomes.

Phocas makes tracking budget variance easy

As mentioned earlier, platforms like Phocas offer advanced financial planning & analysis capabilities that streamline variance analysis and facilitate decision-making. By leveraging these tools, organizations can gain deeper insights into their data, identify trends and patterns, and uncover actionable insights to drive performance improvement.

Phocas budgeting and forecasting enables finance to gain deep insights into variances across multiple divisions, and time periods. The budget model can be created in a live profit and loss template so that once the actuals start to come through, comparing results from planned versus actual performance or drilling down into the root causes of variances is straightforward.  

With Phocas, you have access to live data and customizable dashboards that make it easy to track budget vs actual giving easy to view budget insights. You can also create customized reports and visualizations, such as charts and graphs, to better understand variance drivers and take corrective actions.

In addition to providing comprehensive variance analysis capabilities, Phocas also offers powerful forecasting functionality. This enables organizations to forecast future performance based on actual performance, allowing finance to proactively identify potential variances and adjust their strategies accordingly.

Additionally, with its user-friendly interface and intuitive design, Phocas makes it easy to navigate through complex financial data and gain valuable insights. This ensures that all team members have access to the information they need.

Mastering budget variances is essential for organizations seeking to optimize their financial performance and achieve strategic objectives. By adopting a proactive approach to variance analysis, leveraging advanced fp&a tools like Phocas, and implementing targeted corrective actions, businesses can effectively address budget analysis and drive continuous improvement. With the right strategies and tools in place, budget variances need not be a source of uncertainty but rather an opportunity for growth and optimization.