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A budget, defined basically, is a strategic financial plan. It usually considers income and expenditures. In doing so, a number of other factors, such as labor and raw material availability, may need to be considered. A budget variance arises when there is a difference between the plan and the outcome.
When considering budget variance, it can be very important to differentiate between the things that affect the budget that can be controlled and those that cannot. There are a number of reasons why a budget variance can occur. One reason is that the budget was poorly planned. This is an example of a controllable factor.
Some causes of budget variance can be controlled. Labor costs are another example. A company can control its spending in this area by making decisions such as prohibiting overtime and outsourcing projects that would otherwise require high salaried staff members.
Some causes of budget variance are uncontrollable. Factors in this category are commonly external. This means that these factors are determined by entities outside of the company that has made the budget. A rise in utility prices can be an example of an uncontrollable factor. If a natural disaster causes a shortage of some raw materials, this is also an uncontrollable factor.
When one considers a budget variance, she should not automatically assume that it refers to losses. A budget variance can be either positive or negative. When it is positive, it is commonly referred to as a favorable variance. When it is negative, it is considered an unfavorable variance.
There are several categories of budget variances. Profit variance is one of the most common. This refers to the gap between the profits that were expected and the profits that were actually earned, whether they are higher or lower than predicted.
It is common for large organizations to have numerous budgets. These may, for example, be divided by sector, branch, or department. When this is the case, there is a possibility that there can be numerous budget variances. There are numerous ways this can be handled.
Take the example of a bottling company that has a north and south division. At the end of the year, the north may have a positive variance of $1 million US Dollars. The south, however, has a negative variance of $500,000 USD. One way this could be handled is by allowing the north division to keep the surplus in addition to the amount that it will receive for the new annual budget. On the contrary, the south division could have the $500,000 USD deficit deducted from the new year’s budget.