How to Do Budget Variance Analysis and Write Commentary That Explains

What is budget variance analysis?

Budget variance analysis is the monthly habit of putting actual results beside the budget, line by line, and explaining the differences that matter. The budget is what you expected when the year was approved. The actuals are what the accounting system says happened. The variance is the gap, and the analysis is the work of saying why the gap exists and what, if anything, you will do about it.

In a company of ten to three hundred people the job usually sits with a finance manager, an accountant in industry or a bookkeeper, with department heads supplying the explanations. Done well, it lets the owner see early where the year is drifting and decide while there is still time.

The method below works in any currency, with any accounting system, and in a spreadsheet.

How do you set a variance threshold?

The first decision is which variances deserve attention. A threshold that is only a percentage flags every small line (a 40 percent variance on a 300 stationery line). A threshold that is only an amount flags only the biggest lines and lets a steady two percent leak on a medium line run all year. The answer is to use both, and to flag a line only when both are passed.

Typical settings for a company of this size are five to ten percent and an amount that matters at your scale: 5,000 for a company turning over ten million, 2,000 for a forty-person services firm. Tune them so that a normal month produces three to eight flags.

Show the same flags on the year-to-date columns. A line that is two percent adverse every month never trips a monthly flag, and by September it is a real number. Year-to-date catches the slow leaks that a monthly view misses.

What are the seven causes of a variance?

Once a line is flagged, the next question is the cause, and there are only a handful. Naming the cause is what turns a number into an explanation, and it also tells you what to do next.

Volume: units or activity moved and the cost per unit did not. The response is to flex the budget (see below) and judge the line on the flexed figure. Price or rate: units were on plan but the price per unit moved, because of a supplier notice, an exchange rate or a pay rate; the decision is whether to pass it through or renegotiate. Mix: the total was on plan but the margin moved because the composition changed; compare margin by product line to find which one grew.

Timing: the variance will reverse in a named month, because an invoice was late, an event moved or an accrual was missed. Say the month and do not count it as a saving or a loss. One-off: it will not repeat, such as a repair, a legal fee or a write-off; note it and leave it out of the run-rate when you forecast. Efficiency: activity was on plan but more input was used per unit, such as overtime, waste or carrier overflow; this one needs a process owner. Budget error: the budget was built on the wrong basis; say so, correct the forecast and leave the budget fixed.

A useful discipline is to make the cause a drop-down list on the variance sheet rather than a free-text field. People then have to choose, and 'it went up' stops being an option.

What is a flexed budget and why does it matter?

A flexed (or flexible) budget is the original budget recalculated at the actual level of activity. Fixed costs stay fixed; variable costs are scaled to the actual units. The variance that remains after flexing is the one worth explaining, because the effect of volume has been taken out.

Here is why it matters. Suppose a distributor budgeted gross profit of 272,600 for March and achieved 272,500. On the face of it, nothing happened. But revenue was four percent above budget on volume, so at budget margin the gross profit should have been about 283,500. Volume added roughly 10,900 and margin took away about 11,000. Two real effects cancelled, and one of them, the margin, is a problem that the unflexed comparison hides completely.

The one-line formula is: flexed cost equals fixed budget cost plus variable budget cost per unit times actual units. For profit lines, use budget margin per unit times actual units. You need the unit numbers and a view of which costs are variable, which is one more reason to build the budget from drivers in the first place.

How do you write variance commentary that actually explains?

'Fuel is nine percent over budget' is not a commentary. It is the number again, in words, and the owner could already see it. A commentary has three sentences. First, what happened, with the number. Second, why: the cause, not a restatement. Third, what next: the action, the owner, the date and whether the full year changes.

Rewritten, the fuel line reads: 'Fuel is nine percent over on price; mileage is on plan. Diesel averaged 1.61 a litre against 1.48 budgeted. Two routes move to the larger truck from May, which should recover about half; full-year forecast up 15,000.' Three sentences, a cause, an action with a date, and a forecast effect.

The first draft should come from the department head, because they know what happened, and finance should check it against the ledger, because they can see what was booked. Send a short commentary request within two days of the close, one sheet per flagged line, and return any draft that restates the number with an example of what you need.

