Budget versus actual: how to read your first variance report

The situation

Hana, the group CFO, sends Farida the September report for Palm Gate Logistics with one line: tell me favourable or adverse, and whether it is big. Farida sees columns headed budget, actual and variance, and a bottom line that reads minus 270. She is not sure whether minus is good or bad, and she is not sure what to do next.

Your first variance report will feel the same. This article gives you a reading order that works on any report: signs first, size second, cause last.

The explanation

A variance report has three columns for every line: the budget (the plan), the actual (what accounting recorded) and the variance (the difference). The only real trap is the sign.

Use one convention and state it at the top of every report. In this series, a variance is favourable when it improves profit and adverse when it reduces profit. For income lines, favourable means actual above budget. For cost lines, favourable means actual below budget. So a cost variance of plus 30 means you spent 30 less than planned, and a revenue variance of minus 300 means you earned 300 less. Many reports show the variance as a profit effect so that every line reads the same way: minus is always bad for profit. Whichever you choose, write it down. Management reports follow the company's own conventions, not an accounting standard, which is why the convention must be stated.

Then measure size two ways. The absolute amount tells you the money at stake. The percentage of budget tells you how far the plan was missed. A rule of thumb many teams use is to look at anything above both a percentage and an amount threshold, for example 5% and AED 50 thousand. The thresholds are a company choice; what matters is that they are written, so that nobody argues about which lines to explain.

Finally, move from the line to the cause. A line variance only says where the gap showed up. It does not say why. Revenue is the product of volume and price, and cost depends on volume and unit cost, so ask which of those moved. This step turns a table into advice.

The reading order, then:

• Check the sign convention.
• Find the lines above the threshold.
• Identify which are driven by volume, price or cost per unit.
• Check that the lines add up to the total gap.
• Write the cause in numbers and propose an action.

Worked example

Palm Gate Logistics, September, in AED thousand.

Sign: revenue is an income line, and actual is below budget, so adverse by 300. Cost of sales is a cost line, and actual is below budget, so favourable by 30. Overheads did not move.

Size: the EBITDA gap of 270 is 22.5% of the budget of 1,200, far above any sensible threshold. Revenue is off by 6.25% of its budget. The cost of sales saving of 30 is under 1% of its budget and below the amount threshold, so it would normally not be explained on its own.

Tie: revenue (300) plus cost of sales 30 plus overheads 0 equals (270), which is the gross profit gap and the EBITDA gap.

Cause: the budget assumed 3,200 trips and the actual was 3,000, with variable cost per trip rising by AED 50 because of diesel. Revenue per trip is 1.5 thousand (4,800 over 3,200 trips) and budgeted variable cost is 0.9, so margin per trip is 0.6. The 200 lost trips therefore cost 120, and diesel on 3,000 trips cost 150. That adds to 270. The favourable cost of sales line is therefore misleading: it fell only because fewer trips were run, while cost per trip rose. A reader who stopped at the sign would have praised the cost line.

The common mistake

The common mistake is to believe a negative variance is always bad. In a profit-effect report minus is bad, but in a report that shows actual minus budget for every line, a minus on a cost line is good news. Read the line type before the sign.

The second mistake is the opposite one: to believe a favourable cost variance is a saving. If volume fell, costs should have fallen anyway. Compare the actual cost with a budget flexed to the actual activity before you celebrate. The flexed budget is the subject of the next lesson in the journey.

The third is stopping at the line. A comment that repeats the table says nothing the reader could not see.

Checklist

• The report states its sign convention at the top.
• I know whether each line is income or cost before I read its sign.
• Thresholds in percentage and amount decide which lines I explain.
• The lines add up to the total gap.
• A favourable cost variance is checked against activity before I call it a saving.
• My comment names the cause with a number and proposes an action.

Go further

Watch the full episode FPA-E3 Your first budget versus actual report and use the report template in the lesson FPA-E3 Your first budget versus actual report with your own numbers.

Companies and figures in this article are fictional. Masar-Fintech is independent and not affiliated with any professional body or tax authority.