Based on the information provided calculate the revenue variance percentage

Gross profit is one of the most important measures of profitability in corporate finance. Gross profit is total revenue minus the cost of goods sold (COGS). Because this metric only takes into account those expenses directly attributed to the production of items for sale, gross profit is used as a measure of a company's ability to turn revenue into profit at the most basic level. A weak gross profit often begets weak net profit. The goal of every business is to increase its profit, and they usually have a multitude of tools to be able to do so.

The cost of a product or service, as well as the price that is charged for that product or service, determines what the gross profit will be. Businesses can improve their gross profit by making changes in the cost of goods sold or the price of the product or service.

Gross Margin

The gross profit margin is a more refined metric that compares a company's gross profit to its revenue, resulting in a percentage that reflects the portion of each dollar that remains as profit after accounting for production costs. The gross profit margin, also called the gross margin, is calculated by dividing gross profit by total revenue. For example, a company with revenue totaling $100,000 and costs of goods sold totaling $35,000, would have a gross profit of $65,000 and a gross profit margin of 65%.

The two key features of both of these calculations, revenue and the costs of goods sold, vary based on the number of products sold, the price per item, and the costs associated with production. Both fixed costs and variable costs are included in cost of goods sold, so companies look to reduce both types of expenses wherever possible, which would increase the gross profit margin.

Another way to increase the gross profit margin is by increasing price, thereby increasing revenue, assuming production and sales levels remain constant. A company would have to ensure that the increase in price is commensurate to the supply and demand of the product, otherwise, they risk losing market share to competitors who are selling a similar product for less.

To determine the variance in gross profit margin that these two types of adjustments create, calculate the margin for each price/cost scenario, and subtract the results.

Variance in Gross Margin by Changing Price and Cost

For example, assume company ABC produces table lamps. Under the current business model, ABC produces 5,000 lamps per year at a cost of $25 per lamp. The lamps sell for $50 each. In this scenario, the total revenue for all lamps is 5,000 x $50, or $250,000. The total cost for the production of the lamps is 5,000 x $25, or $125,000. The gross profit is $250,000 - $125,000, or $125,000, meaning the gross profit margin is $125,000 ÷ $250,000, or 50%.

Company ABC is looking to increase its bottom line and determines that the simplest ways to do so are to sell more cheaply made lamps or to increase prices. Management knows the market won't support a drastically inferior product nor a wildly inflated price, so it decides to combine the two factors and sell slightly inferior lamps at a marginally higher price.

It still intends to produce 5,000 lamps, but under the new model, each lamp only costs $17 to produce and sells for $55. The total revenue is now 5,000 x $55, or $275,000, and the total cost is 5,000 x $17, or $85,000. The new model then yields a gross profit of $190,000 and a gross profit margin of 69%. This represents a 19% increase over the original gross profit margin.

The Bottom Line

Companies use comparative analysis like the example above to determine what levels of production, cost, and price yield the greatest profit margin. This type of analysis can also be used retrospectively to determine the cause of declining profits due to sales volume, pricing, or production costs. By making small adjustments to one or all of these contributing factors, companies can increase profits at the most basic level, paving the way for a healthier bottom line.

Put plainly, budget variances are any difference between an actual amount and a planned or budgeted amount. This could refer to material or labor cost variance, or alternatively any sales price variance or any other budgeted line item variance. Variance analysis helps to uncover reasons behind any failure and to identify trends for success.

Causes of budget variances:

• Inaccurate budgeting: If this is a recurring issue you might want to revise your budget, and get help with your budgeting and forecasting as included in our outsourced CFO services.

• Changes in the market economy: Make plans to monitor and adjust your business plan. Maybe you simply missed a sale. Is it time to use a new sales channel? Perhaps you could improve your customer service?

• Client/Customer Acquisition: Related to market economy, increased competition often comes into play. To stay on budget, read more about how to lower customer acquisition costs (CAC) and learn about allowable CAC.

• Employee fraud: Unfortunately, it happens. And it goes without saying that employee or expense-related fraud is something you want to identify and prevent. Having the right workflows and policies will help mitigate your risk.

Related read: If your company provides expense reimbursements, then it runs the risk of fraud. Learn more about how to use Expensify.

• Changes in costs: This might be expected if suppliers implement price hikes after you’ve set your budget. We’ve seen some of our most innovative clients tackle cost-cutting by going to their existing suppliers and competitors to negotiate a better price. Swapping fixed costs for variable costs can also be a strategic move to offset other expenses and cut costs as you grow. Learn more about how to cut business expenses.

• Improved operations: Maybe employee turnover has been at an all-time low. Or perhaps, your team has new, more efficient procedures. Whatever the reason for improved operations they’re as important to note and build on as inefficient operations. Whether good or bad, the reasons behind a variance are essential to your business operations.

Favorable vs. unfavorable budget variances.

A favorable budget variance is any actual amount differing from the budgeted amount that is good for the company. Meaning actual revenue that was more than expected, or actual expenses or costs that were less than expected.

An unfavorable budget variance is, well, the opposite. A variance from the budgeted amounts that has a negative effect on your company. Jump ahead to our budget vs actual example.

The reasons and volatility behind budget variances. (And why you should pay attention).

You might assume that a favorable variance deserves only a quick nod before moving on. But it’s important to understand what’s causing the variance(s) no matter whether they’re good or bad for your company. Budget variance analysis helps you uncover the drivers behind operations. And, if you’re noting unfavorable budget variances you want to determine the source ASAP.

How often should you perform budget variance analysis?

You should perform budget variance analysis on a quarterly basis at the very least. And in more tumultuous climates, more often than that. For example, in the wake of COVID-19 restrictions in Q2 of 2020, we increased our forecasting and analysis to a weekly basis. So, you have to find the right cadence for your company’s needs in response to the industry and market environment.

