Comparing actual vs. budget is often referred to as "variance analysis," a principal function in management accounting. Unlike financial accounting, which concerns the recording of historical business transactions for all interested parties, management accounting focuses on producing forward-looking information, such as developing budgets and measuring performance, for managers for internal, private uses. Management accounting assists managers in formulating business strategies, planning business activities and evaluating business results. Providing decision-oriented information, management accounting serves as a mechanism for better management
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Based on information from financial accounting, management accountants often create budget plans for various aspects of a business's operations, and managers can then use them as a guide to make more informed decisions. While financial accountants stress compliance and record keeping, management accountants forecast and plan future business developments and suggest courses of action. Budget planning provides the basis against which actual results can be measured and evaluated.
Measuring actual results against budget is aimed at monitoring and recording business activities, the results of which are used for further performance evaluation. The comparison of actual vs. budget often shows a difference, or "variance," that can be either favourable or unfavourable. For example, in a cost budget, a lower actual number than the budgeted figure would be considered favourable, while in a sales budget, a higher actual number than the budgeted figure would be seen as favourable.
Variance is analysed to find out what caused the variation between actual and budget. Planning budgets and measuring results are only the start of the process of comparing actual vs. budget. Management uses the budget report to identify the reasons for any variation so that it can recommend appropriate corrective actions. Potential causes for unfavourable variances may include unrealistic budget or subpar performance.
Variance analysis better informs managers about current business operations. Knowing what has performed and what has not, managers can take reinforcing measures or corrective actions. The purpose of comparing actual vs. budget is to add value to the business through better planning, monitoring, evaluating and controlling. Management may adjust a budget upward or downward to better reflect reality and implement new cost-cutting or sales-promoting measures.
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