Revenue Variance Analysis
A process of comparing the difference between actual sales and expected sales
What is Revenue Variance Analysis?
In simple terms, revenue variance analysis is a process of comparing the difference between actual sales and expected sales. Variance analysis can be used to assess sales revenue, the variable cost of sales, the contribution margin, and manufacturing costs.
Revenues, variable costs, and the contribution margin are the line items most affected by the changes in the amount of each product sold, the price each unit is sold for, and the cost of each unit sold.
Variance analysis can be summarized as analyzing the differences between budgeted and actual numbers. The sum of all the variables provides an overview of the performance or failure of a particular reporting period.
For each item, companies evaluate their suitability by comparing actual costs with the average cost in the industry.
Financial budgets and operating plans are made by management before reporting time, usually quarterly or semi-annually or yearly. These budgets remain unchanged. Business goals are futuristic.
Budgets take long-term plans and break them down into manageable pieces on an annual, quarterly, and monthly basis. Creating a budget gives you details of the actions you need to take to achieve your goals.
By comparing the budget you created with the actual performance, you can gain insight into where your assumptions were wrong.
For example, if the half-year income is -3%, you know you have sold 3% less than you predicted. But it does not tell you everything you need to know to fix it; therefore, you must dig deeper to find the reason.
As time passes, actual performance will vary from your assumptions due to changing economic conditions, accounting errors, or more positive/negative sales speculation. For example, these static budgets usually represent the base case scenario used by a company to measure costs and revenue.
As the financial period progresses, managers need to understand how actual performance compares with what they budgeted. The difference between these budgeted and actual values is the variance, and it is important to minimize this value, especially if it is a startup or a small business.
Importance of Revenue Variance
The concept of Variances is important to understand the nature of these variances. A variance can be favorable or unfavorable.
A favorable revenue variance occurs when the actual revenue exceeds the budgeted revenue, while the opposite is true for negative variances. Differences in income result in the difference between budgeted and actual selling prices, volumes, or a combination of both.
Revenues can be correctly estimated by understanding the cause of revenue variances in budgets. The variances in price, volume, profits, and budgets can be tracked down to their causes, leading to efficient decision-making by the organizations.
Price
A favorable or unfavorable income difference occurs when the actual selling price is greater or less than the budgeted sales price.
For example, let's say a store has estimated to make a sale of $1,000 by selling 100 units at $10; this is called a Standard budget.
But in reality, if it sells 100 units at $9, then there is an unfavorable price variance of 1$, and the total unfavorable revenue variance is $100 [(100 x $10) - (100 x $9)].
Volume
A positive or negative income difference also occurs when the actual sales value is greater or less than the sales volume in the budget, respectively.
For example, if the store is estimated to make $1,000 by selling 100 units at $10, then the Standard budget volume is 100 units.
But in reality, it sells 120 units at $10, then there is a favorable volume variance of 10 units, and the total favorable revenue variance is $200 [(100 x $10) - (120 x $10)].
Profit
Variations in a company's revenue may affect its profitability and cash flow. However, profit also depends on other factors, such as the cost of raw materials, earnings, and marketing costs.
You may be showing a loss if a positive income difference is associated with higher costs. Conversely, if lower costs accompany negative income, it may indicate a profit.
Budget
Revenue, expenses, and other factors influence the budget process.
For example, suppose the revenue gap this year is due to a strong price reduction and a small business expecting this trend to continue. In that case, management may adjust product mixing or look at ways to reduce input costs to achieve profit targets
Types of Variances
When comparing a planned result, organizations look at the efficiency of the operation and its effectiveness in meeting organizational goals. This is better understood by comparing the actual results of the company with the budgeted results of the company.
Variances are calculated for various levels. These levels of Variance Analysis help management better understand the changes that take place in terms of cost, price, and volume.
Static Budget Variances
A static budget is a fixed budget that the management creates as a benchmark for all the costs, prices, and volumes of activity to be achieved by the organization in a given period.
It specifies a level of planned activity that should be achieved by the organization realistically. A static budget is a standard for comparing the company's actual results to determine the root of variance.
The variance in static budget refers to the difference between the organization's actual and budgeted results. Variances are caused by more or fewer sales than planned. This helps the management in evaluating the financial measures.
