How to Perform Budget Variance Analysis (Step-by-Step Guide)

Most nonprofit organizations often lack clarity on why actual expenses exceed their budget during their fiscal year.

You can conduct a budget variance analysis to identify actual versus budget differences and understand the causes of these discrepancies. The practice helps you control your finances better, keep the board informed, and reallocate resources effectively on a rolling basis. 

But what is it in the first place, and how can you do it? We'll explore these and more in today's guide. 

Pro tip: You can use financial management software for budget variance analysis. 

For example, Martus integrates with your accounting tool to import actual financial data, allowing you to compare it with your budgeted amounts and identify any differences. 

Check out Martus today to gain financial clarity and make smarter budgeting decisions. 

What Is Budget Variance Analysis?

Budget variance analysis is the process of comparing actual financial results against the budgeted amounts for a given period to identify and understand discrepancies. 

The practice is helpful for nonprofits managing restricted and unrestricted funds across multiple programs. It helps promote financial accountability, identify areas for improvement, control overspending, and maintain donor trust.

Why Budget Variance Analysis Matters

Regular variance checks are important as they help your organization adjust faster to situations and use funds more strategically. 

Below are the main benefits of flexible budget variance analysis.

• Prevents Last-Minute Surprises: You can identify potential financial issues early and address them before they escalate into major problems. For instance, if you are exceeding your budget in a specific expense category, you must investigate the cause and correct the situation in time. 

• Supports Timely Grant Compliance and Reporting: When you identify variances early, you can adjust your spending or activities to stay within grant terms and conditions. You also get a clear picture of how you spend grant funds, which helps with timely grant reporting because you can easily explain any variances. 

• Builds Confidence with the Board and Donors: Through proper nonprofit budget variance analysis, you demonstrate to your board and donors that you are financially transparent, accountable, and committed to effective resource management. The process helps you provide clear explanations for any differences and your corrective measures, which builds trust and confidence for continued oversight and funding. 

Types of Budget Variances

In nonprofit financial management, budget variances are usually classified into the following common types. 

1. Revenue Variance: A difference between the projected or budgeted revenue and the actual revenue is called a revenue variance. When it's favorable, you've earned more than your budget. An unfavorable variance shows you earned less than you budgeted for in a certain period. 
2. Expense Variance: This is the difference between the budgeted amount for expenses and the actual amount spent in a specific period. If it's favorable, your actual expenses are lower than the budgeted amount, which shows cost savings but could also mean underperformance. When the actuals exceed the budget, the variance is unfavorable and indicates overspending. 
3. Timing Variance: A timing variance occurs when the actual timing of an expense or revenue differs from the timing specified in the planned budget. For example, you may launch a program, receive a grant disbursement, or conduct a fundraising event later or earlier than expected. Timing variances usually have a short-term effect on cash flow or revenue recognition. They may not mean a long-term issue if your overall budget is on track. 

Budget Variance Analysis Techniques

You can use different methods to compare budget vs. actuals and analyze the discrepancies between them. Let's check out some common techniques. 

• Absolute Variance vs. Percentage Variance: Absolute variance is the simple difference between actuals and the budget, while percentage variance expresses this difference as a proportion of the budgeted amount. The latter helps you understand the significance of the variance, especially when comparing different budget items. 

• Variance by Category/Program: You can use this method to compare budget categories to actual amounts for each category across program, fundraising, and administrative functions. 

• Rolling Variance Tracking Over Time: This technique involves comparing actual amounts against a rolling budget that's updated monthly or quarterly to showcase the most recent information or organizational changes. You update your budget, incorporate actual results from the prior period, and adjust for any changes you expect in the upcoming period. The result is an updated “rolling" forecast or budget that you can compare with the actuals at the end of each period. 

When applying these techniques, you'll want to combine them for better results, track variances consistently, and communicate clearly with the relevant stakeholders. 

How to Perform Budget Variance Analysis

Here's how to conduct a budget variance analysis in five easy steps. 

1. Collect Actuals from Accounting: Gather actual revenues and expenses from your nonprofit accounting software. Ensure the data is complete, up-to-date, and accurate. 
2. Compare with the Budget: Align the actuals with the budget and calculate variances. 
3. Highlight Significant Variances: Note all the variances, highlighting the most significant ones using conditional formatting or variance flags. Focus on the ones exceeding your predefined thresholds, such as 10%. 
4. Investigate the Root Causes: Identify the reasons behind the variances. Collaborate with all your program leads because they usually understand the key context behind variances. Some common causes include changes in program scope, timing differences, and misclassification of categories. 
5. Recommend Actions: Based on the causes and the extent of the variances, suggest corrective measures or preventive actions for the way forward. You can recommend adjusting budget forecasts, controlling discretionary spending, reallocating resources, and correcting your nonprofit accounting miscodes. 

