Favorable variances occur when the actual performance of a business is better than what was budgeted, leading to an increase in operating income. Specifically, if costs are lower than expected or revenues are higher, this can be classified as a favorable variance, as it positively impacts the overall financial performance.
The concept of operating income being higher than budgeted aligns with what a favorable variance indicates: for example, if sales revenue exceeded expectations, or production costs were reduced significantly, the resulting effect would be increased profitability, thus culminating in higher operating income.
Understanding this concept is essential, as it helps management interpret financial data effectively, allowing them to make informed decisions based on the performance relative to the budget. In contrast, other statements might imply misinterpretations of variances or suggest actions that would not contribute to effective financial analysis.