We’ve all heard the phrase, “Results may vary.”
This applies to your company’s finances — revenue, budget and spending — as much as anything else. Watching for variance in anticipated spending versus what is actually spent, for example, is critical. Reacting appropriately to these fluctuations, and doing so with accuracy, are keys to success in how you define goals and set expectations — particularly with company finances.
Formula for how to calculate variance
Actual Number (A) - Budgeted/Projected Number (B) = V (Variance Amount)
V ÷ B x 100 = Z (Percent Variance)*
*Can be positive or negative
What is variance?
Variance is a statistical term that measures the spread between numbers in a set of data. It calculates the distance a random data point is from the mean of the data set.
Knowing variance is a critical step in catching poor habits in their early stages, and lending urgency to missed targets or flaws in your corporate planning by putting a round number on the deviations (ex. “We spent 20 percent more than we thought we would,” with 20 percent representing the variance between the final spend and the budget amount.)
When a sizable variance is discovered, any negligence or mishandling can spell big-time trouble for your entire operation. On the flip-flop, a variance close to zero is a pat on the back and evidence that your machine is operating as expected. Tracking the variance of various metrics gives you added perspective to make timely decisions, and shift focus to problem areas when the time calls.
A number of accounting software tools offer variance calculators and similar tools, but it’s still beneficial for your company’s financial professionals to know the basics of calculating variance, i.e., the central terms and numbers involved as well as understand what these findings indicate for the future.
There are variances in profit, spending and other aspects of your business, and they each yield valuable data for the company. If you’ve ever tried to predict a number, but the actual number was different from your guess, you’ve created a variance. Your guess wasn’t right, but you may now have valuable feedback for the future.
The basic formula for calculating variance involves some second grade math, but knowing how to correctly apply the formula and respond to the results are what separates the front of the class from the class clowns.
In a second, we’ll provide some real-life examples to help you visualize the formula.
Before applying the formula, your accounting team (or whoever’s managing the numbers on a given initiative) should log its budgets, planned costs, goals and so on. Accuracy and thoroughness are key. Then, at regular intervals (e.g., weekly, monthly or quarterly), they will calculate the total spend, losses, profits and other corresponding results.
Once you have a before-and-after picture of an individual metric and your overall financial health, you can plug these numbers into the variance equation. Make sure you connect the appropriate figures for each desired variance. Your expenditures should be tied to your budget, and your profits should be tied to your projections/estimates. The variances in each should spur different, but equally important, responses from management.
Why variance is important
Variance can be good news or bad, depending on the situation, aka, favorable variance or unfavorable variance. A little variance in either direction is normal, whereas a large variance is newsworthy. If you are trending poorly in your budget but positive in your profits, this works itself out to where you are overall in the green. So that’s cool and all.
In any case, your variances impact everything from salaries to advertising, and should factor into your routine financial planning.
Here are the most common use-cases of variance in businesses:
1. Profit variance
For starters, let’s look at profit variances. This is the deviation between your estimated profit and your actual profit in a given period of time.
Example: You planned to gross $10,000 in January, but you grossed $8,000. When plugged into the variance formula, this gives you a variance of -20 percent. A negative profit variance implies one of two things:
- Your projections were too high.
- Your company was not as effective as it needed to be.
Success-minded management teams are liable to spin the story toward No. 2, to keep employees striving for greatness. In reality, both No. 1 and No. 2 are often true in cases of negative variance. The best decision-makers will view a negative result from all angles and make sensible adjustments when mapping out the next fiscal year.
2. Budget variance
Confusingly, a “negative budget variance” is actually a good thing. A positive budget variance, meanwhile, means you went over budget, aka, y’all spent too much. (It can be a bit confusing. Recap: Positive profit variance = good. Positive budget variance = bad.)
Budget variance is the difference between your scheduled budget — for a department, a single project or event, or the company as a whole — and what you wind up shelling out.
Example: You have a budget of $1,000 for supplies, but you spend $1,200. When plugged into the formula, this is a 20 percent variance. It’s also a positive variance. You went 20 percent over budget. (Shame on you!)
This is important to know so you can reconsider your budget from every angle.
A positive budget variance implies one of two things:
1. You need to spend less or find cheaper alternatives for certain costs.
2. You company has not allocated enough.
Again, there may be arguments for both sides of this coin in nearly every scenario. That is up to your management team to decide (perhaps with the help of local accounting firms). But some action will need to be taken, so you don’t continue to spend over budget and lose money willy-nilly.
How much are you spending on your inventory? Learn how to calculate the cost of goods sold and how it should influence your budgeting decisions.
3. Expense variance
Expense variance is another angle from which to view budget and costs, whether for inventory, staffing, repairs or another item from your laundry list. Also called expenditure variance, this term describes the difference between a budgeted or planned expense and the final amount. Example: You estimate it will cost $500 to ramp up a new employee, but it only costs $400 in the end. This equals out to a negative expense variance of $100, or -20 percent. Negative expense variance, like negative budget variance, is actually a positive. A given expense cost less than you thought it would. You can take that information into account for future expenses. But don’t blow that $100 you saved just for the heck of it. Have some restraint, people.
We’ve gone over a few core concepts of variance as it relates to business. If you’ve got Variance Fever, though, you can roll the concept over to just about any quantifiable aspect of your operation. This can include employee efficiency, head count and labor hours; equipment usage; website traffic and much more.
What variance means for your business
Measuring variance is a super useful way to refine your operation. It’s great to know which areas demand more attention or a different strategy. And the more you track and follow this information, the better. The biggest and best companies in the world know there are lessons to learn from variance. You can never be done evolving or refining your practices and processes.
There is no concrete answer as to what constitutes a reasonable variance versus a “sound-the-alarms!” variance. If you’re just getting off the ground, or your company just experienced a major pivot, spike or plunge — whatever the reason may be — you can expect a wider-than-average margin. But, in general, a number close to 1 percent or 0 means the ship is running how it should, particularly as you master the estimating process over time.
Know your numbers
Developing a firm grasp of your organization’s numbers is a smart play, no matter your industry or size. As you move along, you can dig deeper, by measuring specific performance metrics, operational costs and so on. You can use variance as a barometer for countless decisions. From Day One, you should be closely observing, tracking and organizing your budget, costs, profits and losses. It may sound simple but the importance cannot be overstated.
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