Example: We switched one of our clients to weekly meetings with their outsourced CFO to track financial reporting like budget variances and customer channel profitability. Their revenue has jumped by 120%.

How to monitor and perform budget variance analysis.

The most important thing most business owners want to know is whether they’re going to hit, miss or exceed the budgeted targets. So, how do you monitor these unexpected up and down swings?

First, determine what program or method you will use to track your budget variances. Our favorite approach to budget variance analysis is using either dashboards or dynamic spreadsheets customized for your company.

Next, calculate your budget variances using this very simple formula: Actual Amount – Budgeted Amount

How to calculate budget variances.

To calculate budget variances, simply subtract the actual amount spent from the budgeted amount for each line item.

Budget vs. Actual Example

So, in the sample budget vs. actual below, under revenue, for product sales you would subtract the actual from budget, $125,000-$109,750 = $15,250.

Many entrepreneurs will be familiar with your classic budget to actual in monthly reporting. It helps to add some conditional formatting to quickly hone in on the most important areas to dissect.

In the example below, we’ve used red for unfavorable variances and green for favorable ones. We’ve built in formulas that show all unfavorable variances as negative numbers in both revenue, COGS and expenses.

To calculate the percentage budget variance, divide by the budgeted amount and multiply by 100.

The percentage variance formula in this example would be $15,250/$125,000 = 0.122 x 100 = 12.2% variance.

You can also easily set this up in dynamic spreadsheets and dashboards to automatically calculate your variances each month.

Cloud CFO Tip: Pay attention to sizeable budget variances in both percentage and dollar amounts.

Pay attention to sizeable variances in both dollar amounts and percentage. Say you spend $200 in office supplies compared to $100 budgeted. The variance percentage will be 100% off, but who cares? It’s a mere $100, compared to salaries which may be only 5% off but could mean tens of thousands of dollars over or under budget.

What’s more important, expense or revenue variances?

Especially in high-growth companies, executives tend to spend a lot of time budgeting and looking at expense variances.  A good rule of thumb is to consider anything over 10% as unusually volatile for expenses.

Cloud CFO Tip: A good rule of thumb is to consider anything over 10% as unusually volatile for expenses.

Business owners are inclined to focus on expenses because you can control them. However, when you are halfway through the year, your revenue is always the most volatile number. You could be off by 50% because revenue is so choppy. While you can’t fully control revenue, you gain valuable insight by pinpointing the root cause of the revenue variance.

Budgeting revenue.

To improve business operations, use budget variance analysis to dig into revenue to determine why you are off.

Ideally when you are budgeting revenue, you’re not just picking a number based on last year’s revenue. It’s important to be budgeting revenue based on a key driver. Don’t make the mistake with financial projections of picking some arbitrary percentage to grow your revenue by. Instead, consider how you acquire a customer, the conversion percentage and the length of your sales cycle. If you have recurring revenue you might consider your CAC into your projections and budget.

For example, say you offer a subscription service with a flat monthly fee. Budget in your monthly revenue estimates according to customer acquisition rates and your new monthly recurring revenue (MRR). Next, add in any anticipated new clients and the additional income each month in a sort of waterfall effect.

Reviewing revenue variance: your waterfall revenue should provide a month-by-month recap of your budget. Then you can quickly see any red flags. Did you have negative customer churn? Didn’t sign up as many new customers as anticipated? Or maybe the expected number of customers was correct but they were generating less income per month than forecasted. This budget variance analysis can provide useful insight into places you might need to dig in further like your customer lifetime value (LTV) for example. Follow these four steps to increase LTV. For other clients, they can quickly see when the cost of one sales channel has inflated and whether they should focus their efforts on more economical channels instead to drive more revenue and ultimately profit.

Budget Variances and Forecasting.

Budget variance analysis can create a more accurate forecast for year to date (YTD) and end of year (EOY). Your summary YTD shows how you have performed. It also shows how you will perform compared to budget for the remainder of the year. This becomes especially important in Q3 and Q4 as you prepare your budget for the following year.

The methodology behind budget variance analysis is not to make you feel like you are doing something wrong. Which, as an entrepreneur, it can sometimes feel like. (Speaking from experience here!) Variance analysis not only provides insight into your operations but it also builds accountability. Understanding budget variances places helps you know whether it’s time to scale your company.

Need help understanding your budget variances or the difference between a balance sheet vs P&L or cash flow forecasts? Hire an outsourced financial controller that is dedicated to helping businesses do just that. Contact us for help.

Related reads

Business Planning

The Best 3 Ways to Reduce Inventory Costs

With all warning signs pointing to recession, many companies are looking at ways to reduce costs. For those in the consumer products or ecommerce sector they might specifically be searching for ways to reduce inventory costs: 1). Leverage your data to optimize your inventory management, 2). Forecast your true demand and, 3). Bundle dead stock to sell.

Read More

Budgeting & Forecasting

Business Planning for a Recession: 7 Steps to Recession Proof Business

Inflation, stagflation, recession. While it may sound like doomsday has arrived, there are some things you can do to prepare your business for recession.

What is revenue variance?

Revenue Variance Analysis is used to measure differences between actual sales and expected sales, based on sales volume metrics, sales mix metrics, and contribution margin calculations.

How to calculate percentage variance between budget and actual?

BvA variance can be calculated as either a percentage or a dollar value, using the following two formulas:.

Percentage variance formula: (Actual sales or expenditures ÷ Budgeted sales or expenditures) –1..

Dollar variance formula: Actual sales or expenditures dollar value – Budgeted sales or expenditures value..

Is variance a percentage?

The variance formula is used to calculate the difference between a forecast and the actual result. The variance can be expressed as a percentage or an integer (dollar value or the number of units).