Why is variance analysis important to management

Variance analysis is used to assess the price and quantity of materials, labour and overhead costs. These numbers are reported to management. More importantly, variance analysis plays a significant role in decision-making and how managers approach tasks and projects. When performed correctly and consistently, it can help to keep teams on the right path to achieve long-term business goals.

However, many businesses fail to reap the benefits of variance analysis because it has to be performed consistently and promptly to work. To accurately forecast future revenue or costs, it is necessary to have organised data from history. This calls for automation solutions such as SolveXia that can store all data in a centralised location and can automatically be pulled, manipulated and transformed into insights for decision-making. When your financial team is being pulled in so many directions and spends time on low-value time-consuming data entry and repetitive tasks, then variance analysis can easily fall by the wayside.

To determine how and why this happened, it requires further variance analysis to understand if the difference came from price changes or a difference in the quantity of materials being used.

Maybe it is a growing trend or a one-off event. It could also be erroneous data entry. For accurate variance analysis, data must be correct to reflect what happened. With automation, you will be able to quickly link up all your data systems and compare historical data with current data without human interference and the system will highlight what has since changed allowing the business to find the source of the issue fast and understand quickly if it is a cause for concern, or if there is a risk or opportunity in the business.

Not every organisation will focus on the same variance calculations. Depending on your service line and business goals, you will choose what variance analysis makes the most sense to track to ensure you are maximising efficiency and minimising costs. From all we know, there is a lot in favour of using variance analysis to help control business and manage finances well.

The proper use of variance analysis is a significant tool for an organization to reach its long-term goals. Managers sometimes focus only on making numbers for the current period. A recognizable cost variance could be an increase in repair costs as a percentage of sales on an increasing basis. This variance could indicate that equipment is not operating efficiently and is increasing overall cost. However, the expense of implementing new, more efficient equipment might be higher than repairing the current equipment.

In the short term, it might be more economical to repair the outdated equipment, but in the long term, purchasing more efficient equipment would help the organization reach its goal of eco-friendly manufacturing. Management can use standard costs to prepare the budget for the upcoming period, using the past information to possibly make changes to production elements.

Standard costs are a measurement tool and can thus be used to evaluate performance. To reduce this possibility, performance should be measured on multiple outcomes, not simply on standard cost variances. As shown in Figure , standard costs have pros and cons to consider when using them in the decision-making and evaluation processes. Standard costing provides many benefits and challenges, and a thorough analysis of each variance and the possible unfavorable or favorable outcomes is required to set future expectations and adjust current production goals.

The following is a summary of all direct materials variances Figure , direct labor variances Figure , and overhead variances Figure presented as both formulas and tree diagrams. Note that for some of the formulas, there are two presentations of the same formula, for example, there are two presentations of the direct materials price variance.

While both arrive at the same answer, students usually prefer one formula structure over the other. Direct Labor Variances. Production Barley, Inc. For the month of October, the following information was gathered related to production:.

An unfavorable materials price variance occurred because the actual cost of materials was greater than the expected or standard cost. This could occur if a higher-quality material was purchased or the suppliers raised their prices. An unfavorable materials quantity variance occurred because the pounds of materials used were greater than the pounds expected to be used.

This could occur if there were inefficiencies in production or the quality of the materials was such that more needed to be used to meet safety or other standards. A favorable labor rate variance occurred because the rate paid per hour was less than the rate expected to be paid standard per hour. This analysis is effective when the management reviews the variance on a trend line. Sudden changes in a month to month MoM variance are clearly visible. This analysis also requires investigation of these variances which helps the management to interpret as to why such variance or differences occurred.

Most of the companies are concerned with business planning and meeting their financial commitments. Ultimately all want growth. Accordingly, they analyze the variances between:. In case of companies which are project or program driven, the financial data are evaluated at key intervals such as month close, quarter end, etc.

For example, the month end reports can just provide quantitative data with respect to revenue and expenses or inventory levels. Correlations both positive and negative are critical in business planning. Thereby, revealing a positive correlation between 2 products.

Forecasting: Forecasting uses patterns of the past data for developing a theory about the future business performance. Variances are placed into the context which helps analysts in identifying factors.

Purchase price variance: Purchase Price Variance results when actual price which is paid for materials is different from the budgeted cost for such materials. It is usually used as a lagging indicator for quantifying the efficiency of the procurement function. Companies can suffer variances in actual performance due to several reasons. Sometimes, these reasons may be random or seasonal.

However, variance analysis allows companies to adjust for these variances and allows a better performance analysis. Similarly, variance analysis allows companies to consider material variances only.

During the process, companies can set a threshold for the difference that they want to investigate. If any variance does not meet this threshold, companies can ignore that. This way, the process is much straightforward. Variance analysis takes a budget and compares actual performances with it.

It also allows companies to examine their budgets for any unrealistic expectations. This way, companies can identify any problems with their forecasts and rectify them for the future.

Most of the time, however, variance analysis catches operational inefficiencies. It is one of the reasons why companies use it. Operational anomalies are common in every business environment. By identifying these, companies can uncover any problematic areas within their process and correct any errors. As mentioned, companies may focus on variance analysis toward specific areas.

This way, variance analysis can allow companies to hold their managers accountable for their performance.