Static budget variances can be broken down into two sub-variances:
Flexible Budget Variances
A flexible budget is one in which the budget variable revenues and costs (or Static budget values) have been adjusted to the total revenue or cost that would be anticipated for the actual activity level, as opposed to the budgeted level of activity.
In other words, the standard budget values are adjusted as per the volumes of activity expected to be achieved in the current period. As a result, fixed costs remain the same even in flexible budgeting.
Flexible budget variance = Actual results - Flexible budget amount
Sales Volume Variance
The difference between the flexible budget amount and the static budget amount.
The sales volume variance shows how much of the static budget variance was caused by actual sales volume having been different from budgeted sales volume.
Sales volume variance = flexible budget amount - the static budget amount
Types of Revenue Variance
Sales Price Variance
This is the difference between the budgeted selling price and the actual selling price.
This variance indicates that the company has been forced to accept a different selling price to generate customers. It can determine which products contribute significantly to sales revenue and provide insight into other products that may need to be discounted or discontinued.
Sales Price Variance = (Actual selling price − Standard selling Price) × Units Sold
Sales Volume Variance
This is the difference between the expected sales volume and the actual sales volume that occurred.
Sales volume variance = (Actual units sold - Budgeted units sold) x Budgeted price per unit
Sales volume variance is further divided into sales mix variance and sales quantity variance.
Sales Mix Variance
Sales mix is the difference between the sales combination in the company budget and the actual sales combination. The sales mix is the value of each product sold compared to the total amount sold.
The sales mix affects the company's total profit because some products produce higher profit genes than others.
Sales Mix Variance = (Actual Units Sold × (Actual Sales Mix% − Budgeted Sales Mix)) × Budgeted Contribution Margin Per Unit
Sales Quantity Variance
Variation in sales value varies in profit or contribution margins in organizations due to differences in budget sales value and what it can sell.
We calculate SQV over time and on the basis of a common mix of products and services.
Sales Quantity Variance = (budgeted sales quantity – Actual sales quantity as per standard mix) x standard profit or contribution margin per quantity
What are the steps To Calculate Revenue Variance Analysis?
Analyzing the revenue variance will help us to understand how well our unit prices and sales volumes were managed compared to our budget numbers. There are four steps involved in this process:
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Calculate the difference between what we used and what we planned to use.
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Find out why there is a difference.
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Gather information and talk to management.
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Compile a cost-effective plan in line with the budget.
How To Calculate Revenue Variance?
First, look at your static budget figures and note the amount of money you expect to earn over that period. If your static budget includes revenue per unit and prices, note the prices for both categories. This will help plan for the future.
For example, selling more units at a lower price may earn more revenue than selling smaller units at a higher price or vice versa.
Look at your actual revenue at the same time. Note the units sold and the value per unit received. Determine your variances. Subtract all your estimated revenue from your actual revenue.
If the number is positive, you have exceeded your expected static budget, which is a favorable variance. Conversely, if the number is negative, you have not yet reached your expected revenue budget, which is an unfavorable variance.
When calculating the difference in revenue, it is not always necessary to include units for sale in your calculation; however, if your actual statistics vary widely, you may want to analyze the difference between a static budget and actually sold units of data.
Example of single product variance
ABC Manufacturing Co. is in the business of selling shawls. It has recently launched its business and is estimated to sell 800 units of products during the period, but it sold only 700 units. The price per unit of the products was set at $10, but the company could sell it at $12.
The variable cost per unit was estimated to be $5, but it incurred $6 as the variable cost per unit. Fixed costs remain the same regardless of changes in the price, cost, or volume of sales.
Below is the data from ABC company for the 2nd quarter (April - June), which shows its budgeted and actual contribution margin.
| Budgeted | Actual | |
|---|---|---|
| Total sales (in units) | 800 | 700 |
| Revenue | 8000 | 8400 |
| Variable costs | (4000) | (3500) |
| Contribution margin | 4000 | 4900 |
| Fixed costs | (2000) | (2000) |
| Operating profit | 2000 | 2900 |
Let’s walk through the four steps and analyze
1. Calculate variance:
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Sales volume variance = (Actual units sold - budgeted units sold) x Budgeted price per unit (800 - 700) x $10 = $1000.
