How to Calculate Financial Variance When Budgeting for a Loss
Original post by Lisa Bigelow of Demand Media
When actual results differ from what was planned in the budget, a variance occurs. Budget variances are normal in the course of business operations, although small variances are preferable to large ones. Managers and analysts use business conditions to explain the variance, and when budgeting for a loss, the manager must be able to explain not only why the variance occurred, but if it is likely to occur again. If it is likely to occur, the manager will produce a forecast that takes the revised assumptions into account. Calculating the variance? Easy. Predicting the future? Not so much.
Subtract the budgeted amount from the actual amount. This value is the budget variance. Losses will be less than zero; gains are positive (amounts equal to zero are "on budget"). For example, if your budget is $100,000 and your actual is $90,000, your budget variance is $-10,000, more commonly written as ($10,000).
Divide the budget variance by the budget. This calculates a percentage of how far away your are from meeting your budget. For example, ($10,000) divided by $100,000 is -10 percent, or (10%). This means you're 10 percent below expectations.
Use the actual data to establish a new forecast. If market conditions dictate that things aren't likely to improve, use your actual data as the new forecast target. Keep in mind that the budget itself never changes; if you need to update the budget, the updated budget is called a forecast. You'll only make a new budget when it's time to plan for the new fiscal year.
Review both revenue and expenses. Often, when revenue decreases, it means that expenses can decrease as well. As a result, you may need to adjust your expense forecast downward. This will lessen the impact of the loss.
Tips & Warnings
- Historical data is enormously helpful when budgeting and forecasting. Try to review at least two years' worth of data. Keep in mind that what may appear to be a trend may actually be a normal ebbing of business activity, especially if your business is cyclical. For example, Christmas ornaments sell much better in December than they do in May.
- Ontario Ministry of Agriculture, Food and Rural Affairs; Understanding Your Organization's Financial Statements; November 1997
About the Author
Lisa Bigelow is a freelance writer and editor. She is a former financial analyst and worked at a college, a media company and an investment bank. She also contributes to Patch. Lisa graduated from the State University of New York, Plattsburgh with a Bachelor of Arts in mathematics.