If every business had a crystal ball, they could perfectly predict sales volume and plan spend levels that maximize profits.
While there’s no crystal ball, businesses use forecasting and budgeting to accomplish the same thing. But these reports are rarely, if ever, perfect.
The good news is there’s just as much value in understanding where a forecast or budget went wrong and adjusting based off this new information. To do this, finance pros use variance reports and we’ve got the info you need to start incorporating them into your practices.
What is a variance report?
A variance report compares a business’s actual financial outcomes against a forecast or budget to show and explain why there is a difference.
Variance reporting falls under the umbrella of financial planning and analysis (or FP&A). In the practice of FP&A, it’s common to create a forecast and a budget at the start of a reporting period.
The forecast is a prediction of future financial performance based on historical trends while the budget is the financial plan that optimizes the business’s expenses to hit their performance goals.
In both cases, the variance report helps businesses understand what assumptions they may have gotten wrong and course correct based on new data.
Why do organizations use variance reports?
Variance reports provide different value based on whether the business is looking at the forecast or the budget.
With a forecast, the business is projecting financial performance, including cash inflows like sales revenue. If these assumptions aren’t true, it’s vital to catch the variance and understand why it’s occurring. If revenue is coming in higher than expected, there’s room to increase spend and capture that growth potential while a lower than expected revenue requires cost-cutting.
With a budget, the business is creating a plan to keep costs in check and maximize the return on every dollar spent. If costs are below expected, there’s extra money available to invest in the business. But if they’re above the budget, spend needs to get tightened to stay on track.
There’s a final layer to variance reports which is evaluating the validity of the business’s assumptions. The greater the variance, the more an assumption missed the mark.
Over time, a variance report helps businesses stress-test their assumptions and improve both their forecasting and budgeting practices.
How does a variance report work?
To complete a variance report, you’ll need either a forecast or budget and the actual financial outcomes for the same reporting period. The best places to get actual financial outcomes from are financial statements (income statement, balance sheet, and cash flow statement) or your accounting software.
Once you have both, go through line-by-line comparing the actual performance against the projection.
Variance report formula
Variance reporting can be done as a dollar amount or as a percentage.
To calculate variance as a dollar value, simply subtract the forecasted or budgeted value from the actual outcome. Or, as a formula:
To calculate variance as a percentage, you divide the variance amount by the forecasted or budgeted value. As a formula:
How to create a variance report?
Creating a variance report is best done in a spreadsheet.
Start by listing out each of your revenue and expense accounts on separate rows. Then you’ll need two columns: one for the forecast or budget, the other for the actual values.
Going through each line, populate the forecasted or budgeted amount in that column. Go through the process again for the actual column.
Now it’s time to calculate the variance using the above formulas. In a new column, set up either a dollar value or percentage variance formula with the values you just populated.
Once you’re done, you’ll have a complete list of revenues, expenses, and the variance between the actual and forecast or budget.
With the variance amounts calculated, go through and make notes on the following:
- Where the variance is significant
- Why the variance occurred
- Whether the variance was positive or negative
- What can be done based on this new information
You likely won’t have all the information necessary to explain the variance of each line item. Throughout the process, you should consult with members from other teams within the organization that are responsible for certain costs.
How to organize a variance report
A variance report should be split into two sections: revenue and expenses.
Within expenses, you can split it up into different categories. Some ways you could split up the section are:
- Fixed costs and variable costs: Fixed costs are expenses that will remain the same regardless of your volume of business, like rent or software costs. Variable costs change with production size, like labor or utilities.
- Overhead costs and operating costs: Overhead costs are expenses that support the entire business, you can think of them as the expenses that “keep the lights on” like rent or utilities. Operating costs are those that are required to provide goods or services, like labor and equipment.
- Direct costs and indirect costs: Direct costs are tied directly to production while indirect costs are shared across the organization.
- Expenses by department: All costs that are unique to a singular team or department are bucketed into their own section.
How you categorize expenses provides context for the variance amounts. For example, variance in variable costs can be tied to the volume of business being done while a variance in fixed costs indicates a major change that will repeat in future periods.
Or if you bucket expenses by department, you can see at a glance if a specific team is over or under budget.
Who creates a variance report?
Variance reports are generally created by a member of the finance team, an accountant, or an FP&A professional. Depending on the size of the business and the finance team, you may outsource the creation of variance reports to an external finance professional.
How to analyze a variance report
Variance analysis can be broken up into three simple steps:
- Identify the variance
- Explain the variance
- Determine the next course of action
You should be completing these three steps for each line item on the variance report.
Understanding the “why” behind the variance is tricky. Try to consider as many factors as possible, but don’t hesitate to reach out to others for insights you may otherwise be unaware of. Getting the perspective from multiple people will make the variance report more robust.
This is the same for determining the next course of action. The creator of the variance report isn’t expected to hold all the answers, but rather should present as much information as possible to inform the next step.
Remember, variance isn’t necessarily a bad thing. Coming in underbudget, outperforming sales revenue projections, or having higher variable costs due to increased production are all examples of variance that’s positive for the business.
Benefits of variance reporting
If you’re still on the fence about whether variance reporting is for you, consider these benefits that businesses enjoy from incorporating them into their financial operations.
Identifying forecasting mistakes
Forecasting is based on assumptions and there are times that those assumptions are wrong.
