Last editedSep 20212 min read
For businesses small and large, it’s important to keep track of your organisation’s financial health with various key metrics. Through data analytics methods, you can get a better idea of your performance and how business decisions may need to be amended in order to produce the best results.
This is where analysis of variance comes in. This vital metric is a way to compare planned budgets to the actual numbers, and so indicates whether you are underperforming or over performing compared to your estimates. Read on to find more about how you can calculate budget variance analysis and the significance of this to your business model.
What is variance analysis?
In short, variance analysis is a way that you can assess the difference between estimated budgets and the actual numbers. For example, if you plan for a total of £50,000 sales in your budget but the actual sales are £45,000, then the variance analysis will give a difference of £5000. These figures can also be plotted on a trend line, which can give you an indication of the overall direction of your business. If you see that the numbers are increasingly lower than predicted, then it’s a sign you may need to rethink your business strategies.
There are multiple kinds of analysis of variance. This means that there is not just one simple variance analysis formula, but rather a number of different calculations that work together to provide a full picture of performance. These include, but are not limited to:
Labour rate variance, which is calculated by taking the actual price for direct labour in production, minus standard cost and multiplied by the number of units.
Selling price variance. This is calculated by taking the actual selling price, minus the planned selling price and multiplying by the number of units sold.
Material yield variance, calculated by subtracting the total standard quantity of materials that were supposed to be used from the total used and multiplied by the standard price per unit.
Purchase price variance, which is calculated from the actual price paid for materials, minus standard cost and multiplied by the number of units used.
As you can see, there are many variance analysis formulae, and a clear picture of your financial health can be worked out using a combination of calculations.
The importance of variance analysis
Now that you have a better idea of what variance analysis in accounting is – why is it important? Well, it can inform your business strategy in a number of different areas. Firstly, it can allow managers to create better informed plans and make more accurate budgets that reflect the real numbers. In addition, it gives you a better idea of how to manage different departments and how much budget to allocate to each.
Another important consideration is that analysis of variance can give you insights into the future trajectory of your company. When comparing budget variance analysis over a time period, you can get a better idea of which direction you are moving in and whether you need to make any adjustments to correct this.
Difficulties with variance analysis
While it may be an essential metric, many organisations struggle to use budget variance analysis correctly. These include:
Issues with creating accurate estimates. Given that variance analysis is based on projected figures, there is a possibility for large variance when poor estimates are made. For example, if overly optimistic estimates are made, variance analysis could suggest poor performance, even if the company is actually producing significant revenue.
As variance is calculated at the end of a month, sometimes the results are not quick enough to provide meaningful feedback. Sometimes problems occur within the space of a week, and so other measures are necessary to detect these.
The source of data used for the variance analysis formula may be spread across various locations, such as bills, invoices and other accounting records. This makes for a longer overall process.
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