Key Takeaways
- Unfavorable variance lowers profits versus budget.
- Caused by higher expenses or lower revenues.
- Highlights areas needing managerial corrective action.
- Types: revenue variance and expense variance.
What is Unfavorable Variance Explained: Definition, Types, Causes, Examples?
An unfavorable variance occurs when actual financial results fall short of budgeted expectations, negatively impacting profits. This happens when actual revenues are less than planned or actual expenses exceed the budget, key concepts in variance analysis used by finance professionals and the C-suite to monitor performance.
Understanding unfavorable variances helps you identify operational inefficiencies or market changes affecting your financial outcomes.
Key Characteristics
Unfavorable variances have distinct traits that make them critical for financial control and decision-making:
- Revenue Shortfall: Actual revenue is lower than budgeted, signaling potential sales or demand issues.
- Expense Overrun: Actual costs exceed budget, indicating inefficiencies or unexpected expenses.
- Negative Profit Impact: They reduce overall profitability and require management attention.
- Exception Reporting: Significant variances trigger reports for further analysis, often using data analytics tools.
- Two Main Types: Unfavorable revenue variance and unfavorable expense variance.
How It Works
Unfavorable variance results from comparing actual financial results against budgeted or standard amounts, highlighting gaps in performance. When actual sales miss targets or costs rise above estimates, the variance signals a problem needing investigation.
Managers use variance analysis to understand causes, whether operational inefficiencies, market conditions, or planning errors. Integrating variance insights with broader financial metrics helps guide corrective actions and refine future budgets.
Examples and Use Cases
Practical examples illustrate how unfavorable variances arise and affect companies across industries:
- Airlines: Delta may face unfavorable expense variances from rising fuel costs, while lower ticket sales impact revenue variance.
- Entertainment: A movie theater with unexpected maintenance costs experiences an unfavorable expense variance affecting profitability.
- Investments: Investors tracking best growth stocks should understand how company earnings can be impacted by unfavorable variances.
- Insurance: Companies monitor earned premium variances to assess profitability against expected premiums.
Important Considerations
While unfavorable variances indicate issues, context is crucial; a variance might reflect temporary challenges or strategic choices that benefit other areas. You should evaluate variances alongside comprehensive financial data and industry trends.
Effective variance management involves timely detection, prioritizing significant variances, and using tools like backflush costing to improve cost control and budgeting accuracy.
Final Words
Unfavorable variances signal that actual results are harming your profitability due to higher costs or lower revenues than planned. To address this, regularly review your budgets against actuals and investigate significant discrepancies promptly to improve financial control.
Frequently Asked Questions
An unfavorable variance occurs when actual financial results are worse than budgeted, such as when actual revenues are lower than expected or actual expenses are higher. This negatively impacts profits and signals a need for managerial review.
There are two main types: unfavorable revenue variance, where actual revenue is less than budgeted, and unfavorable expense variance, where actual expenses exceed the budget. Both types indicate deviations that can hurt profitability.
Unfavorable variances can be caused by higher costs due to inflation or inefficiencies, lower revenues from reduced demand or competition, unrealistic budgets, or unexpected external events like economic downturns.
Sure, if a company budgets $280,000 in sales but only achieves $271,000, it results in a $9,000 unfavorable variance, meaning revenue was less than expected and profits are reduced.
When actual expenses exceed the budget, such as spending $12,000 on marketing instead of the budgeted $10,000, the company faces a $2,000 unfavorable variance, which can decrease net income if not offset by higher revenues.
Variance analysis helps identify and investigate the causes of unfavorable variances, enabling management to take corrective actions to control costs, improve revenue, or adjust budgets for better financial performance.
Yes, sometimes higher expenses may be balanced by increased revenues. For example, a movie theater might have higher expenses than budgeted but still achieve an overall favorable net income due to increased sales like popcorn revenue.
Businesses often focus on significant variances, such as those exceeding 10% or $25,000, through exception reporting, to prioritize issues that have the most impact on profitability and require prompt managerial action.
