Definition: A favorable variance is the positive difference between budgeted figures for a period and actual figures for the period. In other words, the company performed better than it originally budged for.
What Does Favorable Variance Mean?
Budgeting is extremely important in the business world. There are all kinds of different budgeting strategies that help management decide when to buy new assets, expand operations, or repair old machines. Needless to say, every company that operates effectively follows some sort of budget.
Business budgets are usually forecasted by management based on future predictions. In other words, a company’s management sits down and discusses financial strategies based on the current performance of the business. They try to estimate what the future revenues and expenses will be for the business if they follow a given strategy. Sound familiar? It’s just a basic budgeting process.
After a certain amount of time has passed, the company’s management has to evaluate how well it has stuck to its budget or forecasted numbers. This is where the variances come into play. Since it is almost impossible for management to 100% accurately determine the company’s future earnings, the budgeted, projected numbers are usually different than the actual numbers. A favorable variance is when the actual performance of the company is better than the projected or budgeted performance. A favorable variance could be caused by anything.
Expenses might have dipped down because management was able to work out a special deal with a supplier. Revenues might have went up because a few large unexpected sales came in. All of these things help produce a favorable variance in the budgeted forecast and the actual business performance.
Unfavorable variances are just the opposite. An unfavorable variance is when a company forecasts for a certain amount of income and does reach it. Say they estimated that there would be $10,000 of profit for the quarter and they only got $7,500. That’s an unfavorable variance and no one wants one of those.