Software for Budget Variance Analysis

It's wise to use dedicated nonprofit financial management software for budget variance analysis. Spreadsheet-based processes in Excel or Google Sheets often suffice, but you risk confusion and delays because they are time-consuming and prone to mistakes. 

Instead, you can use Martus, a nonprofit-specific financial management platform, to enjoy the following capabilities:

• Real-Time Variance Reports: Martus connects with accounting tools like Sage Intacct to automatically import financial data and help you update reports as changes occur. You can even make monthly budget comparisons that show actuals, budgeted amounts, variances, and percentage variances for each month. 

• Program-Based Filtering: You can use Martus to track and manage your nonprofit finances at a granular level. Martus allows you to create and manage budgets for individual programs, making it easy to track expenses and revenues for each and compare them with budgeted amounts. 

• Dimensional Tracking for Grant or Fund Accountability: Using your accounting tool, you can tag financial transactions with various dimensions, such as grant, department, or project. Martus integrates with the accounting tool to help you report on these dimensions and analyze specific grant-funded activities. You can automatically generate Martus reports, ensuring compliance with grant requirements. 

Book a detailed demo today to find out more about Martus's financial management solutions for nonprofits. 

Common Challenges and How to Overcome Them

Although the practice is easy, you are likely to face the following budget variance analysis challenges. 

• Spotting Variances Too Late: When variances are spotted too late, they may have already become significant financial problems that are time-consuming and costly to address. You can use financial management software that provides real-time variance reports to ensure you are always up to date. Also, review variances monthly and quarterly, rather than waiting until after the year-end close, to spot issues early. 

• No Clear Owner for Review and Follow-Up: You may not have a dedicated person to investigate variances, review recommended actions, and follow up on them. You can assign this extra budget ownership obligation to program or department leads, with clear roles and responsibilities based on your financial policies and grant agreements. 

• Difficulty Splitting Expenses Across Programs: It's often hard to allocate shared expenses such as rent and staff salaries fairly across multiple programs. You can use progressive allocation methods based on usage, timing, or headcount to make it easier. You can also implement accounting and financial management tools that support project tags or class tracking for easier granular transaction management. 

Frequently Asked Questions (FAQs)

Let's conclude with a quick overview of common questions regarding budget variance analysis for nonprofit organisations. 

What Are the Key Metrics to Monitor in Budget Variance?

You can monitor key budget variance metrics such as absolute variance, percentage variance, revenue variance, expense variance, and cash flow variance. 

Other metrics include grant spending variance, fundraising efficiency, personnel cost variance, net operating deficit or surplus, and the administrative-to-program ratio. 

Who Is Responsible for Budget Variance Analysis in an Organization?

In a nonprofit organization, the Chief Financial Officer (CFO) or Finance Director usually takes up the responsibility of conducting budget variance analysis. They receive support from the accounting or finance team. 

The board of directors assumes the oversight role of reviewing variances and recommended actions, ensuring that you take corrective or preventive measures as necessary. 

What Is the Difference Between Budget Deviation and Budget Variance?

Budget variance is the difference between planned figures and the actual amounts your organization receives or spends. 

While related, budget deviance generally refers to a situation where an expense or activity veers from the original budget, especially when the intended use of funds changes. 

Budget deviation can also be about exceeding the budgeted amount since deviations can be a cause of variances in that they are specific instances where you didn't follow the budget. 

Can AI or Machine Learning Be Used for Budget Variance Prediction?

Yes, you can use AI and machine learning to predict budget variance. 

AI-powered solutions like Martus's ReportBuilder Assistant can analyze historical financial data, identify patterns, and predict future financial trends, including potential variances. 

Conclusion

Consistent budget variance analysis is empowering to nonprofit organizations of all sizes. The practice helps you make smarter financial decisions, comply with grant requirements, and align your spending with your mission. 

You'll want to use nonprofit-friendly financial management platforms, such as Martus, to help you conduct the process faster, clearly, and accurately. 

For example, Martus can automatically import actual financial results from your accounting tool for comparison with your budgeted amounts. 

Request a product demo today to see Martus in action and discover how it can transform your financial processes.