5.5: Budget Variances
- Page ID
- 112065
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)- Define and discuss budget variances.
- Identify the importance of budget-monitoring activities.
- Analyze budget variances to understand their causes, including possible changes in micro or macro factors.
- Analyze budget variances to identify potential remedies and assess their feasibility.
A budget variance occurs when the actual results of your financial activity differ from your budgeted projections. Since your expectations were based on knowledge from your financial history, micro- and macroeconomic factors, and new information, any variance is likely due to either an inaccurate estimate or a change in one or more of those factors that was unexpected. If your estimate was inaccurate—perhaps you had overlooked or ignored a factor—knowing that can help you improve. If one or more of those factors have changed unexpectedly, then identifying the cause of the variance creates new information to help assess your situation. At the very least, variances will alert you to the need for adjustments to your budget and to the appropriate choices.
Once you have created a budget, your financial life continues. As actual data replace projections, you must monitor the budget compared to your actual activities so that you will notice any serious variances or deviations from the expected outcomes detailed in the budget. Your analysis and understanding of variances constitute new information for adjusting your current behavior, preparing the next budget, or perhaps realistically reassessing your behavior or original goals.
The sooner you notice a budget variance, the sooner you can analyze it and, if necessary, adjust for it. The sooner you correct the variance, the less it costs. For example, perhaps you have had a little trouble living within your means, so you have created a budget to help you do so. You have worked out a plan so that total expenses are equal to total income. In your original budget, you expected to incur a certain expense for gas, which you calculated based on your mileage and the current price of gas. You are following your budget and going along just fine. Suddenly, the price of gas goes way up, and so does this monthly expense. That means you'll have to
- spend less on other expenses to keep your total expenses within your budget
- lower your gas expense by driving less, and/or
- increase your income to accommodate this higher expense
In the short term, monitoring your gas expense alerts you to a need to change your financial behavior by driving less, spending less on other things, or earning more. In the long run, if you find this increased expense intolerable, you will make different choices to avoid it. Perhaps you would consider buying a more fuel-efficient or electric car, or adjust your lifestyle to require less driving. The number and feasibility of your choices will depend on your desire for that particular budget item. But if you hadn't been paying attention and had not been monitoring your budget against the real outcomes as they occurred, you would not have been aware that any change was needed. You would have found yourself with a surprising budget deficit.
It bears repeating that once you have identified a significant budget variance, you must analyze its cause so that you can address it effectively.
Income comes from the sale of labor (wages) or liquidity (interest or dividends). If income deviates from its projection, it is because
- a different quantity of labor or liquidity was sold at the expected price (e.g., you had fewer house painting contracts than usual but kept your rates the same)
- the expected quantity of labor or liquidity was sold at a different price (e.g., you had the usual number of contracts but earned less from them), or
- a different quantity of labor or liquidity was sold at a different price (e.g., you had fewer contracts and charged less to be more competitive)
Expenses result from consuming goods or services at a price. If an expense deviates from its projected outcome, it is because
- a different quantity was consumed at the expected price (e.g., you did not use as much gas)
- an expected quantity was consumed at a different price (e.g., you used as much gas, but the price of gas fell), or
- a different quantity was consumed at a different price (e.g., you used less gas and bought it for less)
Isolating the cause of a variance is useful because different causes will dictate different remedies or opportunities. For example, if your gas expense has increased, is it because you are driving more miles or because the price of gas has gone up? You can't control the price of gas, but you can control the miles you drive. Isolating the cause allows you to identify realistic choices. In this case, if the variance is too costly, you will need to address it by somehow driving fewer miles or arranging for less expensive transportation.
If your income falls, is it because your hourly wage has fallen or because you are working fewer hours? If your wage has fallen, you need to try to increase it either by negotiating with your employer or by seeking a new job at a higher wage. Your success will depend on the demand in the labor market and on your value as a labor supplier.
If you are working fewer hours, it may be because your employer is offering you less work or because you have chosen to work fewer hours. If the problem is with your employer, you may need to renegotiate your position or find a new one. However, suppose your employer is reducing labor demand due to decreased market demand. In that case, that may be attributed to an industry or economic cycle, which could impact your ability to make that change.
If it is your choice of hours that has caused the variance, perhaps that is due to personal factors, such as aging or the need for more care and attention for your dependents. Some personal factors can be resolved to allow you to work more, but others cannot be controlled. If you are able, you might simply choose to work more.
Identifying why you are deviating from your budget is crucial in determining remedies and choices. Putting those causes in the context of the micro- and macroeconomic factors that affect your situation will help identify feasible choices. Figure 5.5.1 shows these factors.
