What is budget variance? Definition, causes, how to calculate it

Budgeting is an important practice in financial planning and management.

But what happens when actual revenue or expenses don’t add up to what was planned?

In that case, you have what’s known as budget variance—a difference between the budgeted amount and actual financial results.

Budget variance is incredibly common and completely normal, but that doesn’t mean it should be ignored.

In this guide, we’ll explore what budget variance is, discuss the different types of variance, the various causes behind it, and how to calculate and analyze budget variance to maintain financial health.

What is budget variance? 

Budget variance definition

Budget variance is the difference between your projected or budget financial figures (revenue and expenses) and actual financial outcomes.

Budget variances occur due to changes in costs, marketing conditions, internal operational decisions, and fluctuating sales volume.

Understanding, calculating, and analyzing budget variance is important as it helps business leaders to:

• Identify cost overruns and revenue shortfalls
• Improve financial forecasting and resource allocation
• Access insights into business performance and discover areas for improvement
• Make proactive adjustments to prevent long-term financial issues

Types of budget variance 

In financial management, the terms positive variance and negative variance are used to describe different kinds of budget variances.

Positive variance is when an amount is higher than projected, and negative variance occurs when the actual figure is lower than projected.

This can be a tricky concept to understand, due to the connotations involved with the words positive and negative.

A positive variance in expenses means actual expenses exceeded the budget, which is not a positive event (i.e., it is undesirable). 

For that reason, some finance leaders prefer the terms favorable and unfavorable.

Favorable variance 

Favorable variance occurs when financial outcomes are better than projected, namely:

• Revenue is higher than expected, or
• Expenses are lower than expected 

For example, if a business budgets $50,000 for expenses but only spends $45,000, this would be a favorable cost variance. Similarly, if a company projects $100,000 in revenue but actually earns $120,000, this would be a favorable revenue variance.

Unfavorable variance 

Unfavorable variance happens when actuals are worse than budgeted, such as when revenue is lower or expenses are higher than expected. For example:

• A company budgets $80,000 for revenue but only generates $70,000.
• A department budgets $20,000 for equipment but ends up spending $25,000.

Implications for financial planning

Calculating and analyzing both kinds of variance is important for accurate and useful financial planning.

Unfavorable expense variance can indicate inefficiencies in cost management or unexpected market changes, and unfavorable revenue variance can lead to cash flow problems if not addressed.

Alternatively, if a business experiences favorable cost or revenue variance, it will have extra cash left over. This should be reinvested or allocated for future growth and is also a signal that the company’s budgeting processes need to be revisited for accuracy.

Causes of budget variance 

Budget variance is incredibly common. In fact, it would be almost strange for no variance to exist—we all know that predicting revenue and expenses with absolute certainty is near impossible.

For that reason, there are any number of potential causes of budget variance.

Here are a few of the most common.

External factors affecting budget variance

External factors are those outside of a company’s control that can have an impact on actual figures.

These include:

• Changes in market conditions such as inflation, economic downturns, and shifts in consumer demand.
• Supply chain disruptions such as delays, shortages, or unavailable components.
• Fluctuating interest rates which can impact loan repayments, investment returns, and borrowing costs
• Regulatory changes to government policies, taxes, or compliance costs

Internal factors affecting budget variance

Internal factors are those that are within an organization’s control—often related to operations, planning, or execution.

These include:

• Operational inefficiencies in production, logistics, or staffing
• Poor budgeting or forecasting that over or underestimates revenue and expenses
• Unexpected project delays or expansions that cause changes in scope and lead to higher costs or deferred revenue
• Pricing strategy adjustments during the period that impact revenue and cause it to deviate from projections

How to calculate budget variance 

Here’s how to determine if your actual spending or revenue stacks up against the budget or if you have a variance.

First, you’ll need the budget variance formula:

Then, it's a matter of following four simple steps:

1. Identify the budget amount for the category in question (e.g., revenue or a specific expense)
2. Calculate the actual amount spent or earned
3. Subtract the budgeted amount from the actual amount
4. Determine whether the variance is favorable or unfavorable

That last point is the most important. Let’s illustrate with a few examples.

Budget variance examples

Advertising expense variance

A company budgets $30,000 for advertising but spends $35,000. Subtracting actuals for budgets leaves a variance of -$5,000.

That’s an unfavorable variance since the business spent more than it budgeted.

Revenue variance

A company expects to generate $50,000 in sales but actually earns $55,000. This is a favorable variance of $5,000.

Travel expense variance

A department plans to spend $15,000 on travel but only spends $12,000. This is another favorable variance, as the expense was lower than anticipated.

However, it still calls for further investigation as to why the budgeted figure was incorrect.

It may simply be that travel costs in general fell, but it could also be that the department failed to invest sufficiently in out-of-town client visits or event attendance, which could reduce the company’s ability to generate additional revenue.

How to perform a budget variance analysis 

Getting ready to run your first budget variance analysis?

Here are the basic steps you’ll want to follow:

1. Gather financial data. Start by pulling together your actual figures and your budget for the same period.
2. Identify significant variances. Look at the biggest gaps first, as they have the most extreme impact.
3. Determine root causes. Dig deeper to understand if variances are due to operational inefficiencies, unexpected costs, or external factors.
4. Address impact. Analyze how the variance affects cash flow, profitability, and financial goals.
5. Adjust future budgets. Use these insights to improve future forecasting

Correcting budget variances 

Addressing budget variances quickly helps prevent financial problems from escalating.

Here are five strategies you can employ to address variances as soon as you spot them.

1. Improve forecasting accuracy (if variance is too common)

Leverage historical financial data and trend analysis to improve your budgeting accuracy.

Look at factors like:

• Seasonal patterns
• Market fluctuations
• Economic indicators 

2. Cut unnecessary expenses (for unfavorable cost variance)

Conduct a thorough expense audit to identify non-essential spending. 

Look for areas to optimize costs, such as:

• Renegotiating vendor contracts
• Reducing waste
• Leverage automation for repetitive tasks to cut labor costs

3. Increase revenue streams (for unfavorable revenue variance)

Look for new opportunities to diversify income and provide more revenue stability. Experience with:

• Adjusting pricing strategies
• Introducing new products or services
• Targeting new customer segments
• Upselling, cross-selling, and bundling service
• Alternative revenue models, such as subscription-based services or strategic partnerships

4. Leverage financial tech (to improve accuracy)

Implement budgeting software and financial analytics tools to track spending in real time and compare actual performance against projections. 

Modern financial tech can:

• Provide automated insights
• Flag potential budget deviations
• Suggest corrective actions

5. Review and update budgets regularly (to identify variance early)

Set a routine schedule for budget reviews (monthly or quarterly, in most cases).

Adjust forecasts based on new financial data, unexpected expenses, or shifts in market conditions.

Stay on top of budget variance 

Budget variance is a natural part of financial management, but understanding its causes and impact is key to maintaining financial stability.

Modern tools like BILL’s integrated financial operational platform can help finance leaders keep variance under control with:

• Real-time visibility into spending
• Customizable budgets
• Automated expense tracking

Discover BILL today.