What Is Variance Analysis? Budget vs. Actual for Small Businesses

Variance analysis compares what you planned to spend or earn with what actually happened, and splits the difference into its causes. A variance is favorable when you spent or used less than planned, and unfavorable when you spent or used more. Splitting a cost variance into a price part and a quantity part shows whether you paid more per unit, used more units, or both.

Billed publishes this page. Definitions and formulas are quoted from the open textbook OpenStax Principles of Accounting, Volume 2: Managerial Accounting, opened on October 29, 2026. For setting standards and budgets in your business, ask your accountant.

Variances, favorable and unfavorable

OpenStax defines the terms (OpenStax 8.1):

• Standard cost: a "cost expectation for price paid and amount (quantities) used", in the words of the chapter's key terms.
• Variance: "A variance is the difference between a standard cost and actual performance."
• Favorable: "A favorable variance involves spending less, or using less, than the anticipated or estimated standard."
• Unfavorable: "An unfavorable variance involves spending more, or using more, than the anticipated or estimated standard."

Static and flexible budgets

Comparing actual results with the budget you set at the start of the year can mislead if your volume changed. OpenStax explains (OpenStax 7.4):

• "A static budget is one that is prepared based on a single level of output for a given period."
• Comparing actual results with it "may be like comparing apples to oranges because variable costs should follow production, which should follow sales."
• "A flexible budget is one based on different volumes of sales."

So compare actual costs with what the budget allows for the volume you actually produced or sold.

The four cost variances

From OpenStax's formulas for direct materials (OpenStax 8.2) and direct labor (OpenStax 8.3):

• Direct materials price variance = (actual price per unit − standard price per unit) × actual quantity purchased
• Direct materials quantity variance = (actual quantity used − standard quantity for the units produced) × standard price
• Direct labor rate variance = (actual rate per hour − standard rate per hour) × actual hours worked
• Direct labor time variance = (actual hours worked − standard hours for the units produced) × standard rate per hour

With these formulas, a positive result is unfavorable and a negative result is favorable. The price and quantity variances add up to the total variance: actual cost minus the standard cost of the units produced.

Worked example (sample figures)

A sample bakery, invented for this example, made 1,000 loaves in May. Its standards for each loaf are 0.5 lb of flour at $0.80 per lb, and 0.1 labor hours at $20.00 per hour. In May it bought and used 540 lb of flour at $0.75 per lb, and its staff worked 95 hours at $21.00 per hour.

Standard quantities for the 1,000 loaves:

• Flour: 1,000 × 0.5 lb = 500 lb
• Labor: 1,000 × 0.1 hours = 100 hours

Flour:

• Price variance: ($0.75 − $0.80) × 540 lb = −$27.00, so $27.00 favorable.
• Quantity variance: (540 lb − 500 lb) × $0.80 = $32.00 unfavorable.
• Total: actual cost 540 × $0.75 = $405.00, minus standard cost 500 × $0.80 = $400.00, is $5.00 unfavorable. The check: $32.00 − $27.00 = $5.00.

Labor:

• Rate variance: ($21.00 − $20.00) × 95 hours = $95.00 unfavorable.
• Time variance: (95 − 100) × $20.00 = −$100.00, so $100.00 favorable.
• Total: actual cost 95 × $21.00 = $1,995.00, minus standard cost 100 × $20.00 = $2,000.00, is −$5.00, so $5.00 favorable. The check: $100.00 − $95.00 = $5.00.

The totals are small, but the parts aren't. The bakery paid less per pound of flour and used more of it, and it paid more per hour and needed fewer hours. OpenStax notes that variances can be linked: "a favorable material price variance could cause an unfavorable labor efficiency variance and an unfavorable material quantity variance." Here, the owner would ask whether the cheaper flour led to more waste, and whether the higher-paid staff worked faster.

Explaining the variances

OpenStax says managers should explain both kinds (OpenStax 8.5):

• "Requiring managers to determine what caused unfavorable variances forces them to identify potential problem areas or consider if the variance was a one-time occurrence."
• "Requiring managers to explain favorable variances allows them to assess whether the favorable variance is sustainable."

Where Billed fits

Variance analysis needs your actual figures. Billed's expense tracking page says: "The expense report shows what you spent over a date range, and the income vs expense report compares income with expenses so you can see how profitable the business is." It adds that "Reports can be filtered by date range and exported for your accountant, bookkeeper or tax software."

When this guide isn't for you

This page covers the textbook direct materials and direct labor variances and the idea of a flexible budget. Overhead variances, sales mix and volume variances, and setting standards for your business call for your accountant's judgment.

Related Articles

• What Is Zero-Based Budgeting?
• What Is Cost Accounting?
• What Is Overhead Cost?
• What Is Contribution Margin?
• Understanding Budgets and How to Create One

Frequently Asked Questions

What is a favorable and an unfavorable variance?

A favorable variance means you spent or used less than the standard or budget. An unfavorable variance means spending more, or using more. In this page's sample, paying $0.75 per pound of flour instead of the $0.80 standard gave a $27.00 favorable price variance.

How do you calculate a materials price variance?

Subtract the standard price per unit from the actual price per unit and multiply by the actual quantity purchased. In the sample, ($0.75 − $0.80) × 540 lb = −$27.00, which is $27.00 favorable.

What is the difference between a static and a flexible budget?

A static budget is prepared for a single level of output. A flexible budget is based on different volumes of sales, so you can compare actual costs with what the budget allows at the volume you actually reached.

Should I investigate favorable variances too?

OpenStax says explaining favorable variances lets managers assess whether they're sustainable, while explaining unfavorable ones helps identify problem areas or one-time events. In the sample, cheaper flour came with more flour used, so the favorable price variance needed a closer look.