After three months, Mark decides to review his budget variances to ensure he's on track. His actual results for January - March 2024 are detailed in Table 5.5.2 .
| 2024 January Actual | 2024 February Actual | 2024 March Actual | |
|---|---|---|---|
| Incomes | |||
| Wages | $ 3,167 | $ 3,167 | $ 3,167 |
| Tutoring | $ 400 | $ 400 | $ 400 |
| Memorabilia Sales | $ 450 | $ 450 | $ 450 |
| House Painting | |||
| Interest Income | $ 31 | $ 34 | $ 34 |
| Total Income | $ 4,047 | $ 3,960 | $ 4,801 |
| Payroll/Income Taxes | -$ 792 | -$ 792 | -$ 792 |
| Disposable Income | $ 3,256 | $ 3,169 | $ 4,009 |
| Living Expenses | |||
| Groceries | -$ 260 | -$ 260 | -$ 260 |
| Car-Fuel | -$ 156 | -$ 156 | -$ 156 |
| Car-Services, etc. | -$ 29 | -$ 29 | -$ 29 |
| Car-Insurance | -$ 400 | ||
| Electricity | -$ 65 | -$ 65 | -$ 65 |
| Phone/Internet | -$ 89 | -$ 89 | -$ 89 |
| Heat | -$ 200 | -$ 200 | -$ 200 |
| Health Insurance | -$ 63 | -$ 63 | -$ 63 |
| Medical | -$ 4 | -$ 4 | -$ 4 |
| Dental | -$ 42 | -$ 42 | -$ 42 |
| Travel/Entertainment | $ 0 | $ 0 | $ 0 |
| Car Loan Payment | -$ 499 | -$ 499 | -$ 499 |
| Mortgage Interest | -$ 897 | -$ 897 | -$ 897 |
| Property Tax | |||
| Total Living Expenses | -$ 2,305 | -$ 2,305 | -$ 2,305 |
| Income after Living Expenses | $ 951 | $ 464 | $ 1,704 |
| Interest Expense | |||
| Capital Expenditures/Investment | |||
| Mortgage Principal | -$ 270 | -$ 270 | -$ 270 |
| Free Cash Flow | $ 681 | $ 194 | $ 1,435 |
| Retirement Account Deposit | -$ 1,000 | ||
| Home Improvement | |||
| Savings Deposit (withdrawal) | $ 681 | $ 194 | $ 435 |
| Draw on (pay off) Line of Credit | |||
| Net Cash Flow | $ 0 | $ 0 | $ 0 |
| Line of Credit | |||
| Money Market Account Balance | $ 8,048 | $ 8,275 | $ 8,774 |
How will Mark analyze the budget variances he finds? In Mark's case, the income variances are positive. He has picked up a couple of tutoring clients who have committed to lessons through the end of the school year in June; this new information can be used to adjust income. His memorabilia business has performed well; although sales volume has not increased, the memorabilia market appears to be up, and prices are better than expected. The memorabilia business is cyclical; economic expansion and increases in disposable incomes enhance that market. However, given the volatility of prices in that market and the fact that there has been no increase in sales volume (Mark is not doing more business, just more lucrative business), Mark will not make any adjustments going forward. Interest rates have risen. Mark can use that macroeconomic news to adjust his expected interest income.
His expenses are as expected. The only variance is the result of Mark's decision to cut his travel and entertainment budget for this year (i.e., giving up his vacation) to offset the costs of the roof. He is planning that capital expenditure for October, which (as seen in the previous section) will actually make it cheaper to do. His adjusted cash budget is shown in Table 5.5.3 .
