Revenue variances are used to measure the difference between expected and actual sales. This information is needed to determine the success of an organization’s selling activities and the perceived attractiveness of its products.
There are three types of revenue variances, which are as follows:
- Sales volume variance. This is the difference between the actual and expected number of units sold, multiplied by the budgeted price per unit. The intent of this variance is to isolate changes in the number of units sold.
- Selling price variance. This is the difference between the actual and budgeted unit price, multiplied by the actual number of units sold. The focus here is on the price that the company has been forced to accept in order to generate customer orders. When prices are driven lower than expectations, one may surmise the existence of considerable competitive pressure.
- Sales mix variance. This is the difference between the actual and budgeted number of units sold, multiplied by the budgeted contribution margin. This measure is used to determine the impact on the overall sales margin of differences in the expected mix of units sold. This is a particularly important variance when the products sold have widely differing margins.
Importance of revenue variances:
The revenue variance for an accounting period is the difference between budgeted and actual revenue. A favorable revenue variance occurs when actual revenues exceed budgeted revenues, while the opposite is true for an unfavorable variance. Revenue variance results from the differences between budgeted and actual selling prices, volumes or a combination of the two.
A favorable or unfavorable revenue variance occurs if the actual selling price is greater or less than the budgeted selling price, respectively. For example, if a small business estimates that it will sell 1,000 units at $20 each, but sells them at $22 each, there is a favorable revenue variance of $2 per unit and a total revenue variance of $2,000–$2 multiplied by 1,000.
A favorable or unfavorable revenue variance also occurs if the actual sales volume is greater or less than the budgeted sales volume, respectively. For example, if the budgeted volume is 1,000 units at $10 each, but the actual volume is 1,100 units, there is a favorable revenue variance of $1,000–$10 multiplied by 100. Management needs to anticipate demand correctly, because it affects profitability.
A company’s revenue variance may affect its profit and cash flow. However, profits also depend on other factors, such as raw material costs, salaries and marketing expenses. If a favorable revenue variance coincides with higher expenses, it could indicate a loss. Conversely, if an unfavorable revenue variance coincides with lower expenses, it could indicate a profit.
Revenue, cost and other variances factor into the budget preparation process. For example, if the revenue variance this year was due to aggressive price discounting and a small business expects this trend to continue, management could adjust the product mix or look for ways to reduce input costs to achieve profit targets.
There are many reasons why revenue variances occur, including the following:
- Cannibalization. A new product generates sales at the expense of an older product.
- Competition. Competitors may have introduced products at attractive points that have similar or better features than the company’s own products.
- Price changes. A price increase could dramatically reduce the number of units sold, while a price reduction may have the reverse effect.
All three of these variances can be used to develop insights into the reasons why actual sales differ from expectations.