Sales volume variance quantifies the increase or decrease in profit due to a difference between the actual number of units sold and the budgeted number of units sold.
In cost and management accounting, a variance is a difference between the actual cost/revenue and standard cost/revenue.
The formula for calculating sales volume variance is as follows:
(Actual sales quantity – Budgeted sales quantity) X Standard profit per unit
(Actual sales quantity – Budgeted sales quantity) X Standard contribution per unit
Standard profit is used when absorption costing is used and the profit equals contribution per unit less fixed cost per unit. In marginal costing, standard contribution per unit is used and is calculated by deducting variable costs from the selling price.
Variance analysis is a crucial part of cost and management accounting and helps in keeping costs under control. At the end of each year, companies prepare their master budgets or financial plans.
These are made based on the maximum profitability of the business and the demand for the commodity expected. The company then follows in the footsteps of the budget in order to keep the costs in check and to earn maximum revenue.
In the end, variance analysis is prepared which compares the budget and the actual financial position of the business. The variances help the entities analyze how costs can be reduced or revenues can be increased for the benefit of the company.
For the sales budget, the sales department prepares a sales budget which notifies the management of how much demand or sales is expected in the coming year and at what selling price.
However, due to numerous reasons the selling price or demand for the commodity might vary. In order to calculate this variation in profitability, the sales volume variance is calculated.
The change in profitability due to a change in selling price is accounted for through the sales price variance while the sales volume variance unravels how the difference in budgeted quantity and actual quantity has affected the business/profitability.
The variance can be of two types; a favorable variance and an adverse variance. When variance is having a positive impact on the profitability of the business, it is referred to as a favorable variance (F).
This happens when the actual cost is less than the budgeted cost or when the actual revenue is greater than the budgeted revenue.
The reasons for a favorable sales volume variance would be a higher quantity of actual units sold than the budgeted units of sales. The reasons for an increase in demand might be:
- Seasonal demand
- Decrease in price
- Decrease in price of complementary goods
Similarly, an adverse variance (A) is when the difference between budgeted and actual cost/revenue has a negative impact on the business. An adverse sales volume variance would be an outcome of a lower number of units sold than what was expected.
This would obviously result in lower profitability than what was expected by the company. Some reasons for a reduction in a number of units demanded or sold might be:
- Reduction in quality of goods
- Increase in price
- Decrease in price of substitute good
For example, Mintea and Co. is a company that sells tea leaves and is one of the most profitable companies in town.
It had expected annual sales of 600,000 packs of tea leave for the year 2019 but ended up selling 650,000 due to a decrease in prices of milk. The standard profit per pack of tea leaves is $5. Calculate the sales volume variance.
Sale volume variance = (Actual sales – Budgeted Sales) x Standard profit per unit
Sales volume variance for Mintea would be of $250,000.
(650,000 – 600,000) x 5 = $250,000 (F)
The sales volume variance is a favorable variance since the net profit of company has increased by $250,000 than what was expected.