How can variance analysis improve your decision-making?

1 What is variance analysis?

Variance analysis is the process of calculating and explaining the differences between your actual and budgeted financial figures. These differences are called variances and they can be favorable or unfavorable, depending on whether they increase or decrease your profits or cash flows. For example, if your actual sales are higher than your budgeted sales, you have a favorable sales variance. If your actual costs are lower than your budgeted costs, you have a favorable cost variance. On the other hand, if your actual sales are lower than your budgeted sales, you have an unfavorable sales variance. If your actual costs are higher than your budgeted costs, you have an unfavorable cost variance.

2 Why is variance analysis important?

Variance analysis is important because it helps you understand the performance of your business and the factors that influence it. By analyzing the variances, you can identify the strengths and weaknesses of your operations, the opportunities and threats in your environment, and the risks and uncertainties in your assumptions. You can also evaluate the effectiveness of your planning and budgeting process, the accuracy of your forecasts, and the efficiency of your resource allocation. Moreover, you can use variance analysis to communicate your results to your stakeholders, such as managers, investors, or lenders, and justify your actions or recommendations.

3 How to perform variance analysis?

In order to perform variance analysis, you must first prepare your actual and budgeted financial statements, such as income statement, balance sheet, or cash flow statement. After calculating the variances for each line item by subtracting the budgeted amount from the actual amount, you can then classify them as favorable or unfavorable. To further analyze the variances, you should break them down into smaller components and find their root causes. For instance, you can use sales volume variance and sales price variance to explain the sales variance, or material usage variance and material price variance to explain the material cost variance. Report the variances by displaying them in a summary table or a graphical format, emphasizing any significant or unusual ones and explaining their reasons and implications. Lastly, take action based on the variances by revising your plans or budgets, implementing corrective or preventive measures, or exploiting new opportunities.

4 What are the benefits of variance analysis?

Variance analysis can provide you with many benefits, such as improving your decision-making by giving you timely and relevant information about your performance. It can also enhance your learning by allowing you to compare actual results with expected ones and evaluate your progress. Moreover, it increases accountability by enabling you to monitor and control activities and outcomes, while stimulating creativity by encouraging you to look for new ways to improve efficiency and effectiveness. Finally, variance analysis can motivate your team by setting clear and realistic goals and providing feedback and recognition.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?