What are Profit Variances?

Profit variance is the difference between the actual profit experienced and the budgeted profit level. It is calculated by subtracting the budgeted profit from the actual profit. The variance is considered to be favorable if the actual profit is greater than the budgeted amount. The variance is considered to be unfavorable if the actual profit is lower than the budgeted amount. For example, a company budgets for $50,000 of net profits. Actual net profits are $60,000. This is a favorable variance of $10,000.

There are four types of profit variance, which are derived from different parts of the income statement. They are noted below.

Gross Profit Variance

The gross profit variance measures the ability of a business to generate a profit from its sales and manufacturing capabilities, including all fixed and variable production expenses. This variance can arise due to several factors, including:

Sales volume variance. Changes in the quantity of goods sold compared to the budgeted amount.
Sales price variance. Differences between the actual selling price and the expected selling price.
Cost variance. Variations in the cost of goods sold (COGS), such as raw material costs, labor, or overheads, compared to the budgeted costs.

Contribution Margin Variance

The contribution margin variance is the same as the gross profit variance, except that fixed production costs are excluded. The variance can be broken down into two primary factors:

Sales volume variance. This measures the impact of selling more or fewer units than expected. If actual sales exceed the budgeted sales, the contribution margin tends to be higher, and vice versa.
Contribution margin per unit variance. This reflects changes in the contribution margin per unit, which could be due to:
- A shift in the sales mix (selling more of higher- or lower-margin products).
- Changes in variable costs (e.g., material or labor cost increases).
- Variations in selling prices.

Operating Profit Variance

The operating profit variance only measures the results of operations; it excludes all financing and extraneous gains and losses. This variance provides the best view of how the core operations of a business are functioning. It can arise due to differences in various factors, such as:

Sales price variance. The impact of actual selling prices being higher or lower than expected.
Sales volume variance. The effect of selling more or fewer units than planned.
Cost of goods sold variance. Variances in the cost of materials, labor, or overhead used in producing goods or services.
Operating expense variance. Differences in fixed and variable operating costs (e.g., administrative, selling, or marketing expenses).

Net Profit Variance

The net profit variance is the most commonly-used version of the profit variance. It encompasses all aspects of a company's financial results, without exception. Factors contributing to this variance include the following: