How do you identify and fix performance gaps with variance analysis?

1 What is variance analysis?

Variance analysis is a process of calculating and interpreting the differences between actual and budgeted figures for a specific period. There are two types of variances: favorable and unfavorable. A favorable variance means that the actual result is better than the budgeted result, such as higher revenue or lower expenses. An unfavorable variance means that the actual result is worse than the budgeted result, such as lower revenue or higher expenses. Variance analysis helps you evaluate the performance of your business units, projects, products, or departments, and identify areas of improvement or corrective actions.

2 How to calculate variances?

To calculate variances, you need to have both actual and budgeted data for the same period and level of detail. You can use a simple formula to calculate the variance for each line item:

Variance = Actual - Budgeted

You can also express the variance as a percentage of the budgeted amount, which can help you compare the relative magnitude of the variances across different line items:

Variance percentage = (Actual - Budgeted) / Budgeted * 100%

For example, if your actual sales revenue for the month was $12,000 and your budgeted sales revenue was $10,000, your variance would be:

Variance = $12,000 - $10,000 = $2,000 (favorable)

Variance percentage = ($12,000 - $10,000) / $10,000 * 100% = 20% (favorable)

3 How to analyze variances?

Calculating variances is only the first step of variance analysis. To understand why they occurred and what they mean for your business, you need to consider the size and direction of the variance, the frequency and trend of the variance, and the cause and effect of the variance. A large or unfavorable variance may indicate a significant problem or opportunity that requires attention, while a small or favorable variance may not be as important or may be due to normal fluctuations or random factors. A consistent or recurring variance may suggest a systematic issue or a change in the business environment that needs to be addressed, whereas a one-time or isolated variance may not be as relevant or may be due to an exceptional event or a timing difference. Additionally, variances can have different causes, such as changes in market conditions, customer behavior, product mix, pricing, costs, quality, efficiency, or errors. Furthermore, they can also have different effects on profitability, cash flow, customer satisfaction, and competitive advantage. You should identify the root causes and consequences of the variances to determine whether they are controllable or uncontrollable and whether they are favorable or unfavorable in the long run.

4 How to report variances?

Reporting variances is a way of communicating the results of your variance analysis to your stakeholders, such as managers, investors, or customers. You can use various formats and tools, such as tables, charts, dashboards, or narratives. When reporting variances, it's important to include a summary of the main variances and their implications for business goals and objectives. Additionally, you should provide a breakdown of the variances by line item, category, or segment with actual, budgeted, and variance amounts and percentages. Furthermore, you should explain the reasons and factors behind the variances and highlight the controllable and uncontrollable causes as well as favorable and unfavorable effects. Lastly, you should provide a recommendation of the actions or adjustments that need to be taken to address the variances. These could include revising the budget, changing the strategy, improving operations, or correcting errors.

5 How to use variance analysis to improve your budgeting and forecasting process?

Variance analysis is not only a tool for measuring and reporting performance, but also a tool for learning and improving your budgeting and forecasting process. By comparing the actual and budgeted results, you can gain valuable insights into your business operations, market conditions, customer preferences, and competitive landscape. These insights can be used to validate or revise assumptions and expectations, identify and correct errors or biases, adjust the budget and forecast to reflect changes in the business environment or strategy, enhance the methodology, data, and tools to make them more realistic, reliable, and flexible. Additionally, variance analysis can help to align the budget and forecast with your business goals and objectives, while monitoring progress and performance.

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?