For example, if a business goes viral and has a massive influx in sales from the prior year, it may assume that sales continue to grow. But if the virality subsides, it’s possible sales actually fall.
Forecasting on the assumption of growth could put the business in a risky situation if they’ve scaled up their expenses to meet an increase in volume. By conducting a variance report, they’ll catch this mistake and could correct it before it causes any damage.
Evaluating revenue streams
When creating a forecast, consider breaking up the revenue section into revenue by product or service. Then your variance report can similarly be broken up to determine what revenue stream is over or underperforming relative to expectations.
If you see variance favors a certain product or service, the organization may want to learn into it more to capture that momentum.
Improving business strategy
Business strategy needs to be adaptable, constantly adjusting to the realities faced. With variance reports, you get a performance assessment with indicators of where the business is falling short or overperforming.
This actionable data gives you the information you need to make changes on the fly, adjust the targets, and rework the strategies that helps the business achieve its goals.
Over time, you’ll have a better understanding of the trends and influences that inform the business’s financial performance. And in that understand comes an informed business strategy that maximizes the potential success.
Identifying crime or fraud
Fraud was responsible for over $10 billion in losses in the United States in 2023, a 14% increase from 2022. Businesses aren’t immune to these risks.
Whether it’s check fraud, invoice fraud, vendor fraud, or something else entirely, these strategies that fraudsters use cause damages that hurt the bottom line. That is, if they aren’t caught in time.
The purpose of these fraud attempts is to bank on a business treating a fraudulent transaction as an authentic one. When you look at a variance report and see an expense type with an abnormally high total, it’s time to look into the transactions and see if something fraudulent occurred.
Forecast variance report vs. budget variance report
There are two main types of variance reports, and they serve different purposes.
A forecast variant report compares actual financial outcomes against your financial forecast. Forecasts are a projection of the sales revenue earned and the expenses required to hit that goal.
The forecast variance report therefore looks at both the money coming in and the money going out, testing whether the assumptions held about the future were true. If there’s a high amount of variance, the assumptions the forecast were built on likely did not hold and it needs to be reevaluated.
When you look at a forecast variance report, the next steps to take are usually adjusting the forecast and the strategy that was derived from it.
A budget variance report looks at just your expenses and compares them against a budget that was set to keep spending in check. The purpose is to evaluate whether the business has been able to stick to the spending plans it set out for itself.
The actionable steps that come from a budget variance report are based on the business’s expenses. Underspending means there’s room in the budget to reinvest in the business while overspending means it’s time to tighten up spending.
To put it simply: a budget variance report covers things within the business’s control while the forecast variance report covers forces both inside and outside of the business.
How to improve budget variance
Variance isn’t necessarily a bad thing. But if you want to cut down on your variance, use these strategies to inform better budgets and forecasts.
Look at past reporting
The best stepping off point for building out a budget is looking at past budgets and income statements. As you look back, bucket the expenses into fixed costs (costs that stay constant) and variable costs (costs that fluctuate with business volume).
Fixed costs are easy to budget for as they should remain the same throughout the reporting period.
Variable costs should be analyzed relative to sales volume. Look for correlation between each variable costs with the sales revenue or order number. You’ll start to see connections that will help you plan a budget based on your anticipated sales volume.
Over time, you won’t just have past budgets to look to for reference, but past budget variance reports as well. The combo of the two will give you the best foundation for forming budgets in the future.
Create accurate forecasts
No one knows the future, but investing in better forecasting practices will give you the best projections to work off of.
Follow these best practices to create the most accurate financial forecasts:
- Invest in your data: High quality forecasting begins with high quality data. Spend time integrating data from different departments and teams to understand their connection with the business’s financial performance.
- Refine your historical data: Identify patterns like seasonality, adjust for anomalies like sales or promotions, and segment your data for different goods or services.
- Incorporate external factors: Consider economic and societal trends that may influence purchasing behavior, like interest rates and inflation.
- Collaborate with teams: Ground-level insights inform forecasts by providing details on what could change in the upcoming period. Maybe a new marketing initiative will boost sales or found efficiency will reduce the costs of fulfillment.
- Use qualitative and quantitative insights: Don’t rely solely on data, the intuition of experts is just as valuable in creating a forecast.
Remember that forecasts aren’t meant to be a perfect prediction, taking steps to improve on each of these factors will maximize the value from your forecasting practices.
Model possible scenarios
Scenario planning involves creating multiple forecasts or budgets based on different assumptions.
For example, a business launching a new product wouldn’t have data about how this product will perform. So they would create assumptions about how much volume they would move and what it would mean for their financial performance.
This would involve making multiple forecasts or budgets based off of different sales projections. They could create three different forecasts or budgets based on best-case, worst-case, and mid-level sales performance numbers.
Then they would create a variance report for each of the possible scenarios. The scenario that has the least variance would be the most accurate anticipation of performance and the best to stick to.
Simplify variance reporting with automation
Variance reports are one part compiling data and one part crunching the numbers. The more time you spend compiling data, the less time you have to glean insights and adjust your financial strategy.
Enter BILL Spend and Expense, an expense management platform that streamlines and automates reporting. With budgeting tools, spend insights, and in-platform forecasting, you have everything you need to build—and stick to—better budgets and forecasts.
Reach out to schedule a demo and see how BILL can help you hit your financial goals.
