Budgeting and Variance Analysis
Budgeting and Variance Analysis
A budget records assumptions before action. A variance identifies where actual results differ; it does not by itself identify cause or responsibility.
Static versus flexible comparison
Northstar planned 900 bikes but produced 1,000.
| Input standard | Per bike | Static budget at 900 | Flexible budget at 1,000 |
|---|---|---|---|
| Material | 4 kg × £8 = £32 | £28,800 | £32,000 |
| Labour | 2 hours × £18 = £36 | £32,400 | £36,000 |
Comparing actual input cost for 1,000 bikes with a 900-bike static budget confuses activity with performance. Flex first, then diagnose price/rate and quantity/efficiency.
Material variances
Actual material: 4,200 kg at £8.50 = £35,700.
Total material variance is £3,700 adverse, reconciling actual £35,700 to flexible standard £32,000.
Possible causes differ:
- price: supplier market, rush order, quality grade, purchasing terms;
- usage: scrap, design, training, machine settings, material quality.
A cheaper material can create a favourable price variance and an adverse usage or warranty outcome.
Labour variances
Actual labour: 1,900 hours at £19 = £36,100.
Net labour variance is £100 adverse. Paying a higher rate may have enabled experienced staff to finish 100 hours below standard. The two variances should be interpreted together.
Favourable is not automatically good
| “Favourable” result | Possible harmful explanation |
|---|---|
| Low material price | Poor quality and rework |
| Low labour cost | Understaffing and late delivery |
| Low maintenance spending | Deferred failure |
| High sales volume | Deep discounts or weak credit |
Variance labels are arithmetic directions. Evaluation needs quality, timing, customer and safety evidence.
Planning error or execution error?
Before holding a manager responsible, ask:
- Was the standard current and attainable?
- Did market prices change outside the manager’s control?
- Did product mix or specification change?
- Which manager controlled purchase, use, scheduling or design?
- Was the action rational given information available at the time?
Revise a standard when the operating model genuinely changes, not merely to erase an adverse result.
Budget design
A useful budget connects:
- sales and capacity assumptions;
- production and resource requirements;
- operating expenses;
- cash collection, payment and financing;
- forecast financial statements;
- named risks and trigger points.
Forecasting software or AI can update scenarios quickly, but it cannot legitimise biased targets, fabricated drivers or hidden overrides. Version assumptions and retain approval evidence.
Quick check
Why is the £1,800 favourable labour-efficiency variance not proof that production improved?