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Introduction
Budgets are valuable estimations for planning the expenditure and income of resources for a specific period. (Tamplin, 2021) The planning and control of various parts of a business entity heavily rely on the information contained in these formal statements. The data compiled in these documents increase the probability of achieving the set targets for any organization if utilized properly. Flexible budgets allow the adjustment of financial plans as per the current level of activity of a company. (Accounting Tools, 2021) Static budgets are its antithesis as they remain unchanged regardless of the volume levels of a firm. Variances are the differences that may occur between the estimated and actual values registered by the company. (Berger, 2011)
Interpretation of Static and Flexible Budget Variances
Budget variances are generally favorable when the actual total expenses are the same or lower than the projected values; also, when recorded revenues are equal to or higher than the estimates resulting in a positive net income or its equivalent. The variation is unfavorable if the actual revenue is lower than initially estimated. (Gartside, 2021) This condition is also met when the recorded total expenses exceed the predicted value culminating in a negative net income. In the case of flexible budgets, an unpropitious variance in the total expenses may be explained by the company’s fluctuation in production levels adapting to changes in the market or customer behavior. (Berger, 2011)
Benefits of Variance Analysis
Variances facilitate communication of vital information to the management, highlighting potential obstacles the entity may face towards achieving its goals. Therefore, decisions are easier to make for the company’s prosperity and the achievement of the organization’s long-term goals. (Accounting Tools, 2021) Crisis management is also enhanced by employing these statistics. The control of various company sections is more efficient, allowing in-depth analysis and investigations if targets are not met. (Borad,2021) Figuring out the timelines of problems, especially when the data is presented using graphs, allows this. Proper resource allocation is also enhanced in case of deficiency or surplus, improving efficiency. Resources are finite, and this course of action reduces the potential of wastage. Their efficient use is critical to the longevity of the entity in most industries. (Berger, 2021)
Limitations of Variance Analysis
As much as it allows information to flow to management, these variations don’t show the exact reason for their occurrence; thus, troubleshooting, recreating, and improving conditions as needed is hindered. (Gartside, 2015) This data is only available on financial results released much later, further compounding the difficulty in knowing what caused the difference observed. (Borad, 2021) It is also hard to objectively deduce whether a variation is significant enough to require action to be taken, thus sometimes leading to indecisiveness which is a clog in any department.
Conclusion
Variance analysis offers key insights that aid the management in making prompt and practical decisions once the data is available. Narrowing things down to specific departments for action to be taken depends on the variation observed favorability. Representing this information on a trend line makes it easier to notice sudden changes on a month-to-month basis, further interpreting why they occurred. Such merits explain why many companies adopt this method in their organizations despite its limitations. (Berger, 2011)
Reference
Borad, S. B. (2021). Variance Analysis. Finance Management.
Gartside, D. (2015, n.d). Accounting for Managers. Side Player. Web.
Berger, A. (2011). Standard Costing, Variance Analysis, and Decision-Making. GRIN Verlag
Tramplin, T. (2021). Budget Definition. Finance Strategists.
Flexible Budget Definition. (2021). Accounting Tools. Web.
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