Budget vs actual
September against the budget the founders wrote in August: favorable and unfavorable by polarity, a flexed cost of revenue, and the three lines that were the budget's own mistakes.
In August the founders wrote a budget for September. Now there are actuals. Budget against actual, line by line, is a variance report, and its job is to say which differences matter and why. Each variance is actual less budget, labeled favorable (F) or unfavorable (U) by the line's polarity. Revenue above budget is good news. A cost above budget is the same positive sign and bad news.
Three of these variances are the budget's fault
Insurance shows a large favorable variance and depreciation and payroll tax show unfavorable ones, and none of them is about how September went. The budget had the year's insurance as a September cost, $7,200, because that's when it was paid. The books expense a month of it. The budget left out the van's depreciation and the employer's payroll tax entirely. A budget has to be built on the same basis as the books, accrual for accrual, or every month's report is partly a basis difference.
Wrong
Insurance budget: $7,200 in September, when the check goes out. No line for the employer's tax or the van.
Right
Insurance budget: $7,200 ÷ 12 a month, as the books will expense it. Payroll tax and depreciation budgeted from day one.
Explaining a basis difference every month is noise. Fix the budget once, so the report shows only what the business did.
Cost of revenue reads favorable against the budget, and that's the wrong conclusion. The flexed budget shows why.
A variance is a question, not an answer. Every flagged line gets a sentence saying why, and who's doing what about it.
Static budget
- Good at
Fixed before the period, so nobody can move the goalposts
- Watch for
Goes stale once volume moves, so variable lines mislead
- Best for
- Holding the plan to account
Flexed budget
- Good at
Separates volume from efficiency
- Watch for
Needs a clear split of variable and fixed costs
- Best for
- Judging cost control on variable lines
Latest forecast
- Good at
Reflects what's now known
- Watch for
Moves with every update, so it can't measure the plan
- Best for
- Cash and hiring decisions mid-year
In this lesson: the flexed budget, which separates selling less from each sale costing more.
Pages in this lesson
1 page goes deeper, about 5 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- Background reading — not an authority
- Wikipedia, “Variance (accounting)” (opens in a new tab)Favorable and unfavorable variances — backgroundFree to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- BudgetThe plan for a period, line by line, approved before the period starts and held fixed while it runs, so actual results can be measured against it. Built on the same basis as the books — an accrual budget for accrual books — or every variance is partly a basis differenceConvention
- VarianceActual less budget (or forecast) for one line, labeled favorable or unfavorable by the line's polarity: revenue above plan is favorable, a cost above plan is not. The sign is arithmetic; the label is the findingConvention
- Flexed budgetThe budget restated at the volume actually achieved, so a variable cost is judged against what it should have been at actual sales. Separates "we sold less" from "each sale cost more"Convention
- Flux analysisExplaining period-over-period variancesConvention
- MaterialityWhether a misstatement or omission would likely change the judgment of a reasonable user of the statements — judged on size and nature together, never a fixed percentage
- Accrual basisRecognizing revenue when earned and expense when incurred, regardless of when cash moves
- Prepaid expenseCash paid before the benefit is consumed — an asset until it is. "Prepayment" is the UK and IFRS word for the same asset; a customer paying us early is a customer advance or deposit, a liability
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Metrics & analysisMetrics & analysis — specs for 13 React components: MetricDefinition, NonGaapReconciliation, MrrBridge, BudgetVsActual and 9 more.
- Periods & the closeThe month-end close in accounting software: fiscal calendars, period states, cutoff, reconciliation vs tie-out, adjusting entries and restatement.
- Journal entry for prepaid insuranceWhen the premium is paid, debit Prepaid insurance and credit Cash. At each month-end, debit Insurance expense and credit Prepaid insurance for the month's share of the policy, until the prepaid balance reaches zero.
- Journal entry for depreciationEach period, debit Depreciation expense and credit Accumulated depreciation for the period's charge. The asset account keeps its original cost; accumulated depreciation, a contra-asset, grows until net book value reaches salvage value.
- Journal entry for payrollOn payday, debit Wages and salaries for gross pay, credit Cash for net pay and credit liabilities for everything withheld. Book the employer's own taxes separately (debit Payroll tax expense, credit Payroll taxes payable), and clear both payables when they are remitted.
- Operating margin calculatorOperating margin is a profitability metric, calculated as Operating income ÷ Revenue.
- Net margin calculatorNet margin is a profitability metric, calculated as Net income ÷ Revenue.
- Contribution margin calculatorContribution margin is a profitability metric, calculated as (Revenue − Variable costs) ÷ Revenue.
- Accrual basis vs cash basisCash basis books revenue and expenses when money moves. Accrual books them when they're earned or incurred, so a year of insurance paid up front is one month's expense on cash basis and a twelfth a month on accrual.
- Gross margin vs net marginBoth are a share of revenue. Gross margin subtracts only the cost of delivering the product, while net margin subtracts every cost, including operating expenses, interest and tax.
- How to read an income statement (P&L)Revenue, cost of revenue, gross margin, operating expenses and net income, read line by line, on accrual basis, with the mistakes founders make most.
- Why startups should close their books every monthA monthly close turns a bank balance into numbers an investor, an auditor or a 409A firm will accept. What it is, and why it gets expensive to skip.
- Income statementRevenue less expenses for a period. Also called the profit and loss statement, or P&L.
- BudgetVsActualPolarity-aware, materiality-filtered, versions tracked.
- VarianceCellAbsolute + percent + significance flag.
- FluxAnalysisPeriod-over-period explanations.
- ProfitAndLossP&L with period comparison and variance.