| 2024 January Actual |
2024 February Actual |
2024 March Actual |
2024 April |
2024 May |
2024 June |
2024 July |
2024 August |
2024 September |
2024 October |
2024 November |
2024 December |
|
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Incomes | ||||||||||||
| Wages | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 | $ 3,167 |
| Tutoring | $ 400 | $ 400 | $ 400 | $ 400 | $ 400 | $ 400 | $ 33 | $ 33 | $ 33 | $ 33 | $ 33 | $ 33 |
| Memorabilia Sales | $ 450 | $ 360 | $ 1,200 | $ 79 | $ 79 | $ 79 | $ 79 | $ 79 | $ 79 | $ 79 | $ 79 | $ 79 |
| House Painting | $ 3,472 | $ 3,472 | $ 3,472 | |||||||||
| Interest Income | $ 31 | $ 34 | $ 34 | $ 15 | $ 15 | $ 16 | $ 23 | $ 29 | $ 34 | $ 0 | $ 2 | $ 2 |
| Total Income | $ 4,047 | $ 3,960 | $ 4,801 | $ 3,660 | $ 3,661 | $ 7,134 | $ 6,741 | $ 6,747 | $ 3,280 | $ 3,246 | $ 3,248 | $ 3,248 |
| Payroll/Income Taxes | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 | -$ 792 |
| Disposable Income | $ 3,256 | $ 3,169 | $ 4,009 | $ 2,869 | $ 2,870 | $ 6,343 | $ 5,949 | $ 5,955 | $ 2,488 | $ 2,454 | $ 2,456 | $ 2,456 |
| Living Expenses | ||||||||||||
| Groceries | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 | -$ 260 |
| Car-Fuel | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 | -$ 156 |
| Car-Services, etc. | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 | -$ 29 |
| Car-Insurance | $ 400 | -$ 400 | ||||||||||
| Electricity | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 | -$ 65 |
| Phone/ Internet | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 | -$ 89 |
| Heat | -$ 200 | -$ 200 | -$ 200 | -$ 200 | -$ 200 | -$ 200 | ||||||
| Health Insurance | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 | -$ 63 |
| Medical | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 | -$ 4 |
| Dental | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 | -$ 42 |
| Travel/Entertainment | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 |
| Car Loan Payment | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 | -$ 499 |
| Mortgage Interest | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 | -$ 897 |
| Property Tax | -$ 4,350 | |||||||||||
| Total Living Expenses | -$ 2,305 | -$ 2,705 | -$ 2,305 | -$ 2,105 | -$ 2,105 | -$ 2,105 | -$ 2,105 | -$ 2,505 | -$ 2,105 | -$ 6,655 | -$ 2,305 | -$ 2,305 |
| Income after Living Expenses | $ 951 | $ 464 | $ 1,704 | $ 764 | $ 765 | $ 4,238 | $ 3,844 | $ 3,450 | $ 383 | -$ 4,201 | $ 151 | $ 151 |
| Interest Expense | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | |||||
| Capital Expenditures/Investment | ||||||||||||
| Mortgage Principal | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 | -$ 270 |
| Free Cash Flow | $ 681 | $ 194 | $ 1,435 | $ 494 | $ 495 | $ 3,968 | $ 3,575 | $ 3,181 | $ 114 | -$ 4,471 | -$ 119 | -$ 119 |
| IRA Deposit | -$ 1,000 | |||||||||||
| Home Improvement | -$ 15,000 | |||||||||||
| Savings Deposit (withdrawal) | $ 681 | $ 194 | $ 435 | $ 494 | $ 495 | $ 3,968 | $ 3,575 | $ 3,181 | $ 114 | -$ 19,471 | -$ 119 | -$ 119 |
| Draw on (pay off) Line of Credit | $ 0 | |||||||||||
| Net Cash Flow | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 |
| Line of Credit | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | $ 0 | ||||
| Money Market Account Balance | $ 8,047 | $ 8,275 | $ 8,744 | $ 9,253 | $ 9,763 | $ 13,747 | $ 17,345 | $ 20,554 | $ 20,702 | $ 1,231 | $ 1,114 | $ 998 |
With these adjustments, Mark can avoid new debt and still support the capital expenditure of the new roof. The increased income that Mark can expect, combined with his decreased expenses (if he can maintain his resolve), can finance the project and still leave him with a bit of savings in his money market account.
This situation bears continued monitoring, however. Some improvements are attributable to Mark's efforts (cutting back on entertainment expenses, giving up his vacation, getting new tutoring clients). However, Mark has also benefited from macroeconomic factors that have shifted to his advantage (rising interest rates and rising memorabilia prices), and those factors could change again to his disadvantage. He has tried to be conservative about making adjustments from now on. Still, he should continue to keep a close eye on the situation, especially as he approaches the relatively large capital expenditure in October.
Sometimes a variance cannot be "corrected" or is due to a micro- or macroeconomic factor beyond your control. In that case, you must adjust your expectations to reality. You may need to modify expected outcomes or even your ultimate goals.
Variances are also measures of the accuracy of your projections. What you learn from them can enhance your estimates and budgeting abilities. The unexpected can always occur, but the better you can anticipate what to expect, the more accurate and useful your budget process can be.
- Recognizing and analyzing variances between actual results and budget expectations
- identifies potential problems
- identifies potential remedies
- The more frequently the budget is monitored, generally
- the sooner adjustments may be made
- the less costly adjustments are to make
- Budget variances for incomes and expenses should be analyzed to see if they are caused by a difference in
- actual quantity
- actual price
- both actual quantity and actual price
- Variances also need to be analyzed in the context of micro and macro factors that may change
You are working fewer hours, which is reducing your income from employment and causing a budget variance. If the choice is yours, what are some microeconomic factors that could be causing this outcome? If the choice is your employer's, what are some macroeconomic factors that could be sources of the variance? What are your choices for increasing income? Alternatively, what might you change in your financial behavior, budget, or goals to improve outcomes?