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How To Calculate Variance

Variance is a term that refers to the difference between planned or predicted outcomes and behaviour and the actual reality of them. In business terms, calculating variance using a formula and then analysing the results can help you investigate the aspects of that business underperforming. 

If your business was expected to bring in £20,000 in sales during a specific accounting period but only actually generated £17,000, then any variance analysis will identify a difference of £3,000. In addition, any variance analysis will be used to try to identify the reasons for this shortfall occurring. 

What a variance analysis could reveal

In the example given above, a business that has identified a variance of £3,000 might carry out an analysis of variance that identifies the loss of a key customer during the month leading up to the period in question. The benefit of thorough variance analysis is that it makes it possible to discover the direct cause of the sales being lower than predicted and also the underlying reasons. 

In this case, for example, the person investigating the variance might find out that the customer had been dissatisfied with previous purchases, and their issues hadn’t been dealt with, convincing them to look elsewhere.         

A detailed variance analysis of this kind, therefore, will enable the management of a company to understand why a figure such as net income from sales fluctuates from time to time, and what the business can do to deal with that fluctuation.  

Different areas that might be covered by variance analysis

Multiple aspects of a business can be understood and evaluated through the lens of variance analysis. Those aspects of running a business that are most likely to be subject to variance analysis include the following: 

Purchase price – variance calculated by taking the price that has been paid for any materials used in production, subtracting the standard cost and multiplying the result by the number of units involved.   

Workforce costs – variance calculated by taking the price that has been paid for the labour involved in any production process, subtracting the standard cost and multiplying the result by the number of employees involved.  

Variable overheads – variance calculated by subtracting the standard overhead cost per unit from the actual cost incurred and multiplying this figure by the total units of output generated. 

Fixed overheads – this variance for fixed overheads is calculated by taking the cost of fixed overheads during the period being analysed and discovering how much these costs have exceeded the total standard cost over that period. 

Selling price – the variance is calculated by subtracting the actual selling price achieved from the standard selling price, and multiplying the figure arrived at by the number of units that have been sold. 

Knowing which variance figures matter

The vast majority of companies won’t have to calculate or monitor each of the types of variance outlined above. In fact, for many, only one or two variances will be strictly relevant to their business model. A manufacturer, for example, might choose to concentrate on the purchase price variance analysis as it has a direct and clear impact on the overall performance of the business, and in particular, the profits generated.  

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If you’re interested in finding out more about variance, or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.

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