Question

How and to what extent are variance investigations and reports required by managers during the budget year?

Answer 1

How are variance investigations and reports required by managers during the budget year?

Once the budget has been formulated, the next steps are reporting the actual performance against it, calculating the variance, breaking down the top level variance into second level variances, root cause analysis and then corrective actions. Variance should not lead to any blame game but it should lead to better and improved understanding of the operational steps and activities.

Performance against budget or benchmarks used in the budget should be analysed for:

1. Effectiveness: Whether high level goals and objectives were met? For example:

• Achievement of operating profits / net profit
• Achievement of top line (revenue)
• Achievement of projected growth rates (say in revenue or PAT)

2. Efficiency: If resources were efficiently utilized? For example:

• Over or under utilization of resources during the budget period (input to output ratio, productivity etc.)

Both the parameters are independent hence performance can be both effective and efficient or effective but inefficient and vice versa.

To what extent variance investigations and reports required by managers during the budget year?

Variance is defined as difference between actual and budgeted performance.
Variance = Actual performance – budgeted performance
It can be both favourable and unfavourable:

• Favorable Variance: A variance that is positive for the company’s budgeted goal; examples include: actual sales higher than budgeted sales or actual costs lower than budgeted costs; favorable variances should be evaluated further to confirm their nature. Example: variance could be a result of low benchmarks or some extraordinary event. If low benchmarks is the reason, it should be addressed during the next budget preparation.
• Unfavorable Variance: A variance that is negative for the company’s budgeted goals; Unfavorable variances should be also assessed to evaluate the trend and take corrective action. Example: consistent increase in wage hike. Also known as adverse variance.

Reasons for variances:

• Inaccurate assumptions at the time of forecasting
• Budget slack at the time of formulation
• Inefficient execution of the plans / budgets
• Systematic fault within the organization
• Unforeseen internal/external developments such as regulatory changes