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Sales price variance = Sales Price Variance = (Actual selling price − Standard selling Price) × Units Sold ($10 - $12) x 700 = $1400.
2. Causes of difference estimation:
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Differences in sales volume occurred because of low demand for shawls due to the Summer season.
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Differences in sales price occurred due to fewer sales, and the price was increased to maintain the profit margin.
3. Analyze: We put together all this information for management and let them know that we charged more than was budgeted as the price per unit of the product but did not increase sales.
4. How could we fix this? We could spend more on marketing the shawls to build a trustworthy brand amongst the customers.
We could also fix competitive pricing during the relevant season to increase the revenue and reduce the pricing during non-relevant seasons to keep the sales stagnant throughout the year.
Example for product mix variance
A sports manufacturing company makes footballs and basketballs. Its sales mix variances would arise from the variations in the actual sales mix of these two products compared to the budgeted sales mix.
Data from the sports manufacturing company:
| Footballs | Basketballs | |
|---|---|---|
| Budgeted sales | 10,000 | 6,000 |
| Standard contribution margin per unit | $8 | $4 |
| Actual sales | 9,000 | 9,000 |
Solution:
Variances As Per The Standard Budget
the sales mix ratio of footballs
(10,000/16,000) x 100 = 62.5%
A sales mix ratio of basketballs
(6,000/16,000) x 100 = 37.5%
As per actual sales, the sales mix ratio of football
(9,000/18,000) x 100 = 50%
A sales mix ratio of basketballs
(9,000/18,000) x 100 = 50%
Sales Volume Variance for Footballs
Sales Mix Variance = (Actual Units Sold × (Actual Sales Mix% − Budgeted Sales Mix)) × Budgeted Contribution Margin Per Unit
= (18,000 x 50%) x $8 = $72,000
= (18,000 x 62.5%) x $8 = $90,000
Sales Mix Variance
$72,000 - $90,000 = ($18,000)
Sales Quantity Variance = (budgeted sales quantity – Actual sales quantity as per standard mix) x standard profit or contribution margin per quantity
= (18,000 x 62.5%) x $8 = $90,000
= (16,000 x 62.5%) x $8 = $80,000
Sales Quantity Variance
$90,000 - $80,000 = $10,000
Sales volume variance = Sales mix variance + Sales quantity variance
= ($18,000) + $10,000
= ($8,000) unfavorable
Sales Volume Variance For Basketball
Sales Mix Variance = (Actual Units Sold × (Actual Sales Mix% − Budgeted Sales Mix)) × Budgeted Contribution Margin Per Unit
= (18,000 x 50%) x $4 = $36,000
= (18,000 x 37.5%) x $4 = $27,000
Sales Mix Variance
$36,000 - $27,000 = $9,000
Sales Quantity Variance = (budgeted sales quantity – Actual sales quantity as per standard mix) x standard profit or contribution margin per quantity
= (18,000 x 37.5%) x $4 = $27,000
= (16,000 x 37.5%) x $4 = $24,000
Sales Quantity Variance
$27,000 - $24,000 = $3,000
Sales volume variance = Sales mix variance + Sales quantity variance
= $9,000 + $3,000
= $12,000 favorable
Total Sales Volume Variance
Sales volume variance = Sales mix variance + Sales quantity variance
Total Sales Mix Variance
($18,000) + $9,000 = ($9,000) Unfavorable
Total Sales Quantity Variance
$10,000 + $3,000 = $13,000
= ($9,000) + $13,000
Total Sales Volume Variance
$4,000 favorable
Why Do Variances Occur?
It can be caused by:
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Differences in sale prices charged: When the unit price of a commodity changes, the total revenue generated by sales varies. This is when a difference between the expected price per unit and the actual price per unit varies and causes a variance. This term is known as price variance.
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Differences in the volume of sales: When the actual volume of sales does not meet the expected volume of sales, it causes a variance in the revenue generated.
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Differences in variable cost per unit: Variance occurs when there are differences between the expected cost per unit and the actual cost per unit.
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Differences in the mix of products sold: A company producing multiple products may have variances associated with the sale of each product which could cause Variance in the overall revenue generated.
Other causes of budget variances include
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Flawed assumptions when preparing the budget
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Inefficiencies in executing the budget
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Internal or external changes in the environment
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Competition
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