What Is Unfavorable Variance?
Let me explain unfavorable variance directly to you—it's an accounting term that points out when actual costs end up higher than what was standard or projected. This kind of variance serves as a warning to management that the company's profits might not hit the expected marks. The key here is detection; the faster you spot an unfavorable variance, the quicker you can focus on resolving the underlying issues.
Key Takeaways
To keep it straightforward, unfavorable variance means actual costs are higher than planned, which can signal that profits will fall short of expectations. It often results from lower revenue, higher expenses, or a mix of the two.
Understanding Unfavorable Variance
You need to know that a budget forecasts revenues and expenses, covering both fixed and variable costs. These budgets are crucial for companies as they help plan ahead by estimating sales revenue, allowing decisions on spending for projects or investments.
Companies build sales budgets to predict new customers and sales from products or services in upcoming months. From there, they figure out the revenue and the costs to achieve those sales and deliver what's promised. Ultimately, they project net income by subtracting all costs from total revenue. If the actual net income is below that forecast, you've got an unfavorable variance.
Put simply, the company didn't make as much profit as anticipated. But remember, this doesn't always mean a loss—it just means profits were lower than projected for that period.
This variance might come from lower revenue, higher expenses, or both. Often, it's a combination, like rising variable costs from pricier raw materials, plus weaker sales than expected.
Types of Unfavorable Variances
In practice, unfavorable variances show up in various forms across budgeting, financial planning, and other areas. Any unplanned deviation from the plan triggers similar responses from management—things didn't go as expected.
In finance, it refers to any category where actual results are worse than budgeted, like publicly traded companies missing earnings forecasts due to higher costs or lower sales.
A sales variance happens when projected sales volumes aren't met, perhaps from not enough sales staff or other issues. Management might respond by hiring temps, offering incentives, or ramping up marketing.
In manufacturing, standard costs add up direct materials, labor, and overhead. An unfavorable variance here contrasts with favorable ones where costs are lower, often caused by rising material prices or production inefficiencies.
Causes of Unfavorable Variances
These variances can arise from shifting economic conditions, like slower growth, reduced consumer spending, or recessions leading to unemployment. Market changes, such as new competitors or outdated products due to technology, can also cut revenue.
It's essential for management to analyze the variance and identify the cause. Once pinpointed, the company can implement changes to get back on track with their plan.
Example of Unfavorable Variance
Consider this example: if a company budgeted $200,000 in sales but only achieved $180,000, that's an unfavorable variance of $20,000, or 10%.
On the expense side, if costs were projected at $200,000 but came in at $250,000, the unfavorable variance is $50,000, or 25%.
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