AI assistants are useful here in one specific way: give them the agreed facts (line, budget, actual, cause, action) and ask for three sentences. They arrange words well. They should not be asked to guess the cause from the numbers, because they will produce something plausible and it will often be wrong.

Why do favourable variances deserve the same scrutiny?

A large favourable variance is where missing invoices, late accruals and timing differences hide. Marketing twelve percent under budget in March is often a trade show deposit that will land in April, or an agency invoice that has not arrived. If the owner banks it as a saving in March, April's report has to take it back.

The rule is simple: investigate favourable as hard as adverse, and make every timing item say the month it reverses. On the cash side the same honesty applies to revenue: an invoice raised is not cash received. Xero's Small Business Insights for the December 2025 quarter, published in March 2026, put average late payment at 8.0 days in the United Kingdom, 7.8 in the United States and 6.6 in Australia, and Atradius's 2025 Payment Practices Barometer reported overdue invoices affecting around a third of B2B invoices in Sweden and more than 40 percent in Denmark and Finland. A revenue line on budget can still leave the bank balance short.

What should the monthly report to the owner contain?

One page, then detail for those who want it. Page one carries revenue, gross margin, EBITDA, cash and headcount against budget for the month, the year to date and the full-year forecast; the month in three sentences; the three variances that change a decision, each with its cause and action; and the decisions needed this month. The pages behind it hold the KPIs, a thirteen-week cash view and the full profit and loss against budget.

The discipline is choosing three. Not every flagged line belongs on page one; the three that would change what the owner decides do. The rest are explained on the variance sheet and summarised on page three. Keep the same KPIs every month, with a target and a trend, so the owner learns to read the page in two minutes.

Speed matters too. APQC, which runs a large open benchmarking database on business processes, reported in January 2026 that top-performing organisations prepare a financial forecast in eight days against a median of eleven, and in January 2024 that top performers complete the annual budget in 28 days or less. Named line owners, causes chosen from a list and adjustments to the remaining months only are what make both fast.

How does variance analysis feed the reforecast?

The budget is never changed during the year. If you edit it you lose the yardstick, and you lose the lessons, because next year's drivers come from this year's variances. The forecast is a separate, honest view of where the year will end, updated quarterly (monthly if cash is tight), and it is the number decisions are made on. The ICAEW's guide for finance teams describes a rolling forecast as one that always extends a set number of periods into the future and is updated regularly; the practical version for a smaller company is a full-year forecast each quarter with a four-quarter rolling view beside it.

The link from variance to forecast is the cause. A timing variance changes nothing for the full year. A one-off already in the year-to-date moves the full year by exactly that amount. A recurring cause, such as a price rise, a mix shift or a step change in a rate, means adjusting the remaining months with the basis written down. When the forecast gap passes a trigger written in the budget policy, named cost controls switch on: hiring delays for specific roles, discretionary spend moved to the owner, capex deferred, a price pass-through.

Every reforecast ends with a note against the driver that was wrong: the supplier inflation that arrived a month early, the hire that started late, the overtime that every new account needs in its first quarter. Twelve months of those notes are the best preparation for the next budget cycle.

A simple monthly routine you can start this month

Day one to five after month end: close the ledger and type the actuals into a sheet with the same lines and order as the budget. Set your two thresholds and count the flags. Day five to seven: send a commentary request for each flagged line to its owner, and check the drafts against the ledger. Day eight: fifteen minutes with each department head to agree cause, action and full-year effect. Day nine: the one-page report to the owner, with the three variances that matter and the decisions needed. Quarter end: the reforecast, the decision record and the lessons note.

If you want the tools ready-made, the Annual Budget and Variance Kit from Bodhih Training includes a sixteen-sheet workbook with flagged variances and a reforecast, a variance commentary sheet, a decision card for the seven causes, a monthly report template and a message library for the requests and the awkward replies. Measuring your own starting point first helps: the AssessAll Estimation & Forecast Calibration assessment tests how well calibrated your estimates are, and a Jobulary development plan can turn what you learn into a sequence of practice, one close and one reforecast at a time.