Variances: Adverse, Favourable

Understanding Variances

Variances refer to the difference between the budgeted figures and the actual ones.
They occur when actual performance deviates from what was planned or budgeted.
Variances can be grouped into two types: adverse and favourable.

An adverse variance occurs when the actual figure is-worst than budgeted.
It results in higher costs than planned or lower revenue than expected.
For example, if the budgeted cost for raw materials was £100,000, but the actual cost rose to £120,000, this would result in an adverse variance of £20,000.

A favourable variance happens when the actual figure is better than what was budgeted.
It leads to lower costs than planned or higher revenue than anticipated.
For instance, if the budgeted sales figure was £500,000, but actual sales came in at £550,000, this would result in a favourable variance of £50,000.

Analysing variances is important for a business to monitor its performance and control costs.
It acts as an early warning system to identify potential financial problems.
Variances show areas where a business performs better or worse than expected, offering insights into possible factors influencing such performance.
It informs future business planning, contributing to more accurate and effective budgeting.

Upon spotting an adverse variance, businesses must investigate the cause and implement corrective actions. This may involve adjusting business operations, scrutinising supplier contracts or revising sales strategies.
For favourable variances, it’s still essential to identify the root cause. This helps ensure the favourable condition can be sustained or improved upon.
Regularly reviewing budgets and comparing them against actual figures helps businesses stay on top of variances and react swiftly to address them.

By setting realistic budgets, businesses can minimise the occurrence of variances.
Unrealistic budgets can demotivate staff if they feel the targets are unachievable, potentially leading to adverse variances.
A well-set budget balances ambition with attainability, serving both as a motivational tool and a solid planning foundation.